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Loan Theory


In September 2007, the law was amended to allow a SMSF to borrow to purchase Property. However the rules implemented were complicated requiring the Property being acquired with borrowings to be held by an external entity. This entity is typically referred to as an Installment Warrant Trust Structure, Bare Trust or Security Custodian Trust. The SMSF was not allowed to purchase the Property directly where borrowings were used to purchase the Property.

 
 
Property is purchased by the Security Custodian Trust Trustee

The Security Custodian Trust (also known as a Bare Trust) is an entity that must be established completely separate from your SMSF. The Security Custodian Trust will have a Company as a Trustee. When a SMSF wishes to borrow to purchase a Property, the Property must be acquired by the Security Custodian Trust Trustee (in its capacity as Trustee for the Security Custodian Trust) and not the SMSF directly. The Property purchased is held on Trust by the Security Custodian Trust on behalf of the SMSF which has a beneficial right (but is not obligated) to acquire the Property from the Security Custodian Trust at a future point in time, usually when the Loan is repaid. It is important to understand that the Trustee of the Security Custodian Trust must be a Company. If you have a Company as your SMSF Trustee this Company cannot be used as the Security Custodian Trust Trustee. The Company must be a completely separate Company.

 
 
Separate Security Custodian Trust Structure required

A separate Security Custodian Trust must be established for each Property that is acquired. You cannot buy multiple properties using the same Security Custodian Trust Structure. Importantly however you are permitted to use the same Security Custodian Trust Trustee Company to act as the trustee for each Security Custodian Trust. This saves you the cost of establishing multiple Companies.

 
 
How to Complete the Purchase Contract

When acquiring Property using borrowings, the Property must be purchased in the name of the Security Custodian Trust Trustee Company. The following is noted:

  • The Property must be purchased in the name of the Security Custodian Trust Trustee Company.
  • All Directors of the Security Custodian Trust Trustee Company must sign the Purchase Contract.
  • It is recommended that the Purchase Contract be signed "subject to finance".
  • You must not put the name of your SMSF on the Purchase Contract.

Example:

If the Security Custodian Trust Trustee Company Name is Smith Pty Ltd then the purchaser on your Purchase Contract will be: Smith Pty Ltd. Neither the Trustees of your SMSF or the SMSF itself should be named on the Purchase Contract when borrowing to purchase Property in your SMSF.

 
 
Evidencing the Security Custodian Trust owns the Property

Given that the Security Custodian Trust Trustee actually signs the Purchase Contract in its own name, no actual mention of the Security Custodian Trust is mentioned on the Purchase Contract. This is actually correct even though the Security Custodian Trust Trustee Company in its capacity as trustee for the Security Custodian Trust owns the Property. This will also mean that the title of the Property will be in the name of the Security Custodian Trust Trustee Company with the relevant State Revenue Office. As the Title does not acknowledge the Trust relationship, you will need to ensure that appropriate documentation exists to evidence that the Company has acquired the Property in its capacity as Trustee for the Security Custodian Trust. This documentation is arranged by ESUPERFUND as part of the Loan Application process.

 
 
Stamping the Security Custodian Trust

On receipt of the documentation, you will need to arrange the stamping of the Security Custodian Trust with the State Revenue Office if required. ESUPERFUND will advise you on the process to do this at the relevant time.

 
 
Loan is made to the SMSF

Whilst the Security Custodian Trust Trustee (in its capacity as Trustee for the Security Custodian Trust) will actually purchase the Property, it is the SMSF who will borrow from the Lender to fund the Property purchase. In return the Trustee of the Security Custodian Trust will provide a mortgage over the Property purchased to the Lender as security for the SMSF Borrowing (which must be a Limited Recourse Loan).

 
 
Limited Recourse Loan

As detailed above the Security Custodian Trust will provide the Property purchased as security for the Loan made to the SMSF. This is the only asset that can be pledged to the Lender as security for the loan made to the SMSF. In this way, the Lender's right to recover is limited to the Property purchased in the Security Custodian Trust. This means that in the event that the SMSF defaults on the Loan the Lender can repossess or sell the Property only, but cannot repossess or sell any other SMSF asset to recoup any loan shortfall (if any).

 
 
SMSF will acquire the Property from the Security Custodian Trust

Importantly under the above arrangement the SMSF must have a right to acquire legal ownership of the Property from the Security Custodian Trust by making agreed instalment payments after the Property is purchased. Practically this means that under the above arrangement the SMSF will acquire the Property from the Security Custodian Trust through a series of agreed instalment payments which typically mean that the SMSF will make an initial upfront payment of part of the Property Purchase Price (eg deposit). In turn the SMSF will repay the Lender in Instalments until the asset is repaid in full. Once the Loan is repaid the Property Title will transfer from the Security Custodian Trust Trustee Company to the Trustee of your SMSF. The ATO has confirmed that no Stamp Duty of Capital Gains Tax will be payable as a result of this transfer.

 
 
Property Income and Expenses

As the SMSF is the "Beneficial Owner" of the Property (the Security Custodian Trust Trustee in its capacity as Trustee of the Security Custodian Trust is the Legal owner of the Property until the Loan is repaid) the SMSF is entitled to all Property Rental Income and will be responsible for paying all SMSF Expenses such as rates, insurance etc.

 
 
Repayment of Loan to Lender

On the repayment of the Loan to the Lender, the Property purchased can be transferred from the Security Custodian Trust to the SMSF. Based on current legislation and assuming the above arrangement has been correctly implemented, the transfer will not be subject to CGT and nominal Stamp Duty will apply.

 
 
What happens when the Property is sold?

When the Property is sold, the SMSF Trustees must use the proceeds of sale to repay the Loan. The balance of the proceeds of sale can then be kept in cash or used to invest as desired by you as the SMSF Trustee. However, the existing Loan cannot be used to buy another Asset.

 
 
Security Custodian Trust Setup Process and Fee

As detailed above a Security Custodian Trust must be established for each Property that is acquired using borrowings. ESUPERFUND will arrange the setup of the Security Custodian Trust for you when you borrow to buy Residential Property for your SMSF. ESUPERFUND has a one off fee of $500 to setup the Security Custodian Trust. The Security Custodian Trust must be setup only after the Loan has been approved and the Property has been acquired (ie the Purchase Contract signed). To apply for a Security Custodian Trust with ESUPERFUND you will need to login to your Client Portal and apply online here.

 
 
Security Custodian Trust Company Trustee Setup Process and Fee

As detailed above a Security Custodian Trust must be established for each Property that is acquired with borrowings. The Trustee of the Security Custodian Trust must be a Company. If you do not have an existing Company, ESUPERFUND offers a Company Setup Service. The cost of establishing a Company with ESUPERFUND is . In addition there is an additional annual ASIC Fee of approximately payable directly to ASIC. Please note that you are not obligated to use the ESUPERFUND Company Setup Service and can arrange to setup a Company with any provider desired. The Company details can in turn be provided to ESUPERFUND when setting up the Security Custodian Trust. The Company that will act as Trustee of the Security Custodian Trust can be setup after the Loan has been approved but must be setup before the Property has been acquired (ie the Purchase Contract signed). To apply for a Company with ESUPERFUND you will need to login to your Client Portal and apply online here.

 
 
It is complicated

SMSF Loan Arrangements are complicated! Failure to correctly implement the above arrangements may result in a breach of Superannuation Laws. The breach may mean the SMSF is not complying, which may result in significant tax penalties or may result in civil or criminal consequences for the SMSF Trustees. So it is important to get it right. As a result of this complicated process, it is strongly recommended that clients use the ESUPERFUND Loan Service when borrowing to purchase Property to ensure all legal requirements are properly met.