Limited Recourse Borrowing to again become a financial product

As we move closer to the implementation of industry reforms regarding the provision of financial advice, Treasury last week has added to the pile with the re-issuing of draft Corporations Amendment Regulations to provide that limited recourse borrowing arrangements as allowed under superannuation law are financial products.

These reforms were previously announced back in March 2010, with industry consultation in June of that year.  In light of the submissions previously made, Treasury has substantially revised these draft Regulations.  However, it remains a clear policy objective of Government to move these type of borrowing arrangements into the financial consumer protection framework as there continues to be concerns of targeted activity and inappropriate advice to acquire property using borrowings.

Under these Corporations Act 2001, those providing advice in respect to the limited recourse borrowing arrangement established in accordance with s67A and s67B will be required to have an Australian Financial Services License (AFSL).  For those simply providing credit facilities, they are not caught by these regulations.

To be able to provide advice in this area, an AFSL that allows for advice on derivatives or securities meets the requirements to also cover limited recourse borrowing arrangements.  This poses an interesting question for many accountants considering their licensing options with the proposed ‘conditional license’ to be implemented to allow for advice likely to be under a ‘class-of-product’.  All of the current limited licence solutions won’t provide for them to deal in securities unless they met additional competency requirements of the AFSL holder (and paid the additional licensing cost as well).

Who issues the financial product?

A previous confusion of the regulations related to the issuer of the limited recourse borrowing arrangement.  As a borrowing arrangement involves numerous parties, it is difficult to determine which party is the “issuer”, or when the product is “issued”.  These concerns posed difficulties for Government and the industry in determining which party, if any, is obliged to disclose information required under the corporations legislation.

These changes now clarify that the limited recourse borrowing arrangement is “issued” when a person enters into a legal relationship that sets up the arrangement and that each party to the arrangement is an “issuer” of the product.  It is unclear from these regulations whether related party lenders get caught under these arrangements as an issuer of a financial product?

When do these changes commence?

These proposed regulations would take effect three months after the legislative instrument was exercised by Government.

As we close in on the two-year review period proposed by the Cooper Review with limited recourse borrowings, in my view the Government can only start the clock ticking once these laws take effect.  With:

  • changes to the definition of limited recourse borrowing arrangements from 7 July 2010,
  • details of the final ruling SMSFR 2011/D1 expected in May 2012, and
  • changes to make these arrangements financial products

surely the Government’s assessment to date would be baseless? or maybe… just maybe once resolved, consumers and advisers alike will have a framework in which to work with moving forward!!  Let’s hope so.

Read the details of the Treasury Exposure draft.

Can you be remunerated as a Fund Trustee?

You simply can't grab money to act in the capacity of trustee for your SMSF.

One of the conditions of meeting the definition of a Self Managed Super Fund is that trustees cannot be remunerated for their services.

There is a need however to distinguish between services that may be provided  as a trustee for which no remuneration can be provided, against services provided by an individual but not in their capacity as a fund trustee/director.  An example of this is a builder who renovates a property owned by a SMSF where he is the trustee or director of a corporate trustee.

Clarification of this issue has been long overdue, and finally we have seen the ATO through TIES (Tax Issues Entry System) escalate this issue with Treasury to add certainty to the interpretation contained within superannuation law (SIS Act).  Tax Laws Amendment (2011 Measures No. 9) Bill 2011, has been introduced to clarifies that the prohibition on the remuneration of trustees and directors of a corporate trustee of the fund applies only to duties or services performed in:

  • the capacity of trustee or in the capacity of  corporate trustee director; and 
  • connection with the body corporate’s capacity of trustee.

Section 17B will be inserted into the SIS Act, which will place certain restrictions on trustee remuneration for non-trustee duties and services.  The purpose of these restrictions is to ensure that trustee remuneration is not used by trustees to obtain access to their superannuation benefits before they are eligible.

What can trustees/directors be remunerated for?

Trustees and directors may be remunerated for non-trustee duties or services, provided that:

  • they are appropriately qualified and licensed to perform the duties or services;
  • the duties or services are performed as part of a business through which the trustee or director provides the same services to the public; and
  • the remuneration is on an arm’s length basis.

When does this take effect?

Subsection 17B(1), which applies to remuneration of trustees, applies from 8 October 1999 because this is when paragraphs 17A(1)(f) and (2)(c) were inserted.   Subsection 17B(2), which applies to the remuneration of a director of a body corporate that is trustee of the fund, applies to the 2007-08 income year and later income years because those are the income years to which paragraphs 17A(1)(g) and (2)(d) apply.

Replacing assets using limited recourse borrowings affected by natural disasters

The ATO will exercise its discretion to allow for disaster-affected properties within SMSFs using borrowings to be replaced

It was pleasing to read recently in Investor Daily recently (23 March 2011) the Australian Taxation Office saying that it will use its discretionary powers to provide relief for SMSF trustees with limited recourse borrowing arrangements affected by the recent spate of natural disasters.

According to the article, the Tax Commissioner, Michael D’Ascenzo will use powers provided to him under the Superannuation Industry (Supervision) Act (SIS Act) to allow SMSF trustees to use limited recourse borrowings to repair the fund asset damaged by the disaster in question.

In many instances the type of repairs that are needed would normally be classified as an improvement to the asset or even a replacement asset.  As a result, the rebuilding of assets would be a breach of the requirements contained within section 67B of the SIS Act.

However, the Commissioner has indicated that he was willing to disregard breaches of the replacement asset rules contained within section 67B due to the extraordinary circumstances faced by some individuals.

“In financing repairs or incurring other costs, trustees may need to borrow funds and if trustees contravene the limited recourse borrowing provisions due to the natural disasters experienced Australia-wide, we would be favourably inclined to exercise the commissioner’s discretion under section 42A(5) of the Superannuation Industry (Supervision) Act 1993 to continue to treat the super fund as complying,” D’Ascenzo said.

“We are currently reviewing this matter with APRA (Australian Prudential Regulation Authority) and Treasury to ensure no unintended consequences arise.”

Whilst this is a logical and positive result for SMSF trustees affected by these natural disasters, it appears illogical as to why the replacement rules remain so restrictive to disallow somebody to replace a property that may have been burnt down in a fire?

Whilst discretion isn’t granted lightly by the Commissioner, I believe it does open the door ajar slightly for SMSF trustees to be able to ask for discretion to be applied in the future.

Reflecting on the year that was 2010…

Tis’ the season to reflect on what has been a big year for self-managed super funds and the financial services industry as a whole.

The year started with a bang, with Phase Three of the Super System Review on Structure including Self Managed Super Funds.  This phase of the review was arguably the most debated with industry funds and the retail sector pushing for mandatory education of trustees, amongst other things.  The statistical summary ordered by the Chair of the Review, Mr Jeremy Cooper seemed to lay to rest many of the myths around people abusing the privilege of an SMSF.  The final recommendations noted that the SMSF industry was robust and in fairly good shape.

With the final recommendations handed to government on 30 June 2010, the question remained when the government would look to action any of these recommendations (I say “any” instead of “many”, given the handling of the Henry Tax Review, where the government announced to implement 2 out of 138 recommendations).

It is good to see however, the industry and regulator starting to already address some of these key recommendations, including the introduction of the ATO member verification system to rollover monies from an APRA regulated fund.  We are also seeing industry recognition of the need to increase competency requirements for advisors, accountants and auditors within this specialist superannuation field (and hence my decision to create The SMSF Academy).

NB. Minister Shorten is expected to announce this week their response to the Super System Review recommendations.

From the Ripoll Enquiry came the announcement of the Future of Financial Advice reforms.  FoFA as it is now more commonly known, also integrated some of the key recommendations from the Cooper Review, including the removal of the Accountant’s Exemption.  The basis for these reforms are to improve the trust and confidence of investors (including SMSF trustees) in the financial planning sector, and are designed to tackle conflicts of interest that threaten the quality of financial advice provided.

This week has seen the first meeting of the advisory panel to tackle the FoFA reforms.  It will be interesting to see how much we actually hear on some of the key issues, with the panel members being asked to keep discussions strictly confidential.

It was pleasing to see recently a common sense approach by the Accounting Professional and Ethics Standards Board (APESB) to defer the introduction of APES230.  This standard was to impose fee-for-service only for financial planners that were members of a professional accounting body (CPA, ICAA, NIA) from 1 July 2011.  This has now been deferred, subject to the direction of FoFA.

Australia’s Future Tax System review, chaired by Dr Ken Henry turned into arguably the “fizzer of the year”.  From a super perspective though, the government announced some important reforms around a ‘fairer super system‘, including the progressive increase of super guarantee contributions to 12%.  The catch here of course for the super industry is we are never forever entwined with the resources sector and the super profits tax.

As a result of these key announcements, the Federal Budget was a low-key affair, with reiteration of the many announcements about a fairer super system the week before.

The year also saw a federal election.  Whilst there was no change to government, there was a promotion for the very well-regarded Minister Chris Bowen into the key portfolio of immigration from his superannuation and financial services post.  There was some trepidation about the appointment of former Secretary of the Australian Worker’s Union (AWU) and Australian Super (industry fund) director, Mr. Bill Shorten.  Time will ultimately dictate the legacy he leaves behind on the superannuation and financial services sector.

I commented earlier this year in a meeting with Jeremy Cooper, that 2010 was going to be the ‘year of the gear’ with SMSFs.  He tended to agree… Limited Recourse Borrowing inside a SMSF has certainly started to take hold, predominantly from two key factors,

  1. the reduction in the concessional contribution caps; and
  2. our country’s love affair with property.

The date, 7 July 2010 is now an important one as we saw the introduction of section 67A & B into the SIS Act, with s.67(4A) being repealed.  These changes have certainly had an impact on how these arrangement are now structured, with only a single acquirable asset being able to be held on trust.  The issue of personal guarantees was resolved with them now being allowed, and on a positive note, the ability to refinance will certainly make the lending market far more competitive.

I actually think 2011 will continue to be ‘gearing heaven’ for SMSFs and limited recourse borrowing arrangements.

In addition to the SIS Act changes to limited recourse borrowing, the government also announced reforms to make these arrangements a financial product and allow only those advisers with a derivatives license to be able to recommend such arrangements.  There were many submissions made to Treasury about concerns with the draft regulations, from professional bodies, banks and other financial services institutions and businesses.  When an election was called, this fell off the radar, but I suspect will resurface again into the new year.

The ATO continued to deliver more rulings and interpretive decisions in the area of SMSFs, including the issuing of:

  • TR2010/1 – super contributions,
  • SMSFR2010/2 – addressing the issues about remaining a SMSF through the appointment of an Enduring Power of Attorney; and
  • many ATOIDs covering limited recourse borrowing arrangements

Excess contributions tax continues to be the ‘white elephant in the room’ for government.  With the halving of the contribution caps last financial year, there is expected to be more than 100,000 excess contribution tax assessment notices issued by the ATO. for FY2010.  Lobbying on this issue to date appears to have fallen on deaf ears…

Personally, 2010 also presented a change in direction for me as I now focus on the delivery of The SMSF Academy to provide education and training to both trustees and advisors.  We are achieving small but significant milestones with its development, with the website to be up and running in mid-February 2011.  We intend to have our first monthly SMSF eCPD update in February 2011 as well.  Click here to register your interest to keep up to date with future developments.

A reminder that if you haven’t completed either or trustee or advisor surveys, then we encourage you to do so by 4pm this Friday.  The winner will  be announced next Monday.

2011 looks to be as exciting and challenging as 2010… I look forward to continuing to deliver my views and strategies regarding issues affecting SMSFs.

(C) The SMSF Academy 2012
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