‘Adverse’ tax risks for SMSFs in newer finance options
With greater numbers of SMSFs turning to related party loans or opting to settle without a loan due to tighter lending restrictions, a technical expert has highlighted some potential traps that can arise.
SuperConcepts executive manager of SMSF technical services Mark Ellem said with lenders withdrawing from the SMSF loans space and tightening up on valuations, loan-to-value ratios and minimum loan amounts, many SMSFs are hitting a brick wall when attempting to obtain finance.
There are also banks pulling out of SMSF lending entirely, he said, with Westpac Group exiting SMSF lending across all of its brands including St George at the end of July.
Macquarie made pricing changes to its SMSF loans in July, announcing a 0.10 per cent increase in variable rates across its investment and SMSF loans.
AMP also announced pricing in July and removed interest only payments as a payment option for new loans.
Mr Ellem said he has recently seen valuations from lenders fall $90,000 below the purchase price.
“Generally, a value more than 10% below purchase price will see the loan application fail,” he warned.
Low to value ratios are another hindrance, he said, with some dropping as low as 50 per cent.
Mr Ellem said failure to obtain finance is particularly problematic where the SMSF has already entered into an LRBA and signed a contract as this leaves the SMSF trustee with only a few options.
SMSF practitioners and their clients should first check to see if the purchase contract contains a “subject to finance at purchaser’s choice” clause and obtain legal advice on this before executing the contract.
“This may give [the client] the option to withdraw from the contract. It’s best to seek legal advice if you believe the fund cannot settle due to being unable to obtain finance,” he said.
Some SMSFs in this situation are turning to related party loans where they have the ability to borrow against non-super assets and lend to their SMSF, he said.
Mr Ellem reminded practitioners that the SMSF in this case will need to comply with the related party lender safe harbour rules or have evidence that the loan is on commercial terms.
Other SMSFs may decide to settle on the property with a loan where they have sufficient monies to settle without the need for finance, he said.
SMSFs need to be careful doing this where the purchase has been done via an LRBA, he warned.
“Under an LRBA, the SMSF invests in a related trust, a bare trust, and therefore, prima facie, an LRBA is in-house asset,” he explained.
“However, the regulator has effectively exempted an LRBA from being considered an in-house asset, provided the LRBA is used for its intended purpose. If not, and there is no actual money borrowed as part of the LRBA, the exemption does not apply and the LRBA is treated as an in-house asset.”
Consequently, where the SMSF can settle on the purchase of a property without the need for finance, but the contract has been entered into under an LRBA, the SMSF may want to consider a small related party loan, he explained.
“There would also be the option of rescinding the original contract and executing a new contract in the name of the SMSF’s trustee. However, this requires extreme care and depends on the state jurisdiction. Consultation with a lawyer would be advised to ensure no adverse stamp duty outcomes,” he said.
“When it comes to LRBAs, whilst it is important to ensure all the requirements under the law are satisfied, in my experience it’s equally important to focus on where the funding will come from. With more lenders withdrawing from this space, this may be easier said than done.”