SMSFs and Instalment Warrants
SMSFs and Instalment Warrants
by Bill Thompson, Minter Ellison
Released March 2008
last year, the Government changed the law to allow super funds, including SMSFs
to invest in instalment warrants to remove doubt about their legality.
Instalment warrants are a form of non-recourse borrowing, which have the
effect of allowing funds to leverage their investments without breaching the
prohibition on borrowing in SIS.
Originally designed to cover listed securities, instalment warrant
products for property and collectibles have now appeared on the market, as they
too are permissible under the changes.
The incoming government has already expressed some concern over the
program examines the nature of instalment warrants, the types of warrants
available in the market, the scope of the changes to the law, and the issues for
super funds (including the sole purpose test and the investment strategy) in
using them. The
program is very topical given the popularity of these new instruments with
controllers of SMSFs.
Issues in Investing via an SMSF – Instalment Warrants and Private Unit Trusts
& Current Issues in Investing
Background to Warrants Market
to information found at the Australian Stock Exchange ('ASX') website, the ASX
has operated a warrant market since 1991.
The market began by the trading of equity call warrants.
can be created over all manner of underlying assets including currency,
commodities, shares in listed companies, debt, real estate and various stock
Short dated share warrants are used for trading type activities and
longer dated share warrants are more suited to investing activities.
Longer dated share warrants emerged on the ASX as the market evolved and
may be either 'call warrants' or 'put warrants'.
can be either call warrants or put warrants.
Call warrants benefit from an upwards price movement in the underlying
instrument whereas put warrants benefit from a downward trend.
A deliverable call warrant generally gives you the right to buy the
underlying instrument (e.g. a share) from the warrant issuer at a particular
price on, or before a particular date.
A deliverable put warrant generally gives you the right to sell the
underlying instrument to the warrant issuer at a particular price on, or before,
a particular date.'1
have some similarities to exchange traded call and put options.
number of different types of warrants are available for trading now on the ASX
including 'instalment warrants'.
Instalment warrants are a longer dated warrant suited for investment.
ASX website notes that the ASX 'instalment warrants' have been available for
trading for over fifteen years.
their nature, instalments (warrants) are considered to have some characteristics
of call warrants, giving holders the right to exercise the instalment to acquire
the underlying instrument.'2
are a type of derivative investment as they are contracts which derive their
value from an underlying thing (such as a share in a listed company, for ASX
ASX website notes that instalment warrants are uniquely Australian financial
products whose genesis was in the innovative sales of the Commonwealth Bank and
Telstra which allowed investors to pay for their shares by two instalments using
the instalment receipt mechanism.
Instalment receipts are different from instalment warrants.
Instalment receipts are exchange traded securities which give investors
exposure to shares through an initial part payment of the price of the share and
a mandatory final payment at a later date.
The amount of the final payment is fixed.
instalment warrants have some similarities to instalment receipts, they also
differ from instalment receipts in that they are instruments created by
investment banks specifically for retail investors, rather than instruments
created by existing shareholders in a listed company or the listed company
itself for the sale of its shares.
warrants are generally limited to shares in the Top 50 ASX listed companies.
Features of Instalment Warrants
instalment warrant is a contract for the purchase of an underlying ASX listed
share by payment of two instalments with a loan from the issuing investment bank
to the warrant holder to enable payment of the second instalment.
simple terms, instalments are a loan to buy shares, without the obligation to
repay the loan nor the risk of receiving margin calls.'3
first payment (which is roughly half of the share price) is set at an amount
which includes the first instalment of the price plus an interest charge in
respect of the loan for the second instalment, and fees payable to the issuing
investment bank, together with a fee for the purchase of a put option.
loan from the issuing investment bank is a limited recourse loan in that it is
secured only over the share which is the subject of the instalment warrant.
The second instalment is only payable at the election of the warrant
the second instalment becomes due the warrant holder has a number of choices.
The holder may:
the instalment warrant on the secondary market;
over' the warrant into a new series of instalment warrants over the same
shares (if available);
the second instalment and acquire the underlying shares;
the put option, in which case the shares will be sold and the proceeds from
the share sale applied to repay the loan.
If the share price exceeds the loan amount then the holder receives
the excess amount;
nothing – in which case the shares will be sold and the same result will
obtain as if the put option had been exercised.
the time of purchase of the instalment warrant the issuing investment bank
arranges for the purchase of the underlying shares in the name of a security
trustee who holds the underlying shares upon trust for the warrant holder.
This creates a trust over the shares under which the warrant holder is a
beneficiary, subject to the terms of the warrant.
warrant under which the issuer places the underlying instrument in a trust on
behalf of the holder is said to be "covered".4
the terms of issue of the warrant the issuing investment bank only has recourse
to the underlying shares for repayment of the loan amount.
There are now many investment banks in Australia offering instalment
The terms of all warrants are specific to the particular instalment
all warrants are the same.
It is necessary to check the terms of the particular instalment warrant
being examined to determine the precise terms of the contract between the
parties, and, accordingly the precise nature of the legal relationships created
by the warrant between the warrant holder, the security trustee and the issuing
That is, all warrants are subject to their own terms though they may have
broadly similar features.
are different instalment warrants developed by different issuing investment
are proprietary to each bank and are sold under different product names.
So, for example, a type of instalment warrant (discussed further below)
is a self funding instalment warrant ('SFI').
Broadly, under an SFI, dividends paid on the underlying shares reduce the
loan amount and the interest calculation is made on the outstanding loan as
reduced by such dividend payments from time to time.
If the holder of the warrant does not quote their tax file number, then,
while the amount of the dividend will nevertheless be deducted from the
outstanding loan, the withheld amount of tax may become a separate debt due
immediately by the warrant holder to the issuing bank.
That separate debt may be a full recourse debt.
warrant holder, as the beneficiary under the security trust, is entitled to all
dividends and attached franking credits in respect of the underlying shares.
Comparison of instalment warrants and instalment
following table sets out the major differences between an instalment warrant and
an instalment receipt.
bank makes a loan equal to the second instalment.
The loan is limited recourse.
second payment is a debt to the seler of the share.
There is no loan.
holder acquires a put option to put the shares back to the issuing bank
at the greater of the current market price or the amount of the loan at
the date of exercise of the put option.
on the loan is prepaid annually for the life of the instalment warrant.
is no loan and therefore no interest payment.
payment of the second instalment of the price of the shares is optional.
second payment is mandatory.
underlying share is held on trust for the warrant holder via a security
underlying share is held in trust for the holder of the instalment
warrant holder is entitled to all dividends and franking credits while
the underlying share is held in the security trust.
holder of the instalment receipt is entitled to all dividends and
franking credits in respect of the underlying share while the share is
held on trust.
real difference between instalment warrants and instalment receipts, therefore,
may be seen to be in the fact that with an instalment receipt there is no loan
made to the holder of the instalment receipt to enable the second payment.
There is simply a debt owed for that amount.
Types of Instalment Warrants
Instalment Warrant Products
issuing investment banks have different product names for their different series
of instalment warrants.
Each investment bank offers a different series in respect of each of the
underlying shares and different warrant features.
The instalment warrants offered by each investment bank will fall into
different product categories differentiated by:
levels of gearing – ranging from 30% to 95% of the price of the underlying
underlying shares – for example, some warrants will be in respect of
shares in companies providing a high dividend yield and others will be in
respect of companies offering high capital growth;
different features of the different product categories can be observed by
visiting the websites of the issuing investment banks or by perusing their
product disclosure statements.
Typical Instalment Warrant – Cash application or
are instalment warrants having the features broadly described above and may be
distinguished from an instalment warrant offered by way of 'shareholder
instalment warrant by way of shareholder application offers a means for an
existing shareholder in a company to extract the equity from those shares
without selling the shares.
A further advantage of this is that it does not trigger a CGT event in
respect of the shares.
an instalment warrant by way of shareholder application a person who already
holds shares in a company over which the issuing investment bank is prepared to
offer an instalment warrant, will transfer the underlying shares which they own
to a security trustee and borrow from the issuer the amount available under the
a cash application, where the loan from the issuing investment bank may be used
to acquire the underlying shares, the loan in respect of a shareholder
application will be used by the warrant holder to invest in additional shares or
for other business or investment use.
Self Funding Instalments ('SFI')
a SFI warrant an upfront payment is paid by the warrant holder for the
instalment warrant and a loan is obtained from the issuing bank for the balance
amount payable in respect of the underlying shares.
This loan will be repayable over a number of years (ranging from 5 to ten
years depending on the terms of the SFI).
Under SFI's, the upfront payment may be lower than with other types of
instalment warrant due to the period of the loan.
particular feature of SFI's is that dividends received by the warrant holder
during the term of the instalment warrant are retained by the issuer and applied
to reduce the loan, with the annual interest payment being calculated on the
reducing loan balance.
Franking credits in respect of the dividends continue to flow to the
An objective of warrant holders investing in an SFI will typically be to
achieve a positively geared investment by reason of the dividends outstripping
the interest payments on the reducing loan balance.
Rolling Instalment Warrants
are a variation on the ordinary instalment structure.
On a periodic basis…the instalment will undergo a reset of the loan
the annual reset date you may choose to exercise some or all of the instalments
and take delivery of the underlying securities, cash out the instalment, roll
into the following year (by agreeing to any additional amounts necessary) or do
you do nothing you are deemed to have accepted the new exercise price and will
automatically roll into the following year.
Conceptually, these instalments can be explained as a series of
consecutive ordinary instalments that run back to back with the exercise price
being reset on a periodic basis'.6
Advantages and Disadvantages of Instalment Warrants
warrants enable the gearing of an investment into ASX listed shares.
Like any form of gearing, instalment warrants have the ability to magnify
returns from the investment but can also magnify losses if the value of the
underlying asset declines.
typical investor in instalment warrants will have a positive view of the likely
future value of the underlying shares.
warrants enable an investment in shares using gearing in a way which ensures
that the loan can be repaid. This is achieved by the use of the put option.
The put option is intended as a loan protection feature not a capital
That is, the price of the instalment warrant will be set according to the
value of the underlying shares agreed for that instalment warrant series at the
time the instalment warrant is acquired.
The put option will enable payment to be made of the second instalment
(the put option being for the greater of the current market price or the loan)
so that the total payment of the originally agreed price can be made.
If the value of the underlying shares declines prior to maturity of the
instalment warrant, the first instalment will still have been paid by reference
to the agreed higher price of the underlying shares.
In an extreme case, if the value of the underlying share falls to zero,
the whole up front payment would be lost.
warrants enable the warrant holder to receive the cash dividends on the
underlying shares and the franking credits attached to those dividends despite
the fact that the second instalment has not yet been paid.
features of instalment warrants enable them to be used to pursue a number of
share investment strategies with the benefit of providing more income and more
franking credits through the leverage offered by the loan of the second
identified on the ASX website which may be pursued using instalment warrants
purchase of shares;
extraction (by the shareholder application method);
call options using instalment warrants;
of share portfolio using instalment warrants;
strategies using put warrants;
a share portfolio in a rising market – by locking in gains using put
franking credits to offset tax on other income, for example, sheltering
contributions and earnings tax in a superannuation fund.
prospective investor in instalment warrants must assess the terms of the
particular instalment warrant.
The cost of the borrowing inherent in an instalment warrant needs to be
considered against the investor's view of the performance of the underlying
share and any other benefits (including taxation savings) which may be obtained
in light of the intended strategy for the use of the instalment warrant.
Taxation Treatment of Instalment Warrants
interest component of the first instalment and of subsequent annual payments of
interest (e.g. if using an SFI) may be deductible.
The usual tests of deductibility apply.
the extent that there is an identifiable payment for the put option then that
payment is not deductible7.
If instalment warrants are being used for trading type activities then
the cost of the instalment warrant (including the cost of the put option) and
the gains on disposal and losses will be on revenue account.
the instalment warrants are to be used in an investing activity then the capital
gains tax rules will apply.
Instalment Warrants and Self Managed Superannuation
Sole Purpose Test
starting point in considering the investments which a regulated superannuation
fund may make is the definition of 'superannuation fund'.8
A superannuation fund is defined to be a fund, which is indefinitely
courts have emphasised the significance of the requirement that a superannuation
fund be a 'fund'.
Scott's Case,9 Windeyer J held that the expression 'fund' means money or
does not contemplate a business or trading activity or an enterprise in the form
of a speculation.
So, in that case, a trust which engaged in real estate developments with
a view to profit making by sale, was not a 'fund' and as a result could not be a
superannuation fund as then defined under the Income Tax Assessment Act 1936,
for tax exemption purposes.
This fundamental definitional issue must be borne steadily in mind when
considering the 'sole purpose test' in its current form.
section 62 of the Superannuation Industry (Supervision) Act 1993 ('SIS') a
trustee of a regulated superannuation fund must ensure that the fund is
maintained solely for one or more of the identified core purposes or 'ancillary
purposes' as defined in that section.
This means, broadly, that a trustee of a regulated superannuation fund
must ensure that the fund is maintained solely for the provision of benefits to
a member in the event of retirement, death or disability.
requirement that the fund be 'maintained' for core or ancillary purposes, means
that those purposes must be present on a continuing basis.
Engaging in trading or speculative type activity may be evidence that the
fund is not being maintained for a requisite purpose, but for an impermissible
collateral purpose, such as tax minimisation or estate planning.
52 of SIS prescribes that the governing rules of a superannuation entity are
deemed to contain certain covenants described in section 52(2).
Amongst those is a covenant by the trustee:
formulate and give effect to an investment strategy that has regard to the whole
of the circumstances of the entity including but not limited to the following:
risk involved in making, holding and realising and the likely return from
the entity's investments having regard to its objectives and its expected
cash flow requirements;
composition of the entity's investments as a whole, including the extent to
which the investments are diverse or involve the entity in being exposed to
risks from inadequate diversification;
liquidity of the entity's investments having regard to its expected cash
ability of the entity to discharge its existing and prospective
67 of SIS prohibits a trustee of a regulated superannuation fund from borrowing
money or maintaining an existing borrowing of money except for certain temporary
8 of SIS limits investments by regulated superannuation funds in in-house
71(1) defines an in-house asset of a superannuation fund as including an
investment in a 'related trust' of the fund.
expression 'related trust' is defined in section 10(1) of SIS as:
trust that a member or standard employer sponsor of the fund controls (within
the meaning of section 70E) other than an excluded instalment trust of the
expression 'excluded instalment trust' in relation to a superannuation fund is
defined by section
10(1) of SIS to mean:
arises because a trustee or investment manager of the superannuation fund
makes an investment under which a listed security (within the meaning of
subsection 66(5)) (the underlying security) is held in trust until the
purchase price of the underlying security is fully paid;
the underlying security and property derived from the underlying security is
the only trust property;
an investment in the underlying security held in trust would not be an
in-house asset of the superannuation fund.'
No Charges over Assets of Funds
Regulation 13.14 provides that it is a standard applicable to the operation of a
regulated superannuation fund and an approved deposit fund that the trustee of
the fund must not give a charge over or in relation to an asset of the fund.
The expression 'charge' is defined, by SIS Regulation 13.11 not
exhaustively but inclusively.
It includes 'mortgage lien or other encumbrance'.
A 'lien' is a possessory security, for example, a workman's lien on his
work until paid.
The expression 'encumbrance' is not defined by the SIS Regulations and
therefore has its ordinary meaning in the context of the Act.
The Shorter Oxford Dictionary defines 'encumbrance' in its legal sense as
'a claim, lien, liability attached to property; as a mortgage'.
In Evans v Evans, 11 Lord Cranworth LC held that:
word "incumbrance" has no strictly technical meaning; but what is
usually understood is, that where a person has a right at his pleasure to charge
Ł3,000 upon an estate, that is an incumbrance.
In such a state of things nobody could say he had an estate free from
incumbrances while his estate was laible at any time to be charged with such a
sum of money.'
ordinary meaning of the expression 'charge' gives the chargee certain rights to
take possession of, or receive payment out of the proceeds of sale of, the
charged property. 12
Accordingly, the SIS definition of charge is extended by the inclusion of
the words 'mortgage lien or other encumbrance'.
to a consideration of the use of instalment warrants by superannuation funds,
SIS Regulation 13.15A provides that:
trustee may give a charge over or in relation to an asset of a fund if:
charge is given in relation to a derivatives contract entered into…by or
on behalf of the trustee; and
charge is given in order to comply with the rules of an approved body…that
requires the performance of obligations in relation to the derivatives
contract to be secured;
fund has in place a derivatives risk statement that sets out:
for the use of derivatives that include an analysis of the risks
associated with the use of derivatives within the investment strategy of
and controls on the use of derivatives that take into consideration the
expertise of staff;
processes to ensure that the controls are effective (for example
reporting procedures, internal and external audits and staff management
investment to which the charge relates is made in accordance with the
derivatives risk statement.'
expression 'derivative' in this context is defined to mean:
financial asset or liability the value of which depends on or is derived from
other assets, liabilities or indices.'
expression 'derivatives contract' is defined to mean:
options contract or a futures contract relating to any right, liability or
reference to an 'approved body' includes the Australian Stock Exchange.
Policy of Regulators
Borrowing and Charging Assets
Superannuation Circular Number II.D.4 'Borrowing by Superannuation Entities'
(released by the Australian Prudential Regulation Authority (APRA) in September
1998) APRA sought to explain its interpretation of the borrowing prohibition on
regulated superannuation funds.
That Circular remains operative in relation to regulated superannuation
funds for which APRA is the responsible regulatory authority.
The Australian Taxation Office (ATO) since assuming responsibility for
regulation of self managed superannuation funds (SMSFs) has continued to apply
APRA policy as reflected in APRA Circulars.
The Circulars do not represent the law but APRA's view of the law.
At paragraph 16 of Circular II.D.4, APRA noted that:
all liabilities of a superannuation entity will be borrowings within the meaning
of section 67…
Whether a particular transaction constitutes a borrowing will depend on
the facts and applicable legal principles in any given case.
In general however, a borrowing usually involves receiving a payment from
someone in the context of a lender/borrower relationship on the basis that it
will be repaid.
A transaction which gives rise to a debtor/creditor relationship does not
necessarily give a rise to a lender/borrower relationship and hence may not
necessarily represent a borrowing for the purposes of this restriction.'
that extent, APRA recognises in the Circular the traditional meaning of a
borrowing or loan at law as money advanced by one party to another with the
intention that it will be repaid. A financing arrangement will not amount to a
contract for the repayment of money lent where there is "nothing which
could be represented as a lending of money and the promise to repay it".13
to a consideration of the character of instalment warrants, at paragraph 19 of
the Circular, APRA gave as an example of an amount paid on behalf of or owed by
a regulated superannuation fund which would not constitute a borrowing, the
purchase by a trustee of property where ownership of the property passes to the
trustee before the instalments are finalised.
Under this example an investment in endowment warrants or instalment
receipts may not be considered borrowings.
It is necessary to check the obligations that lie with the purchaser to
meet the instalment(s) as these determine whether the investment is a borrowing.
Where the remaining instalment(s) is not 'compulsory' and the
warrant/receipt holder receives the value of the warrant/receipt (less handling
or sales costs) on 'default' APRA considers the warrant/receipt does not
constitute a borrowing.'
at paragraph 20 of the Circular, APRA noted that:
regulated superannuation funds…there may also be a separate question whether a
charge has been given over the entity's property which, subject to certain
exceptions, is prohibited under SIS Regulation 13.14.'
is to be noted that in that Circular, APRA did not refer to 'instalment
warrants' but to 'endowment warrants' and 'instalment receipts'.
are long term call warrants typically with a 10 year life.
Endowments are promoted as investment products to be bought by investors
and held until expiry.
issue price of an endowment is between 30 and 65 percent of the market value of
the underlying security at the time of issue.
The exercise price (called the 'outstanding amount' of the endowment) is
initially the remaining sum plus other costs.
The outstanding amount varies over the life of the warrant.
In this respect endowment warrants differ from most warrants as they do
not have a fixed exercise price.
The outstanding amount is reduced by any dividends that are paid in
relation to the underlying security.
However, an interest rate is also applied and the outstanding amount is
increased by these interest amounts.
At expiry, if you exercise the warrant and pay the balance of the
outstanding amount (if any) the issuer will transfer the underlying securities
appears that, administratively, both before and after the release of that
Circular, both APRA and the ATO took the view that an investment by regulated
superannuation funds in instalment warrants did not constitute a prohibited
borrowing or a charge over the assets of a superannuation fund.
on 16 December 2002, in a joint media release APRA and the ATO urged
superannuation funds to exercise 'extreme caution in the purchase of instalment
guidelines released by the Regulators with that media release, the Regulators
noted that they had previously taken the view that a superannuation fund
investment in an instalment warrant may not constitute a borrowing under section
67 of SIS. However,
they noted also that the SIS prohibition on borrowing was developed before many
of the then currently available geared products had been developed and
Regulators had reviewed the position in the light of those products.
They also noted that instalment warrant issuers were now actively
targeting superannuation funds with more complex products.
they noted that in some cases instalment warrants could form an appropriate part
of a superannuation fund investment strategy in certain situations.
the conclusion of the Regulators at that time was that an investment in
instalment warrants by means of 'shareholder application' would normally involve
a charging of a fund asset.
Their conclusion was that:
investment via shareholder application is generally not an appropriate means of
implementing any part of a fund's investment strategy and is likely to
contravene regulation 13.14.'
also noted that any superannuation fund trustee considering an investment in
instalment warrants must:
the appropriateness of instalment warrants in the context of the fund's
whole investment strategy and be mindful of the trustee covenants under
section 52(2) of SIS;
that they are familiar with the risks involved in the use of such
instruments prior to making such investments;
in place adequate risk management procedures to manage the risks associated
with such investments prior to making those investments;
that an investment in a particular instalment warrant series does not
constitute a borrowing under section 67 or involve charging of an asset in
breach of SIS Regulation 13.14.
Instalment warrants do not have standardised terms and the conditions
so each product must be examined separately.
under those 2002 guidelines in the exercise of their administrative powers the
regulators granted transitional relief in relation to past investments in
instalment warrants by means of shareholder application.
release of those guidelines was interpreted by the market, and applied in
practice by the Regulators, as only prohibiting investments by regulated
superannuation funds in instalment warrants which occurred by way of shareholder
application, and only on the basis that that involved the giving of a charge
over assets of the superannuation fund, not on the basis that the instalment
warrant involved a prohibited borrowing, or a breach of the in-house asset
the light of Circular II.D.4, this was explained by the market on the basis that
instalment warrants by way of cash/issuer application not shareholder
application did not involve a 'borrowing' because the loan made by the issuer
was a limited recourse loan, and, therefore, effectively there was no obligation
upon the warrant holder to repay any borrowing.
In the language of paragraph 19 of Circular II.D.4, payment of the
remaining instalment(s) was not 'compulsory'.
Regulation of Use of Derivatives
ISC and subsequently APRA have, issued Guidance Notes and Superannuation
Circular II.D.7 on investments by superannuation fund trustees in derivatives,
and for licensed registered superannuation entities in relation to the
formulation of risk management statements and risk management plans in
connection with derivatives.
Those Guidance Notes and Circular discuss what uses of derivatives would
normally be seen as appropriate by a regulated superannuation entity (for
example, hedging risk, reducing exposures, obtaining better prices than the
physical/cash market, adjusting the duration of a fixed interest portfolio and
so on15) and what would be an inappropriate use of
derivatives for a trustee (for example speculation or the avoidance of
the prohibitions contained in SIS on borrowing16).
whole tenor of Superannuation Circular II.D.7 is that an investment in
derivatives may be an appropriate supplement of an overall investment strategy
to achieve or operate that strategy in a more effective, less risky, optimal (in
terms of raising returns and lowering costs) way.
Circular clearly does not contemplate a superannuation fund engaging in a purely
speculative or trading activity in derivatives:
use of derivatives must be subordinate to the investment strategy and be
consistent with the objectives of the strategy.
Thus, for example, the use of derivatives to obtain exposure
substantially different to that which could be obtained through physical
securities would generally be inappropriate' 17
emphasis in Circular II.D.7 upon the subordinate role derivatives may play in an
investment strategy is exemplified
by the description of options in the Circular18.
The Circular only discusses the buying of options to insure (hedge)
There is no consideration of the selling of options to earn premium
should also be able to demonstrate through the trustee's records that they have
assessed the risks and benefits of particular investments in derivatives.
self managed superannuation funds need not meet the requirements of a formal
risk management statement and risk management plan as must a licensed registered
superannuation entity, it is nonetheless a useful discipline and assistance to
the fund auditor for a trustee to have a paper trail setting out a record of the
trustee's consideration of such matters in connection with the written
investment strategy of the fund and demonstrating that an investment decision,
which the trustee is considering, has been properly undertaken.
Further, if a self-managed fund wishes to undertake a derivatives
transaction on an Australian or international exchange, and thereby will create
a charge over the fund's assets, then the fund must prepare a risk management
statement to satisfy SIS Regulation 13.15A19.
Of course, the trustee must be satisfied that the investment is permitted
under the fund's trust deed and written investment strategy.
2006 Announcement and Proposed Legislation
3 November 2006 the Minister for Revenue and Assistant Treasurer announced that
the Commissioner of Taxation and APRA have 'now concluded that (instalment
warrants) entail a borrowing for the purposes of section 67…and are therefore
not an allowable investment.'.
government decided, in order to avoid disruption to markets, that following
consultation with the superannuation industry, it would seek amendments to SIS
and that pending the change in the law, superannuation funds investing in
'traditional instalment warrants' will not be considered to be non-complying
merely because of their investment in those products.
22 May 2007, the Minister for Revenue and Assistant Treasurer announced that
following the process of consultation with industry, the government would enact
legislation 'to allow superannuation funds to invest in instalment warrants
of a limited recourse nature over any asset a fund would be permitted to invest
in directly. This
will restore the status quo that existed before the ATO and APRA determined that
the instalment warrant structure entailed a borrowing.'
Tax Laws Amendment (2007 Measures Number 4) Bill 2007 ('2007 Bill') has now been
introduced into Parliament.
Schedule 3 to that Bill contains the proposed amendments to section 67 of
addition there is a proposed amendment to section 71 in relation to the 'in
house asset' rules.
Explanatory Memorandum to the Bill notes that the amendments are seen as
ATO and APRA have come to the view that instalment warrant arrangements
constitute a borrowing for the purposes of section 67;
Regulation 13.14 states that a trustee must not give a charge over or in
relation to an asset of a fund.
While this does not apply in relation to certain charges specified in
regulation 13.15A these relate only to options and futures contracts
provided the superannuation fund meets certain conditions;
ATO has also determined that an investment by a self managed superannuation
fund in an instalment warrant is an in-house asset of the fund under section
71 of SIS.
the apparent change in the interpretation adopted by APRA and the ATO after
years of a contrary administrative practice is surprising, the following points
may perhaps be noted:
Circular II.D.4 did not actually refer to instalment warrants not
constituting a borrowing.
It only referred in that context to instalment receipts and endowment
This does not appear to have been a distinction relied upon by the
Regulators at any time.
basis upon which shareholder applications were said by APRA in Circular
II.D.4 to offend the requirements of SIS was not that they constituted a
prohibited borrowing but that they were a charge over the assets of the fund
in breach of SIS Regulation 13.14.
did say in Circular II.D.4 that no general statement could be made that an
investment by a superannuation fund did not constitute a borrowing. Rather
the terms of the investment and the basis on which funds were provided would
need to be examined in each case.
can be seen how, depending upon the terms of an instalment warrant, the
investment in the instalment warrant could involve a borrowing by the
The argument might be made that if upon the exercise of the put
option the sale proceeds were to be regarded as the holder's money to be
applied at the direction of the holder for the repayment of the loan then
that arrangement might readily be construed as a borrowing.
On the other hand, if the terms of the instalment warrant amount to a
contract that upon exercise of the put option the issuer would cause the
security trustee to sell the underlying shares and simply provide for a
payment of any excess of the sale proceeds over the loan amount to be paid
to the holder that might simply be a contract for a payment of money rather
than for a borrowing and repayment of a loan.
Ultimately the question is, under the terms of the instalment
warrant, is the payment of the second instalment truly 'optional' or is it a
repayment of a loan at the direction of the borrower?
Circular II.D.4 did not consider the in-house asset rules at all.
The reference in the Explanatory Memorandum to the 2007 Bill to the
Commissioner considering that an instalment warrant is an in-house asset is
not further explained in the Explanatory Memorandum.
However, the proposed amendment to section 71 contained in the 2007
Bill, suggests that the Commissioner of Taxation must consider that the
creation of the security trust arrangement (under which the underlying
shares for an instalment warrant are held) constitutes a 'related trust' for
the purposes of the in-house asset rules.
noted earlier in this paper, a 'related trust' is defined by section 10(1) of
SIS to mean a trust, relevantly, that a member of the superannuation fund
controls within the meaning of section 70E of SIS.
While it is counter-intuitive to consider that the security trust
arrangement under an instalment warrant would be regarded as 'an investment in a
related trust of the fund' for the purposes of the in house assets rules,
nevertheless the arrangement may fall within the literal meaning of those terms
as defined. Given
that the definition of a 'related trust' expressly excludes excluded instalment
trusts, the security trust which arises under an exchange traded instalment
warrant or under an instalment receipt in respect of ASX listed shares could not
be a related trust.
amendments proposed by the 2007 Bill are not limited to exchange traded
instalment warrants or instalment receipts over ASX listed shares.
It is nevertheless strange that if the ATO has a concern that an
investment in instalment warrants may breach the in-house asset rules as
described in the Explanatory Memorandum that reference is not made to the
existing exception for investments in 'excluded instalment trusts' of a
Schedule 3 to the Tax Law Amendment (2007 Measures Number 4) Bill 2007, the
Government proposes to amend SIS in two respects namely:
provide in respect of instalment warrants an exception to the prohibition
upon borrowings by superannuation funds in section 67;
amend the restrictions on investments in in-house assets to remove the
security trust created by an instalment warrant from the meaning of an
borrowing exception in respect of instalment warrants will be provided by a
proposed new section 67(4A) of SIS.
Rather than refer to instalment warrants, the proposed section 67(4A)
describes the features which an arrangement must have in order to fall within
the proposed borrowing exception.
Those features match typical instalment warrant arrangements.
Specifically, a regulated superannuation fund will not be prohibited from
borrowing money or maintaining a borrowing of money:
an arrangement under which
money is or has been applied for the acquisition of an asset ('the original
assets') other than one the RSF Trustee is prohibited by this Act or any
other law from acquiring; and:
original asset, or another asset ('the replacement') that:
an asset replacing the original asset or any other asset that met the
conditions in this sub-paragraph and sub-paragraph (ii); and
not an asset the RSF Trustee is prohibited by this Act or any other law
held on trust so that the RSF Trustee acquires a beneficial interest in the
original asset or the replacement; and
RSF Trustee has the right to acquire legal ownership of the original asset
or the replacement by making one or more payments after acquiring the
beneficial interest; and
rights of the lender against the RSF Trustee for default on the borrowing or
on the sum of the borrowing and charges related to the borrowing, are
limited to rights relating to the original asset or the replacement; and
under the arrangement the RSF Trustee has a right relating to the original
asset or the replacement (other than a right described in paragraph (c)) -
the rights of the lender against the RSF Trustee for the RSF Trustee's
exercise of the RSF Trustee's right are limited to rights relating to the
original asset or replacement.'
In-House Assets Exemption
amendments to the definition of in-house asset will be contained in proposed new
subsections 71(8) and (9) as follows:
if at a time:
asset (the investment asset) of a superannuation fund is an investment in a
related trust of the fund;
related trust is one described in paragraph 67(4A(b)) in connection with a
borrowing by the trustee of the fund that is covered by subsection 67(4A);
only property of the related trust is the original asset or replacement
described in that subsection;
investment asset is an in-house asset of the fund at the time only if the
original asset or replacement described in subsection 67(4A) would be an
in-house asset of the fund if it were an asset of the fund at the time;
Subsections (1),(2) and have effect subject to subsection (8).'
following comments may be made in respect of these proposed amendments:
The arrangements described in the proposed amendments to section 67, while
describing an instalment warrant typically created over listed company shares,
are not limited to listed shares.
In this way, the proposed amendments reflect the policy contained in the
announcement by the Minister for Revenue and Assistant Treasurer in May 2007
that superannuation funds will be allowed to invest in instalment warrants of a
limited recourse nature over any asset a fund would be permitted to invest in
paragraph 67(4A)(a)) ensures that assets which would otherwise be in-house
assets, for example, may not be the subject of a borrowing within this new
any other asset in which a regulated superannuation fund trustee might invest
may now be the subject of an instalment warrant borrowing and investment.
Even before the announcement by the Government at the end of November
2006 property investments structured as instalment warrants were being offered
by some product providers to the trustees of regulated superannuation funds. 20
It may be expected with the passage of the proposed amendments to section
67 and section 71, a range of product offerings in different asset classes using
the instalment warrant structure will become available for superannuation fund
trustees to consider.
The proposed amendments to section 71 do not alter the existing definition of a
'related trust' or an 'excluded instalment trust' of a superannuation fund.
Instalment warrant investments by way of shareholder application (cash
extraction) are still not permitted.
This arises from the requirement in paragraph 67(4A)(a) that the borrowed
money must be 'applied for the acquisition of an asset'.
The loan must be a limited recourse loan (limited to rights relating to the
original asset or the replacement asset in respect of the borrowing and charges
related to the borrowing).
For reasons explained earlier in this paper a SFI warrant would not
satisfy this requirement if part of the loan (or any increased loan) becomes a
full recourse debt.
The amendments to section 67 and section 71 will take effect from the date on
which the Act receives Royal Assent.
The Explanatory Memorandum notes 21 that existing technical breaches
arising by investment in instalment warrants by regulated superannuation fund
trustees will be managed through the discretionary powers of the Commissioner of
Taxation and APRA.
It will be necessary to consider the previous announcements by the
Commissioner and APRA of 16 December 2002 and 3 November 2006 in relation to the
exercise of the discretions of those Regulators.
The proposed amendments to section 67 and section 71 do not in any way alter the
obligation of the trustee of a regulated superannuation fund in considering of
the exercise of the trustee's powers of investment.
Any investment in instalment warrants in any asset class would still
require a determination by the Trustee that the investment:
the sole purpose test;
within the investment powers of the trustee under the superannuation fund
within the investment strategy previously determined by the trustee;
in all other respect an appropriate investment for the fund;
not breach the in-house asset rules and so on.
The amendments by this Bill and the provisions of the Explanatory Memorandum do
not refer to any proposed amendments to the SIS Regulations to clarify the
previously expressed concerns of APRA and the ATO that an investment in
instalment warrants or certain types of instalment warrants may
constitute a breach of the prohibition in SIS Regulation 13.14 (upon a trustee
giving a charge-over or in relation to an asset of the superannuation fund.).
Enquiries made by the writer with the Treasury revealed that the Treasury
may enter into a process of consultation with APRA and the industry, following
passage of the amending legislation, to determine whether or not any amendments
to the SIS Regulations will be made.
While the previously expressed APRA and ATO concerns in relation to the
application of SIS Regulation 13.14 were only in relation to instalment warrants
by way of shareholder application, it would seem to be desirable that there be a
clear statement now in the SIS Regulations that an investment in instalment
warrants which otherwise satisfies the requirements of proposed section 67(4A)
of SIS would not constitute a breach of SIS Regulation 13.14.
the time of writing this paper the amending Bill had been passed by the House of
Unit Trust Issues
latest information22 discloses that funds invested in self managed
superannuation funds (SMSF's) roughly equals the funds invested in industry
funds and corporate superannuation funds combined, and are second only to the
amount invested through retail funds.
With the introduction of choice of funds, the removal of the work test
for those under 65 the transition to retirement reform, and the Superannuation
Simplification reforms, the increasing use of SMSF's is a trend which seems set
experience shows that the weight of money invested through SMSF's, the desire
for diversification of investments, the chase for property assets promising
secure returns and capital growth, the opportunities available to private
investments in the property market, and the temptation to access cash in an SMSF
for that purpose, all feed an ongoing interest by trustee/members of SMSF's in
structures which permit them to use cash in SMSF's as 'equity' in direct
are generally discounted as property investment vehicles.
This is on the basis that the property is being considered as a long term
investment and use of a company will not only impose a layer of company tax
(30%) on rental income (which may not ultimately be an issue as superannuation
should recoup excess franking credits through the imputation system) but
will also deny a superannuation fund investor in a company access to discounted
aim is for income and capital gains to flow untaxed through a unit trust to the
superannuation fund, to be taxed at 15% (or 10% effectively on capital gains) or
at 0% if the fund is in pension paying phase.
result will not be achieved if the unit trust is deemed to be a public trading
trust under Division 6C of Part III of the 1936 Act.
possible application of Division 6C must be considered whenever superannuation
funds together hold 20% or more of the units in any unit trust.
In that case, the unit trust will have satisfied the alternative test of
a 'public unit trust' in Division 6C.
If the trust is engaged in anything other than principally letting
property for rent, or owning securities, it will be a trading trust, and a
'public trading trust'.
A trust engaged in developing land for resale at a profit would be a
trading trusts are, of course, taxed as companies.
In-house Asset Rules
83 of SIS requires that a superannuation fund trustee not acquire an in-house
asset if the acquisition would result in the ratio of the market value of the
fund's in-house assets to the market value of all of its assets exceeding 5%.
71 of SIS defines in-house assets as follows:
For the purposes of this Part, an in-house asset of a superannuation fund
is an asset of the fund that is a loan to, or an investment in, a related party
of the fund, an investment in a related trust of the fund, or an asset of the
fund subject to a lease or lease arrangement between a trustee of the fund and a
related party of the fund, but does not include:
asset which the Regulator, by written notice given to a trustee of the fund,
determines is not an in-house asset of the fund; or
asset which the Regulator, by written determination, determines is not an
in-house asset of:
class of funds in which the fund is included; or
the superannuation fund has fewer than 5 members – real property subject
to a lease, or to a lease arrangement enforceable by legal proceedings,
between a trustee of the fund and a related party of the fund, if,
throughout the term of the lease or lease arrangement, the property is
business real property of the fund (within the meaning of subsection 66(5));
investment in a widely held unit trust; or
owned by the superannuation fund and a related party as tenants in common,
other than property subject to a lease or lease arrangement between a
trustee of the fund and a related party; or
asset included in a class of assets specified in the regulation:
to be in-house assets of any fund; or
to be in-house assets of a class of funds to which the fund belongs.
this purpose, a class of assets may consist of, but is not limited to, assets
that are investments in entities that undertake, or do not undertake, specified
for the purposes of this paper, an investment by a superannuation fund in a
related trust of the fund, is an in-house asset of the fund.
71(1) of SIS paragraphs (a) to (j) are a list of assets which are excluded as
'in-house assets' of a superannuation fund.
Relevantly for present purposes, an investment in a widely-held unit
trust is excluded as an in-house asset.
trust is a 'widely held unit trust' if:
is a unit trust in which entities have fixed entitlements to all of the
income and capital of the trust, and
is not a trust in which fewer than 20 entities between them have:
entitlements to 75% or more of the income of the trust; or
entitlements to 75% or more of the capital of the trust. 23
the 'widely held unit trust' exemption requires some care and attention to the
provisions of the Corporations Act.
Consideration would need to be given to whether or not the unit trust
must be registered as a managed investment scheme.
Consideration must also be given as to whether or not those involved in
promoting the unit trust require appropriate licenses.
The need for product disclosure statements should also be considered. 24
section 71(1)(j) the Regulator may determine certain assets not to be in-house
assets of a fund.
Conversely under section 71 the Regulator may determine that a loan,
investment or an asset subject to a lease which is not otherwise an in-house
asset is to be treated as if it was a loan to or an investment in a related
party or related trust or an asset subject to a lease between a trustee of the
fund and the related party.
This is a wide discretion with no guidance in the SIS legislation as to
how it is to be exercised.
expression 'related trust' is defined 25 in relation to a superannuation fund as
a trust that a member or a standard employer sponsor of the fund controls
(within the meaning of section 70E) other than an excluded instalment trust of
70E(2) states that:
entity controls a trust if:
group in relation to the entity has a fixed entitlement to more than 50% of
the capital or income of the trust;
trustee of the trust or a majority of the trustees of the trust is
accustomed or under an obligation (whether formal or informal) or might
reasonably be expected to act in accordance with the directions,
instructions or wishes of a group in relation to the entity (whether those
directions, instructions or wishes are or might reasonably be expected to be
communicated directly or through interposed companies, partnerships or
group in relation to the entity is able to remove or appoint the trustee or
a majority of the trustees of the trust.'
this context the expression 'group' in relation to the member means the member
acting alone or a 'Part 8 associate' of the member acting alone or the member
and a Part 8 associate or associates of the member acting together or two or
more Part 8 associates of the member acting together.
relation to a member of a superannuation fund it is necessary to turn to section
70B of SIS to determine who is a 'Part 8 associate' of an individual.
section 70B includes as Part 8 associates of the member, any relative of
the member, if the member is a member of a superannuation fund, then each other
member of the fund, each director of the corporate trustee and each individual
trustee, any partner and any spouse or child of the member's partner, a trustee
of any trust which the member controls or a company that is sufficiently
influenced by or in which a majority voting interest is held by the member or a
Part 8 associate of the member or any two or more entities which are Part 8
associates of the member.
result of these definitions is that an investment in a unit trust by an SMSF is
limited to 5% of the market value of the fund's assets unless entities other
than the member or Part 8 associates of the member (relatives, partners,
trustees or controlled companies of the member),
50% or more of the units of the trust; or
direct the actions of the trustee of the unit trust; or
able to remove or appoint the trustee of the unit trust.
Unit Trust Gearing Strategies
those other entities can do that, then the trust in which the superannuation
fund invests is not a related trust for the purposes of the in-house asset
is possible to conceive of unit trust structures in which a number of unrelated
superannuation funds and/or other trusts, companies or individuals might invest
so that the unit trust would fall outside the definition of a 'related trust' of
any one of the investing superannuation funds. 26
subject to the prohibition upon superannuation funds borrowing and the
prohibition upon the granting by a superannuation fund of a charge over its
assets, it is possible for a unit trust in which a number of superannuation
funds invest to borrow to gear up the investments by the unit trust.
the unit trust borrows from an external financier such as a bank, it is likely
that the lender will require security over the assets of the unit trust
presumably by way of a first mortgage.
Does the granting of that mortgage by the trustee of a unit trust over
its property amount to a 'charge' over the assets of a superannuation fund which
invests in or lends money to that unit trust?
first consideration one might think that the giving of a mortgage over the
property of the unit trust has nothing to do with the assets of the
superannuation fund which invests in the unit trust or lends money to it.
The superannuation fund's assets are units in or a loan to the unit trust
by the superannuation fund.
The rights created by the unit holding superannuation fund's investment
in or loan to the unit trust must be considered to determine if the charging
prohibition is breached.
nature of a unitholder's interest in a unit trust was recently considered by the
High Court of Australia in the CPT Custodian case27.
Prior to the decision in that case, it had been generally accepted
following the decision of the High Court in Charles' case28 that a unitholder in
a unit trust, unlike a shareholder in a company, had a fixed beneficial interest
in the assets of the trust.
may be seen that if Charles' case did stand for that proposition, then as a
unitholder would have a beneficial interest in each unit trust asset, any
mortgage given by the trustee over the unit trust assets would be a 'charge' on
the unitholder's assets for SIS purposes.
CPT Custodian, the High Court clarified that Charles' case was not authority for
any such general proposition.
Rather, the decision in that case (as was noted in reasons of the High
Court in that case) turned upon the specific (and somewhat unusual) terms of the
particular trust deed which the court had to consider in that case.
In contrast with the trust deed considered in Charles' case, in the CPT
Custodian case the trust deed provided that the unitholders did not have any
interest in any particular asset of the trust.
Rather, they had a fixed proportionate entitlement on a winding up of the
trust to the surplus remaining after discharge of all of the liabilities of the
those liabilities included the claims of the trustee and manager to their fees
This would be so even if there was only one unitholder.
a trust on those terms (which is common in a modern unit trust deed), the nature
of the unitholder's interest is closely analogous to the interest of a
shareholder in a company.
a trust deed similar to that considered by the High Court in the CPT Custodian
case, no 'charge'
is imposed upon a unitholder's interest in the trust by reason of there being a
charge on the assets of the unit trust.
if the investment by the superannuation fund in the unit trust is made by way of
asset which the superannuation fund holds in that instance is not a unit in the
unit trust but the loan to the unit trust, or, more precisely, to the trustee of
the unit trust.
the unit trust has obtained funding from an external lender the security for the
superannuation fund's loan may be a second mortgage.
The superannuation fund in that instance has an additional asset being
the rights under the second mortgage.
Is the subordinated loan made by the superannuation fund to the unit
trust 'charged' by the prior loan and mortgage to the bank?
The bank loan and mortgage certainly have priority over the
superannuation fund's subordinated loan and second mortgage.
In an extreme case if the value of the property held by the unit trust
declines it may be that there is only enough equity remaining in the property to
discharge the prior loan to the bank.
that mean that the superannuation fund's asset (being the loan and second
mortgage) are subject to a charge?
noted earlier in this paper, the prohibition upon giving a 'charge' over or in
relation to an asset of a regulated superannuation fund, is a broad one, due to
the width of meaning of the expression 'charge'.
argument that the existence of a prior bank loan and mortgage is not a charge on
the superannuation fund's loan and second mortgage is simply that those assets
of the superannuation fund are not subject to any charge.
Rather it is the asset of the unit trust which is subject to the
obligation to repay the bank and discharge the bank's mortgage.
contrary view is that SIS Regulation 13.14 is not to be read so narrowly and
that in the context of the SIS legislation the prohibition on charging a
superannuation fund's assets may extend to prior claims which defeat or inhibit
or clog the recovery of the superannuation fund's investment.
is the writer's view that the latter approach would be straining the language of
SIS Regulation 13.14.
If the Parliament and the Regulator had intended the prohibition upon
charging a superannuation fund's assets to extend so far as to preclude
investments which rank with a lower priority to other investments then more
appropriate language would have been used than the language of charging assets.
In the writer's view, the investment by a superannuation fund in
investments which have a lesser priority, such as second mortgage security, is a
question to be determined by reference to the fund's investment powers and
strategy not by reference to the prohibition upon charging of fund assets.
addition, it would be anomalous, if a charge was said to exist upon a
superannuation fund's investment in or loan to a unit trust which has a bank
loan and prior mortgage, but not upon a superannuation fund's shares in a
company which had borrowed and granted a prior mortgage.
Nevertheless, the CPT Custodian case means that, at least in respect of a
superannuation fund investment in trust units in a geared unit trust, the unit
trust deed must be considered on each occasion.
Exception for ungeared related trusts
the purposes of section 71(1)(j) of SIS the Regulator has made regulations (in
SIS Regulations 13.22A to 13.22D) which essentially enable the continuation of
investments or new investments to be made by superannuation funds in certain
related trusts which satisfy the conditions set out in the SIS Regulations.
unit trusts being created now the relevant regulations are SIS Regulations
13.22C and 13.22D.
Subject to satisfying the conditions in those regulations these unit
trusts while not able to borrow, may be used as investment vehicles by SMSF's
and related entities.
requirements which must be satisfied to fall within this exception are:
superannuation fund must have fewer than five members;
trustee of the unit trust must not be a party to a lease with a related
party of the superannuation fund unless the lease relates to business real
property and the lease is legally binding;
trustee of the unit trust must not have outstanding borrowings;
assets of the unit trust must not include:
interest in another entity;
loan to another entity (except a bank deposit); or
asset over or in relation to which there is a charge; or
asset that was required from a related party of the superannuation fund
after 11 August 1999 unless the asset was business real property acquired
at market value; or
asset that had been at any time (unless it was business real property
acquired by a trustee of the unit trust at market value) an asset of a
related party of the superannuation fund since the latter of 11 August
1999 and three years before the day in which the fund first acquired an
interest in the unit trust.
trustee of the unit trust must not conduct a business.
unit trust must conduct all transactions on an arms length basis.
the context of the present consideration of superannuation funds investing in
unit trusts to undertake direct property investment, the requirement that the
unit trust not conduct a business if it is to qualify for the exception to the
in-house asset rules in SIS Regulations 13.22C and 13.22D, should be noted.
This effectively precludes reliance on this exception if it was intended
to establish a unit trust for which superannuation funds might invest to
undertake property development activity.
Sole purpose test
is important to begin and end any consideration of an investment by a
superannuation fund in a closely held property unit trust by reference to the
sole purpose test.
The sole purpose test presents a conceptual difficulty.
While it requires regulated superannuation funds be maintained solely for
one or more of the core purposes or the ancillary purposes, (essentially the
provision of retirement benefits), it may be said that any investment made
within the regulated superannuation fund environment will be for that purpose,
as that is the only end to which the investments in the fund may be put pursuant
to the terms of the governing rules of the fund and the SIS legislation.
that is so, it is also apparent from the structure of the SIS legislation with
its various limitations on investments by regulated superannuation funds, that
the legislature intended that the investments remain available to fund
retirement benefits at retirement (or on earlier death or disability).
Further, given the tax concessional treatment of contributions to and
investments in and benefits received from regulated superannuation funds the
legislation intends that those funds not be used other than solely for the
This means, that collateral purposes such as estate planning or tax
minimisation if pursued take the trustees of a superannuation fund outside the
sole purpose test.
breach of the sole purpose test is an offence.
Moreover, in the case of a self managed superannuation fund where the
members of the fund are the trustees, and vice versa, the breach may cause the
trustees to fail the culpability test29 with the result that the fund could
become a non complying fund, with its attendant penal tax consequences.30
or not the sole purpose test may be breached by an investment in a closely held
property unit trust is a matter which must be decided on the facts of each case.
Certainly, the starting point should be
a consideration of what was said by Windeyer J in Scott's case about the
nature of a superannuation fund and the inappropriateness of a superannuation
fund engaging in profit making by purchase and resale of property.
To the extent that such activity is not appropriate to a superannuation
fund if undertaken directly it also would not be appropriate if undertaken by
the fund through interposed entities, except perhaps if the investment was no
more than a portfolio investment.
considerations apply where the investment in a property unit trust is intended
to be a long held investment to derive a secure income stream and eventual
One off property investments of a speculative nature through a unit
trust, however, would not be in that category.
it would also be relevant to consider what proportion of the superannuation
fund's assets was to be represented by the investment in the property unit
would be expected that the Regulator would consider the matter closely in
circumstances where an investment in the property unit trust is the only
investment of the superannuation fund.
It would be relevant in such a case to consider the planned future
contributions to the fund and future investment strategy of the fund to
determine how significant the initial sole investment might be over the planned
duration of the fund.
Instalment warrants – property
conclusion, because of the complexities surrounding the in-house asset rules in
relation to investments in unit trusts, it may be expected, with the 2007
amendments to permit investments in prescribed instalment warrants, that
appropriately structured property instalment warrant products may be well
received as a much simpler and less worrisome means of direct property
investment for SMSFs.
'Warrants – Understanding trading and investment
warrants' - ASX June 2005
ibid at page 13
'Warrants – Understanding trading and investment
warrants' - ASX June 2005
Note 3 at page 13.
'Warrants – Understanding trading and investment
warrants' - ASX June 2005
'Warrants – Understanding trading and investment
warrants' - ASX June 2005
Refer to the recent amendments to the Income Tax
Assessment Act 1997 (Cth) in relation to capital protected borrowings
contained in Schedule 7 to the Tax Laws Amendment (2006 Measures No. 7) Act
Section 10 of SIS
Scott v Federal Commissioner of Taxation (1966) 117
A similar prohibition is contained in section 95 in
respect of approved deposit funds and in section 97 of SIS in respect of
pooled superannuation trusts.
(1853) 22 LJ Ch 785 at 790, CA
Encyclopaedic Australian Legal Dictionary.
Chow Young Hong v Choong Fah Rubber Manufactory
 3 All ER 1163. Also refer to Prime Wheat Association Ltd v Chief
Commissioner of Stamp Duties (1996) 42 NSWLR 505 at 511-512; Australia and
New Zealand Savings Bank Ltd v Commissioner of Taxation (1993) 42 FCR 535 at
560; NM Superannuation Pty Ltd v Young (1993) 113 ALR 39 at 56-58; Eastern
Nitrogen Ltd v Commissioner of Taxation (2001) 108 FCR 27.
'Warrants – Understanding trading and investment
warrants' - ASX June 2005
Circular II.D.7 Appendix 1 Part B.5
Circular II.D.7 paragraph 22
Circular II.D.7 Appendix 1 Part B.4
Circular II.D.7 Appendix 2
Superannuation Circular II.D.7 paragraph 30
for example the Quantum Warrants described in ATO
product ruling PR2005/27.
APRA Quarterly Superannuation Performance – March
2007 (issued 28 June 2007).
Section 71(1A) of SIS
C Ketsakidis and J Sudano 'SMSF's and Property
development through unit trusts and private companies' Taxation in Australia
Issue 39 No. 9 April 2005
Section 10(1) of SIS
Examples of such strategies are provided in a paper
by Richard Friend 'The use of unit trusts and other property strategies'
Taxation Institute of Australia Superannuation Intensive 17 July 2007.
CPT Custodian Pty Ltd v Commissioner of State
Revenue; Commissioner of State Revenue v Karingal 2 Holdings Pty Ltd (2005)
224 CLR 98
Charles v Federal Commissioner of Taxation (1954) 90
Previously section 288A in the Income Tax Assessment
Act 1936 (Cth), now section 295-325 in the Income Tax Assessment Act 1997
What is a traditional instalment warrant?
and Sue as trustees of the ABC Superannuation Fund wish to purchase 2,000 shares
in BHP Billiton. However the fund only has available cash this year to allow the
purchase of approximately 1,000 shares. The trustees who are the only members of
the fund understand that the members plan to contribute sufficient funds in the
next year to enable the purchase of another 1,000 shares.
investment advisor to the fund suggests the acquisition of 2,000 BHP Billiton
instalment warrants, through an instalment warrant product offered by an
investment bank purchases 2,000 BHP Billiton shares in the name of a security
trustee on behalf of the trustees of the fund, and arranges a limited recourse
loan to the fund trustees for the second instalment of the price. The trustees
pay an initial instalment approximately equal to one half of the price of the
2,000 shares plus interest on a loan for the second instalment of the price,
bank charges and a put option fee.
trustees acquire a put option to put the shares back to the investment bank at
the greater of the current market price or the amount of the loan at the
exercise date of the put option.
trustees are entitled to all dividends and franking credits in respect of the
2,000 BHP Billiton shares underlying the instalment warrants.
the payment of the second instalment becoming due, the fund trustees may:
the second instalment and acquire the underlying shares;
the put option in which case the shares will be sold and the proceeds from
the share sale applied to repay the loan. If the share price exceeds the
loan amount then the fund trustees receive the excess amount.
over' the warrants into a new series of instalment warrants over the same
shares (if available).
the fund trustees may sell the instalment warrants on the secondary market.
and Sue decide to consult their superannuation advisor before investing in
the instalment warrants. The advisor says that until late 2006 it had been
commonly understood in the investment advising community that investments in
traditional instalment warrants by SMSF's did not involve any breach of the
SIS Act or SIS regulations. However on 3 November 2006 the Government
announced that the ATO and APRA had concluded that instalment warrants
involve a borrowing which breaches the borrowing prohibition of section 67
of SIS. Further the explanatory memorandum to the 2007 amending legislation
noted that the ATO also considered that such investments involved an
investment in an in-house asset under section 71 of SIS.
2007 amendments however, were designed to allow investments not only in
traditional instalment warrants by SMSF's but also through instalment purchases
using limited recourse loans to invest in any asset a fund could invest in
advisor also noted that if the fund trustees had previously invested in
traditional instalment warrants before the 2007 amendments took effect on 24
September 2007 then the amendments did not operate retrospectively to
rectify any previous breach of SIS by the investment. Rather the explanatory
memorandum said that previous breaches would be managed through the
discretionary powers of the Commissioner of Taxation and APRA.
What is an instalment warrant by 'Shareholder application'.
and Katrina as trustees of the GK Superannuation fund, own 2,000 shares in
Westpac Banking Corporation. The shares have increased significantly in value
since the fund acquired them. The trustees wish to access the equity in these
shares to leverage an investment by the fund in shares in ANZ Banking
investment advisor mentions that an investment bank would be prepared to offer
instalment warrants over the Westpac shares held by the fund under which the
fund trustees would transfer the Westpac shares to a security trustee who would
hold them on behalf of the fund trustees as security for a loan from the
investment bank. The loan could be used to purchase the ANZ shares.
investment advisor further explains that under this arrangement there is no
disposal of the Westpac shares such as would trigger a CGT event and the fund
trustees would continue to be entitled to all dividends and franking credits on
the Westpac shares.
and Katrina consult their superannuation advisor. She tells them that on 16
December 2002 APRA and the ATO announce that they considered that investments
and instalment warrants by way of shareholder application were generally not
regarded as an appropriate means of implementing a funds investment strategy and
was likely to contravene the prohibition upon a fund granting a charge over any
of its assets, contained in SIS regulation 13.14.
Gearing by SMSF's permitted by 2007 SIS amendments – Traditional Instalment
Warrants over ASX listed shares.
investment in BHP Billiton instalment warrants contemplated in case study 1
above falls within the exception to the prohibition upon borrowing by
superannuation funds now contained in section 67 (4A). That new exception is not
limited to investments in traditional instalment warrants over ASX listed
shares, however. Rather extends to the use of limited recourse loans to acquire
an asset (which the SMSF is otherwise permitted to acquire) through making one
or more payments under an arrangement where the asset is held in trust for the
SMSF until the payments are made and the rights of the lender in the event of
default under the loan are limited to rights relating to the asset.
Gearing by SMSF's not permitted by 2007 SIS amendments.
investment in instalment warrants by way of shareholder application referred
to in case study 2 above would not be permitted by the 2007 amendments
introducing new section 67 (4A). This is because:
Westpac shares in case study 2 were already owned by the fund. Therefore
the borrowing would not be used for the acquisition of an asset by the
SMSF. The use of the borrowed monies to acquire an asset is the first
requirement to fall within section 67 (4A).
the instalment warrant arrangement over the existing Westpac shares owned
by the fund would involve a charge over the fund assets in breach of SIS
trustees of the D&N Superannuation fund wish to acquire from Damien, a
member of the fund, the residential property which is Damien's home. They
have heard of the ability to gear superannuation fund investments under the
2007 amendments and wish to use a limited recourse loan arrangement falling
within section 67 (4A) to complete the purchase. They have found a finance
company willing to lend money on this basis for this purpose subject to
confirmation that the arrangement will not cause the fund to breach the
borrowing prohibition in section 67.
legal advisors to the fund trustees advise that the exception to the borrowing
prohibition in new section 67 (4A) will not be available as the purchase by the
fund of Damien's home would involve an acquisition of an asset from a member of
the fund. The asset being Damien's home does not fall within the exception for
business rule property so that the purchase would breach section 66. As such the
asset would be one which the fund is prohibited by SIS from acquiring and
outside the exception in section 67 (4A).
Gearing by SMSF's permitted by 2007 SIS amendments.
and David are the trustees of the Maritime Superannuation Fund. They are also
the owners of a commercial warehouse and office premises in Brisbane from which
their company conducts a marine supplies business. They propose that the
purchase of the premises by the fund for lease at a commercial rent back to
their company would be a valuable investment and income earner for the fund.
accountant notes that they do not have sufficient available funds in the
superannuation fund in order to the make the purchase. With the new contribution
limits for contribution to the fund by them it would take years to accumulate
the necessary purchase price or pay for the land by instalments. An instalment
sale may also raise questions under division 7A of the Tax Act unless the loan
is at commercial interest under a division 7A loan agreement.
accountant suggests that the trustees investigate whether or not the limited
recourse loan borrowing exception in section 67 (4A) of SIS would be available.
If so he thought that a bank could be approached to organise the necessary loan.
loan monies would be used to buy business real property. On that basis even
though the purchase was from a related party the exception in 66 of SIS to
the prohibition on purchase of assets from a related party would be
available. The asset therefore would not be one the trustees were prohibited
security trust arrangement could be created under the loan arrangements for
the asset to be held on trust by a custodian for the fund trustees until the
asset had been paid for.
agreement for sale of the land would provide for the fund trustees to
acquire the land by one or more payments after acquiring the beneficial
interest under the security trust.
rights of the lender in the event of default on the loan by the fund
trustees would be limited to rights against the land.
lawyer for the fund trustees advised that the requirements of section 67 (4A)
could be satisfied if the purchase and loan were arranged on that basis. Further
the security trust would not be an in-house asset by reason of new section 71(8)
and (9) SIS.
the lawyer also advised that the following would need to be confirmed:
funds investment strategy would need to be reviewed to allow for the
trustees would need to be satisfied that the investment was being made
within the sole purpose test.
the investment involve the granting of a charge over an asset of the fund?
The terms of any mortgage required by the lending bank in relation to the
land would need to be considered. For example, does a mortgage given by the
security trustee over the land give rise to a charge on assets of the fund?
It may be possible to negotiate that a mortgage is not necessarily given the
security trust arrangement.
sale and all of the loan terms would need to be on an arms length basis to
comply with section 109 of SIS.
the key features of a typical instalment warrant.
a typical instalment warrant, what choices does the warrant holder have when
the second instalment becomes due?
warrants offered by different investment banks will fall into different
product categories differentiated by what?
the purpose and effect of the put option under a typical instalment warrant.
the tax treatment of instalment warrants.
do the Commissioner of Taxation and the Australian Prudential Regulation
Authority view instalment warrants?
the 2 principal reasons why the laws passed in late September 2007 are
the basic provisions for using an instalment warrant laid down in section
67(4A) of SIS.
that the usual SIS restrictions will still apply to geared investments
contemplated under section 67(4A), what will SMSF trustees need to consider
when evaluating instalment warrants?