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The Borrowing Ban

Liz Westover

The Financial System Inquiry has drawn attention to the issue of borrowing within super funds, highlighting it as a potential area of risk. However, with only a small proportion of total SMSFs using limited recourse borrowing arrangements to invest, some industry experts have questioned whether the proposed ban is premature, writes Elizabeth Somerville.

The Financial System Inquiry’s (FSI) final report, handed down by inquiry chair David Murray in December last year, proposed the banning of direct borrowing by superannuation funds in order to safeguard Australia’s financial system.

The FSI’s rationale for the proposed ban is twofold: to prevent the unnecessary build-up of risk in the superannuation system and in Australia’s financial system more broadly; as well as to ensure superannuation remains a savings vehicle for retirement income as opposed to one for wealth creation.

The FSI’s recommendation notes that “over the past five years, the amount of funds borrowed using LRBAs (limited recourse borrowing arrangements) increased almost 18 times, from $497 million in June 2009 to $8.7 billion in June 2014”.

Citing this increase as a “growing trend”, the report goes on to suggest the government “remove the exception to the general prohibition on direct borrowing for limited recourse borrowing arrangements by superannuation funds”.

However, although the industry has experienced an increase in direct borrowing, as the report states, SPAA technical and professional standards director Graeme Colley says this only makes up a small proportion of all SMSFs.

“The proportion of superannuation funds that have got limited recourse borrowing is only a tiny percentage. It’s a little bit over 1 per cent of the total assets in SMSFs, and that’s based upon the ATO’s statistics, which they revised in June last year,” he says.

CPA Australia superannuation senior policy adviser Michael Davison agrees, and says although borrowing in super has increased over the years, the increase isn’t large enough to warrant legislative change.

“We acknowledge growth there, but it’s still a small number. We actually think [the recommendation] is premature in as far as growth in borrowing in super funds and investing in property is still small,” Davison says.

Further, according to Chartered Accountants Australia and New Zealand head of superannuation Liz Westover, the recommendation can be considered premature in the sense that it lacks the background analysis on borrowing and the legislative structure that currently permits it, which is needed to make an informed decision on a prospective ban.

“We’ve been pushing for a review for some time, but it needs to be more comprehensive than the review being undertaken by the FSI panel,” Westover says.

“We need to have an assessment if borrowing in super is appropriate or not [and] secondly, do we have the right legislative framework [for this]? I don’t think enough analysis has been done about borrowing and the legislative framework for this to take place.”

Suggesting that the FSI’s recommendation may have been influenced by the current legislative framework, Westover believes the industry needs to take a step back and consider the underlying issue providing the basis for the FSI’s proposed ban. “Is borrowing the issue or are the consequences arising from it concerning people?” she says.

“We’ve got property spruikers pushing people into SMSFs inappropriately so people can borrow to invest. It’s a problem, but is it about borrowing or the legislative framework around borrowing? I would suggest it’s the latter.”

Property spruikers have been of concern to the industry for some time, however, there is currently no legislation governing what advice they can and cannot give around setting up an SMSF or relating to what assets a trustee should hold in one.

The Australian Securities and Investments Commission is of the view that borrowing advice should also be called product advice, however, the general concern in the industry is this is not supported legally, Davison says.

“People in the property space are giving advice they are not licensed to give and property advice itself is unregulated. We don’t believe leveraging itself is the problem; the issue is really the inappropriate advice around the borrowing,” he explains.

Macquarie Group head of government relations, banking and financial services David Shirlow agrees, and suggests limiting the use of personal guarantees could help to mitigate some of the risk associated with LRBAs.

“Current legislation permits lenders to take personal guarantees from people other than SMSF trustees, [for example] members of a fund,” Shirlow says.

“Lenders are prepared to lend more if they have a personal guarantee. One of the concerns the FSI expressed is that things like personal guarantees undermine the limited recourse of superannuation indirectly.”

He says this is because superannuation rules prevent lenders from being repaid if the lender has got recourse to a fund member. “The limited recourse rules break down in a sense, as that fund member repays whatever’s outstanding. Limiting the use of personal guarantees would go some way to address that issue and would go some way to address property spruiking,” he says.

Although borrowing to invest can be a legitimate strategy if used properly, Davison feels it does need to be regulated.

“Only once this is addressed can you really gauge the risk around leveraging. Our advice to government is to acknowledge this,” he says.

His concerns are shared by Institute of Public Accountants senior tax adviser Tony Greco, who believes spruikers are enticing people to borrow in order to achieve their retirement goals, even though leveraging to invest in property only suits a minority.

“At the moment, yes, there is concern with respect to people setting up SMSFs to take advantage of the fact that they can borrow within super funds,” Greco says.

Used correctly leveraging can enable investors to accumulate assets of higher value within an SMSF and achieve a self-funded retirement, in turn alleviating some of the burden placed on Australia’s pension system.

However, just because an investor is able to purchase property through an LRBA, it doesn’t mean they should, Westover says.

“When people undertake borrowing arrangements and crunch numbers, it can work really well as a retirement savings vehicle, but it doesn’t always work,” she says.

Part of the concern surrounding LRBAs is that people are not doing the correct analysis behind them and are instead “just going for it”, she adds.

“People are undertaking substandard investments because they can borrow to do it. If you wouldn’t invest in an asset without borrowing, why on earth would you do it with borrowing?” she says.

Indeed, many in the industry, like Colley, believe the government will end up compromising on the FSI’s recommendation and instead implement a measured approach to address LRBA concerns.

“I think you may see some compromises in there because the main concerns of the regulators are the compliance issues relating to private arrangements being put in place,” he says.

“So that may be an area that we’ll see some compromise in, in that investments or loans [have to be] made by approved deposit-taking institutions.”

He adds this will take away the capacity of private lenders to facilitate LRBAs for investors, which is where the majority of compliance issues currently are.

Shirlow agrees a compromise solution will most likely be implemented, but pointed out there are no guarantees.

“I think there’s a fair chance that government will engage on middle ground, but there’s always a risk that it would move all the way as well,” he says.

“One of the things I would expect them to be very careful about are the transitional rules. A lot of focus will be needed on the transitions [in terms of] how you address people with existing borrowing arrangements, regardless of what is introduced.”

Introducing grandfathering provisions in this space would ensure people currently entered into or about to commence LRBAs are not disadvantaged, however, care would also need to be taken to make sure any restrictions that are imposed do not cause people to rush into leveraging arrangements, he says.

“People won’t want to be halfway through a transaction when more stringent rules get put in place,” he says.

Westover agrees the government would have to investigate grandfathering options to provide clarity and prevent people rushing into gearing strategies for the wrong reasons.
“We would really need to grandfather those people who already have LRBAs. We don’t want people rushing into them now as they think legislation is going to be imposed on them,” she says.

Murray’s inquiry also touched on the issue of non-concessional caps within the superannuation system, suggesting the government’s tax white paper should consider aligning the earnings tax rate across accumulation and retirement phases, and exploring options that would better match tax concessions with the superannuation system.

As part of this observation, the FSI suggests tightening the non-concessional contributions cap as a method of achieving this goal.

However, Shirlow does not favour this move as he thinks it could potentially disadvantage low-income earners, the self-employed and people with broken work patterns.

“The first difficulty with tightening caps is there’s a whole cohort of older people in the workforce who have been without the benefit of a significant level of compulsory super, so they’re playing catch-up,” he says.

People with broken incomes or fluctuating income levels could also be adversely affected, he says.

He suggests unless the cap is structured differentially for different age groups, this could potentially be an issue in the future.

Westover agrees and says non-concessional caps are one way of helping small business owners to top up their super when they do have extra assets.

“These people are not always high-income earners so shouldn’t be hindered in doing that. Non-concessional contributions allow them, at a time when it best suits their business, to put large amounts of money into super,” she says.

The caps exist to enable people to save a certain amount in super in a low-tax environment, Davison says, adding the size of the caps and being able to bring them forward two years gives people the opportunity to save where they can.

“For the majority of people, putting $540,000 into superannuation is a once-off. The majority of people are not looking to abuse the system. The issue is we continue to build rules and regulations to capture the 1 per cent or less who are,” he says.

In contrast, Colley believes the removal of the $540,000 bring-forward rule will not have a huge impact on the savings of people who are able to contribute this much.

“There would be a small impact on someone who puts in $540,000 today rather than over three years, but it’s only a very minor impact as you’re really just putting the money in a bit earlier,” he explains.

“I think that’s all it’s going to do. It might mean there could be a little bit less there for retirement income when people start drawing that down, simply because you’re drawing it out over a longer period and the impact of compounded earnings.”

Both Westover and Davison, however, believe whatever the government gleans from the FSI’s observations on non-concessional caps, the issue should not be approached in an exclusive manner.

“It’s dangerous for the Murray inquiry to be making suggestions in isolation,” Davison says.

He suggests the government should consider alternative treatments of non-concessional caps. “Instead of just looking at the restrictions going in, they could be looking at how benefits are taxed and if they should be taxed and limited on how much they can take out tax free,” he says.

Westover too believes the observation regarding non-concessional caps be looked at as part of a larger picture. “Some of these recommendations are very clearly tax items. They will have impacts on the tax system and the super system. They need to be very careful about making recommendations in isolation without looking at how they impact on the entire tax system,” she says.

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