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Instalment contracts an LRBA workaround

Instalment contracts could be a potential solution for SMSFs wanting to employ gearing-like strategies to acquire property in the event limited recourse borrowing arrangements are prohibited, a legal expert on the sector has suggested.

Under an instalment contract, the super fund would make an initial payment to the vendor of the property in question, upon which it would receive all rental income from the asset. The SMSF would then make a series of subsequent payments incorporating an implicit interest rate and the title of the property would not pass to the super fund until the final instalment payment was made.

“It would be a debtor/creditor relationship and that is not a borrowing, so we haven’t necessarily contravened anything here and the instalments keep being made so the debt is being reduced all the time,” DBA Lawyers director Daniel Butler said.

“So this is an alternative that could be used for borrowing.”

Butler pointed out for a borrowing to exist in the eyes of the ATO a temporary transfer of an amount of money from one entity, the lender, to another entity, the borrower, had to exist.

“It hasn’t really occurred here and example nine of SMSFR 2009/2 says: ‘Even though the agreement provides financial accommodation to the SMSF trustee, not all forms of such accommodation are borrowings of money. Accordingly, the SMSF trustees have not contravened paragraph 67(1)(a) [of the Superannuation Industry (Supervision) Regulations],’” he said.

“So the ATO has ruled on this that an instalment purchase is not a borrowing.”

He did warn there were occasions where the vendor might impose conditions that would change the nature of the agreement whereby it would possess the characteristics of a borrowing.

“If the Sale of Land Act comes into it, there is a provision that says if you do a vendor terms contract, the vendor can request a transfer of the title and then a loan and a mortgage back,” he explained.

“So the vendor has the option under the Sale of Land Act to convert the instalment contract into a normal sale agreement with a mortgage over the property, which would then jeopardise your SMSF status.”

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