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Tag: LRBA

  • Total superannuation balance and limited recourse borrowing arrangements: Part 1

    Total superannuation balance and limited recourse borrowing arrangements: Part 1

    If the Treasury Laws Amendment (2018 Superannuation Measures No. 1) Bill 2018 (‘Bill’) becomes law, an individual member’s total superannuation balance (‘TSB’) may be increased by their share of the outstanding balance of a limited recourse borrowing arrangement (‘LRBA’) that commenced on or after 1 July 2018. However, the increase only applies to members:

    who have satisfied a relevant condition of release with a nil cashing restriction, or

    whose superannuation interests are supported by assets that are subject to an LRBA between the superannuation fund and its associate (often referred to as a ‘related party’ in everyday conversation).

    This article (the first in a two-part series) examines the effect of the proposed law on members who have satisfied a relevant condition of release with a nil cashing restriction. For completeness, we note that the proposed law applies to both members of self managed superannuation funds (‘SMSFs’) and other funds with fewer than five members. For the purpose of this article series, we will focus on its application to SMSFs.

    Members satisfying a condition of release with nil cashing restrictions

    Under the proposed law, the relevant conditions of release with nil cashing restrictions are:

    • retirement;
    • terminal medical condition;
    • permanent incapacity; and
    • attaining age 65.

    Only members who satisfy the relevant condition of release with nil cashing restrictions will have their TSB increased. We illustrate this with an example.

    EXAMPLE 1

    Pierre and Samantha are the only members of their SMSF. The value of Pierre’s superannuation interests in the SMSF is $1 million. The value of Samantha’s superannuation interests is $500,000. The assets of the SMSF comprise of cash only.

    Pierre is 61 years old and has retired. Samantha is 54 years old and employed on a full-time basis. For completeness, she wishes to continue working until she attains age 65 years. Therefore, Pierre is the only one who has satisfied a condition of release with a nil cashing restriction.

    The SMSF acquires a $2.7 million property. The SMSF purchases the property using all of its cash (ie, $1.5 million) and borrows an additional $1.2 million from an unrelated third party lender using an LRBA.

    The SMSF now holds an asset worth $2.7 million (being the property). The SMSF also has a liability of $1.2 million under the LRBA.

    Of its own cash that it used, two-thirds ($1 million) was supporting Pierre’s superannuation interests and the other one-third ($500,000) was supporting Samantha’s interests. These proportions also reflect the extent to which the asset supports Pierre and Samantha’s superannuation interests.

    Pierre’s TSB is $1.8 million. This is comprised of the two-thirds share of the net value of the property (being $1 million) and the two-thirds share of the outstanding balance of the LRBA (being $800,000).

    Samantha’s TSB is $500,000. This is because she has not satisfied a condition of release with a nil cashing restriction. Accordingly, the one-third share of the outstanding balance of the LRBA (being $400,000) does not increase her TSB.

    The following are some key points to note from the above example.

    • An increase in the member’s TSB as a result of their share of the outstanding balance of an LRBA can create liquidity issues for the SMSF. Considering the above example, if Pierre’s TSB just before 1 July 2019 is $1.8 million (ie, greater than $1.6 million), this would prevent him from making any non-concessional contributions (‘NCCs’) without an excess in the financial year ending 30 June 2020. This may affect the SMSF’s ability to repay the LRBA.
    • An increase in the member’s TSB can also affect other superannuation rights and obligations.
    • Where the loan has not been repaid by the time that a member satisfies a relevant condition of release with nil cashing restriction, the member’s share of the outstanding balance of the LRBA will increase their TSB. Considering the above example, although the one-third share of the outstanding balance of the LRBA does not increase Samantha’s TSB, if she subsequently satisfies a relevant condition of release with nil cashing restriction (eg, retirement or attaining age 65 years) before the LRBA is repaid, her share of the outstanding balance of the LRBA will increase her TSB.

    Practical application

    LRBAs commenced pre-1 July 2018

    The proposed law does not apply to:

    • LRBAs that commenced before 1 July 2018; and
    • the refinancing of the outstanding balance of an LRBA that commenced before 1 July 2018.

    For these circumstances, a member’s TSB is unaffected by the proposed law.

    LRBAs commencing on or after 1 July 2018

    An SMSF trustee that is considering acquiring an asset via an LRBA should consider the potential effect of the proposed law on each member’s TSB where the members satisfy or are about to satisfy a relevant condition of release with a nil cashing restriction. For example, if a member is about to satisfy a condition of release with a nil cashing restriction because they have met preservation age and are about to enter into retirement for superannuation law purposes, the SMSF trustee may need to consider how the member’s TSB will be calculated if the proposed law comes into operation and upon the member entering into retirement for superannuation law purposes. The SMSF trustee may also consider whether there are any flow-on consequences, such as the member’s ability to make NCCs, which could affect the SMSF’s ability to repay the LRBA. Careful planning and forecasting may be necessary before an SMSF trustee can make an informed decision about whether to enter into an LRBA.

    Similarly, for any SMSF that has commenced an LRBA on or after 1 July 2018, the SMSF trustee should monitor and assess the effect that the proposed law has on each member’s TSB. If the member’s TSB is affected, the SMSF trustee may need to consider whether there are any strategies available to:

    manage the increase in the relevant member’s TSB that results from their share of the outstanding balance of an LRBA; and

    ensure that the LRBA can be repaid. For example, the repayment of an LRBA might be assisted by admitting additional members into the SMSF who have the ability to make NCCs. Naturally, the SMSF trustee should consider thoroughly the advantages and disadvantages of admitting additional members into an SMSF before making a decision.

    Before implementing any strategies, consideration should be given to determine whether the implementation of a certain strategy might trigger the application of the general anti-avoidance provisions such as Part IVA of the Income Tax Assessment Act 1936 (Cth).

    In relation to this aspect, we note that paragraph 4.24 of the Explanatory Memorandum to the Bill states:

    …artificially manipulating the allocation of assets that are subject to [LRBAs] against particular superannuation interests at a particular time may be subject to the general anti-avoidance rules in Part IVA of the ITAA 1936 where such allocations formed part of a scheme that had the dominant purpose of obtaining a tax benefit.

    (For a discussion on some general strategies to manage a member’s TSB, please refer to the following links:

    Strategies to reduce your total superannuation balance Part 1

    Strategies to reduce your total superannuation balance Part 2

    Strategies to reduce your total superannuation balance Part 3

    Conclusion

    As can be seen from the above, an SMSF trustee that is considering acquiring an asset via an LRBA should carefully plan and consider the potential effect of the proposed law on each member’s TSB where the members satisfy or are about to satisfy a relevant condition of release with a nil cashing restriction.

    The existing and proposed law in relation to TSB is a complex area of law and where in doubt, expert advice should be obtained. Naturally, for advisers, the Australian financial services licence under the Corporations Act 2001 (Cth) and tax advice obligations under the Tax Agent Services Act 2009 (Cth) need to be appropriately managed to ensure advice is appropriately and legally provided.

    Article written and provided to LT by Joseph Cheung, Lawyer and Bryce Figot, Special Counsel, DBA Lawyers

    For more information about SMSF please contact our SMSF Specialists

     

     

     

     

  • The new ipso facto regime and SMSFs

    The new ipso facto regime and SMSFs

    The new law pertaining to ‘ipso facto’ clauses came into operation on 1 July 2018. This article highlights the relevance of the new law for SMSFs. Note that the law in this area is complex and a detailed and careful analysis is required to properly understand how the new ‘ipso facto’ regime operates.

    Background: Purpose of the new law

    ‘Ipso facto’ is a Latin phrase that means ‘by the fact itself’. An ‘ipso facto’ clause is a provision in a contract that allows one party to terminate or modify the operation of a contract upon the occurrence of some specific event, regardless of otherwise continued performance of the counterparty. For example, in an insolvency context, a clause in a lease that allows one party to terminate the lease if the counterparty enters into external administration is an ‘ipso facto’ clause.

    For the counterparty that is affected by an insolvency or formal restructure process, some negative consequences of ‘ipso facto’ clauses include (but are not limited to) the following:

    • the ability to successfully restructure could be reduced; or
    • the market value of a business entering formal administration could be destroyed; or
    • the business could be prevented from being sold as a going concern.

    The introduction of the new law relating to ‘ipso facto’ clauses is part of the Federal government’s reform of Australia’s insolvency laws. This new law is aimed at enabling businesses to continue to trade in order to recover from an insolvency event.

    Summary of the new law

    Broadly, this new law applies to contracts entered into on or after 1 July 2018 and makes certain ‘ipso facto’ clauses that amend or terminate a contract unenforceable if the ‘ipso facto’ clause is triggered merely because:

    • the company is entering into administration (Corporations Act 2001 (Cth) (‘CA’) s 451E) ; or
    • a managing controller has been appointed over all or substantially all of a corporation’s property (CA s 434J); or
    • the company is applying for or undertaking a compromise or arrangement for the purpose of avoiding being wound up in insolvency (CA s 415D).

    Generally, where a triggering event under any of the abovementioned three categories occurs, there is a ‘stay on enforcing rights’. Please note that there is further detail in each relevant section of the CA, covering aspects such as the timing of the stay and the Court’s ability to extend the period of the stay. However, a detailed examination of these sections is beyond the scope and purpose of this article.

    Note also that there also exists exceptions to a ‘stay on enforcing rights’. We summarise these exceptions into four categories:

    • The right is a right under a contract, agreement or arrangement entered into after a triggering event.
    • The right is contained in a kind of contract, agreement or arrangement that is prescribed by the regulations or a kind declared by the Minister.
    • The right is a right of a kind declared by the Minister.
    • Certain parties (named in the CA) have consented in writing to the enforcement of the right.

    Where a party wishes to enforce their rights despite a stay, they can apply for a court order. Broadly, the Court may issue an order if the Court is satisfied that this is appropriate in the interests of justice. (Refer to the CA ss 415E, 434K, 451F for further details about the criteria that the Court considers before making an order).

    Despite the operation of a ‘stay on enforcing rights’, the new law does not prohibit the exercise of a right for any other reason. For example, where there is a breach involving non-payment or non-performance by one party, the counterparty party can pursue its legal rights.

    Relevance of the new law for SMSFs

    While the new law relating to ‘ipso facto’ clauses is not specifically targeted at SMSFs, it is relevant since there are an increasing number of SMSFs, especially SMSFs with corporate trustees, and these SMSFs often enter into various contracts that may contain ‘ipso facto’ clauses. The following are some common scenarios:

    • An SMSF owns business real property and leases it to either an unrelated third-party tenant or a related party tenant. A lease agreement is executed by the SMSF as lessor.
    • An SMSF invests by providing a loan to an unrelated third-party borrower. A loan agreement is executed by the SMSF as the lender.
    • An SMSF enters into a limited recourse borrowing arrangement (‘LRBA’) to purchase real property. The SMSF executes a loan agreement in its capacity as the borrower. The custodian/bare trustee company might also be included as party to the loan agreement.

    Naturally, there are many other scenarios where an SMSF may enter into a contract.

    In the first scenario, the lease may contain provisions stating that the lease agreement is terminated if the tenant enters into administration or the tenant fails to make a lease payment within a prescribed time period. Similarly, in the second scenario, the loan agreement may contain provisions stating that the loan agreement is terminated if the borrower enters into administration or the borrower fails to make a loan repayment within a prescribed time period. In both the first and second scenarios, the SMSF trustee may seek to rely on these provisions to terminate the agreement with the other party on the occurrence of a triggering event.

    In the third scenario, the LRBA documents may contain provisions stating that the loan agreement is terminated if a certain triggering events occur, such as if the SMSF trustee enters into administration or the SMSF trustee fails to make a loan repayment within a prescribed time period. In the third scenario, the third party may try to rely on the provisions against the SMSF trustee upon the occurrence of a triggering event. In all three scenarios, there may be other clauses that deal with the consequence of the termination. It is important for SMSF trustees and advisers to know whether such clauses can be relied upon if a certain triggering event occurs. In certain circumstances, they may also have to decide whether any documents need to be updated in light of the new law relating to ‘ipso facto’ clauses.

    The following is a brief checklist of questions for SMSF trustees and advisers to consider when reviewing contracts.

    • Is a certain clause in the contract an ‘ipso facto’ clause? For example, a clause stating that the contract is amended / terminated if the borrower enters into administration is most likely an ‘ipso facto’ clause.
    • If the clause in the contract is an ‘ipso facto’ clause, does an exception apply? Consider whether the right falls within one of the four categories of exceptions. If an exception applies, there is no ‘stay on enforcing rights’, and the relevant party can seek to rely on the ‘ipso facto’ clause to amend / terminate the contract.
    • If an exception applies and there is a ‘stay on enforcing rights’, can another clause be relied upon for the amendment / termination of the contract? For example, if the borrower has entered into administration and has also failed to make a loan repayment on time, the lender (ie, the SMSF trustee) may seek to terminate the loan agreement. A clause that states that the loan is terminated if the borrower enters into administration may be an ‘ipso facto’ clause and the lender may be prohibited from enforcing a right to terminate based on this fact. However, there may be another clause that states that any outstanding moneys can be recovered if a payment is not received on time. Further, the loan agreement may also specify that the full amount of the loan becomes payable if the borrower fails to make a loan repayment within the prescribed time period. This could allow the lender to recover the full loan amount plus interest plus costs, and to effectively bring the loan agreement to an end despite the other ‘ipso facto’ clause. Such a clause could protect the SMSF trustee in its capacity as a lender.

    For completeness, please note that a ‘stay on enforcing rights’ relating to an ‘ipso facto’ clause does not by itself invalidate a contract. Furthermore, the law in relation to ‘ipso facto’ clauses may be subject to further change in the future. For example, the exceptions to ‘stay on enforcing rights’ may change, so it is prudent to review the law on a regular basis.

    Conclusion

    SMSF trustees and advisers should review all contracts entered into on or after 1 July 2018. SMSF trustees should also obtain documentation (such as LRBA documentation) from a quality supplier firm that has reviewed its documentation to ensure that it is up-to-date in light of this new law in relation to ‘ipso facto’ clauses.

    The law in relation to ‘ipso facto’ clauses is a new area of law and where in doubt, expert advice should be obtained. Naturally, for advisers, the Australian financial services licence under the CA and tax advice obligations under the Tax Agent Services Act 2009 (Cth) need to be appropriately managed to ensure advice is appropriately and legally provided.

    Joseph Cheung, Lawyer and Daniel Butler, Director, DBA Lawyers

    For further information about SMSFs please contact our team at Leenane Templeton