Super Funds Can Refinance Under Amended Borrowing Arrangements
by Hall & Wilcox Lawyers www.hallandwilcox.com.au
A Bill is currently before Parliament which will amend the limited recourse borrowing provisions in section 67(4A) of the Superannuation Industry (Supervision) Act 1993 (SIS Act). The Bill will repeal section 67(4A) and replace it with a new section 67A and 67B (one of the main changes being the title of the section changing from 'Instalment Warrants' to 'Limited Recourse Borrowing Arrangements'). If enacted, the Bill will make significant changes to the limited recourse borrowing rules for fund trustees.
Changes at a glance
- Refinancing arrangments now allowed
- Borrowed funds can cover expenses associated with the transaction.
- The replacement asset is limited to a share or class of shares in the same company which will facilitate corporate transactions only. Share trading within the instalment warrant is not allowed. There is still the exception for takeover offers where shares in one company can be replaced with shares in another.
- Limited recourse nature clarified. The rights of not only the lender, but any other party, against the fund trustee in respect of the borrowing are specifically limited to the asset acquired with the loan. Arguably there will be no change in approach here.
Commentary
Despite the substantial redesign of the law, there are not many surprises in the changes (other than the ability to refinance, which the ATO never seemed keen on but which Treasury has probably included as a matter of practicality).
Section 67A clarifies the ability for fund trustees to use borrowed funds for expenses associated with the transaction as it makes sense. It is no surprise that the law has specifically ruled out using the borrowed funds for 'improvements', as this may suggest that development of property was within the scope of the provisions.
In our view, a fund trustee can borrow to buy real property as a 'house and land' package or 'off the plan' and it will be treated as a single asset for the purposes of section 67(4A), as there is a single title of land and the purchase is undertaken under a single contract or contemporaneous contracts that are contingent upon the other. However, the improvement or development of real property is prohibited. The difference in a property development situation is that the asset is acquired and then subsequent structural changes are not contemplated by, necessary to, or contingent upon, the contract for purchase, which increases the risk to the fund's assets.
Section 67B clarifies what constitutes a 'replacement asset'. It is now clear that a fund trustee, for example, could not sell $100 worth of BHP shares and buy $100 worth of CBA shares and call them a 'replacement asset'.
Rights of lender and third party limited to asset
Section 67A will largely replicate the current section 67(4A), but with some refinements. The rights of not only the lender, but any other party, against the fund trustee in respect of the borrowing are specifically limited to the asset acquired with the loan. The current wording of the legislation only limits the rights of the lender to the asset acquired with the loan, which leaves open the possibility of other parties, particularly a guarantor that is seeking to recover against the fund trustee, having recourse to the assets of the fund generally.
Section 67A(1)(d) is designed to ensure that a guarantor that is seeking to exercise a right of subrogation, having paid out under the guarantee, will also only be able to claim against the asset acquired with the loan. As the lender will probably have already liquidated the asset and will only go after the guarantor for the balance of the loan, there is unlikely to be any 'asset' for the guarantor to have recourse to.
We take the view, along with a number of other practitioners, that a guarantor will have to waive, or limit to the relevant asset, its rights of subrogation for the loan to be truly limited recourse within the spirit (if not the wording) of the law. Thus our approach in relation to such limited recourse borrowings will not change. Importantly, any amount of the loan which a guarantor waives its right to recover will be treated as a contribution to the fund in accordance with Taxation Ruling TR 2010/1.
Borrowing to 'improve' an asset is not permitted
Section 67A(1)(a)(i) confirms that associated expenses in acquiring the underlying asset (ie conveyancing fees, stamp duty, brokerage, loan establishment fees) can be paid from the borrowed funds. The provision also notes that the borrowed funds can be used for 'maintaining or repairing the asset, but not the expenses incurred in improving the asset. This is consistent with the approach we have taken that borrowed funds could not be used to improve (read 'develop') an asset - and will raise the old chestnut for advisors as to what is 'repairing' an asset and what is 'improving' it.
Refinancing is permitted
Section 67A(1)(a)(ii) specifically allows refinancing of loans, as this section allows the fund trustee to minimise the risk of default on a borrowing resulting from a temporary inability to make a repayment. For example, when the fund is facing solvency issues due to benefit payment obligations. It is not entirely clear from the wording of the provision whether it contemplates the fund trustee 'un-winding' the original borrowing arrangement (including the security trust) and starting again with a new lender in respect of the same asset or simply permitting the borrowed amount to be repaid and a new loan arrangement entered into within the same security trust arrangement. In our view, the Explanatory Memorandum indicates that the fund trustee is 'maintaining a borrowing' of money, if there is a substitution of one lender for another within the existing structure.
What is a 'replacement asset'?
The concept of 'replacement asset' in section 67(4A) is now dealt with in section 67B. This section exhaustively lists what constitutes a 'replacement asset', and includes most circumstances where a share or unit is exchanged for another share or unit, with the same market value, in the same entity, or where there is an exchange of scrip as a result of a corporate reconstruction or takeover by scheme of arrangement.
New concept of 'acquirable asset'
Section 67A replaces the concept of 'original asset' from section 67(4A) with 'acquirable asset'. An 'acquirable asset' is defined as a single asset or a collection of assets (which can include a parcel of shares or units in the one entity) which the fund trustee can acquire with the borrowed funds (and which it is not otherwise prohibited from acquiring). The Explanatory Memorandum notes that the current drafting of section 67(4A) could allow a fund trustee to borrow money to acquire multiple assets (ie a portfolio of shares in different companies), and the lender could then choose which assets from the portfolio are sold in the event of a default on the loan. By limiting the recourse of the lender to the 'acquirable asset' or a 'replacement asset', it is intended that lenders will not have the ability to choose which assets within a portfolio they can liquidate upon a default.
The Explanatory Memorandum gives examples of a collection of assets that can be treated as a single 'acquirable asset' including:
- a collection of shares of the same type in a single company (for example, a collection of ordinary shares in X Ltd) or units in a unit trust that have the same fixed rights attached to them; or
- a collection of economically equal and identical commodities (ie a collection of gold bars, irrespective of whether they might, for example, have different serial numbers).
In order to be considered a 'collection', the assets must be treated as a single asset when they are acquired or sold. For example, a parcel of shares would need to be acquired and sold as a single parcel. They could not be acquired as a parcel and then sold down in tranches over time.
This also impacts on limited recourse loans to purchase real property. The Explanatory Memorandum gives an example of a single title for land and the accompanying house on it being a single acquirable asset. Additional items such as furnishings would not be allowed to be purchased through the same limited recourse borrowing arrangement. Furnishings (or 'non-fixtures' of the property) must therefore be acquired through separate limited recourse borrowing arrangements over a single acquirable asset or bought outright (but not held as security under the borrowing arrangement over the property).
Are lease agreements affected?
The Explanatory Memorandum also notes that the amendments do not prevent an asset from being leased. For example, where real property is bought that is subject to an existing lease, the lease should not be treated as a separate asset for the purposes of section 67(4A) if the lease and the property are dealt with under the same arrangement.
Author: Hall & Wilcox www.hallandwilcox.com.au
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