Wednesday, September 16, 2009

Part 1: Trading SMSF assets (and replacement assets) bought under an instalment warrant arrangement

Christopher Balmford, MD

Since the original blog post below, the law on SMSF borrowing - and the replacement assets issue - has been clarified. In particular, there are some useful comments in the Explanatory Memorandum issued with the Bill. The changes to the law were passed in late June 2010. They will receive Royal Assent in early July 2010.

You can download a copy of the bill and the Explanatory Memorandum here

Cleardocs reports on the changes, and on related developments, in ClearLaw articles here

Orginal blog post
An issue puzzling people about SMSF borrowing is what happens when the SMSF trustee(s) sell an asset (especially shares) bought under an instalment warrant arrangement. I know that our lawyers at Maddocks have received quite a few calls about this on our free legal helpline — and people asked about it at the breakfast seminar on SMSF borrowing that we ran with Maddocks, and with bankers from NAB and St George.
You can watch a video of the seminar here.
You can see some introductory information about instalment warrants — including an interactive graphic overview of how they work and the documents involved — here.
The main issues that people have raised on our free legal helpline are:
  • If the SMSF trustee(s) buy shares in a listed public company through an instalment warrant arrangement, then what are the implications for trading those shares?
  • When the shares are traded, what happens to the legal documents that record the instalment warrant arrangement?
If you attended the Cleardocs' Business Insights Breakfast Forum (in Sydney or Melbourne), or if you've watched the video of the Melbourne session, then you may remember Julian Smith (Partner, Maddocks) cautioning us all that the legislation is not entirely clear on what constitutes an "asset" and a "replacement" asset — particularly when it comes to share trading. To date, the ATO has not shed any light on this uncertainty.
I've been trying to think through the implications for SMSF trustee(s) when they trade shares bought under an instalment warrant arrangement.
Below, I set out where my thinking gets to. I'm keen to hear your comments and to know if anyone has heard from the ATO on any of this. By the way, I can't give advice (… and I'm not giving advice and I don't give advice). Instead, this blog post is me thinking through the issues and sharing my thinking. Feel free to share this post with your colleagues, advisors etc. But you need to form your own view. And they need to form their own views too.
An ATO private tax ruling on this would be handy ...
Maybe this topic is one that you might ask the ATO about under the new system that allows SMSF trustee(s) to apply for a private ATO tax ruling on planned activities, see the ATO website here.
If you do learn anything about all this from the ATO (that you are allowed to disclose), we'd be delighted to learn about it.
A thought about "LVRs" — Loan (amount borrowed) to value (value of shares) ratios are relevant
If you borrow against shares (or any other asset), then you provide the lender with security (say, a mortgage or charge) over those shares. So the lender is always concerned to compare the amount you owe it under the loan, with the value of the security which the lender holds – this comparison is known as "the loan to value ratio" or "LVR".
The LVR is a vital factor in this discussion and in the case studies which I'll post on this Blog a few days. A lender won't let you sell shares and keep the proceeds of sale if you leave the lender without enough security – that is, if it will result in you breaching your agreed LVR.
SMSF trustee(s) three options when selling the asset
It seems to me that, logically, the SMSF trustee(s) have 3 options when selling an asset (let's focus on listed shares) bought under an instalment warrant arrangement:
  1. Option 1 Buy and sell (and trade generally) in the usual wayThe SMSF trustee(s) sell some, or all, of the shares and use the proceeds of sale to buy shares in another company. Effectively, the SMSF trustee(s) trade the shares in the normal way.
  2. Option 2 Repay some (or all) of the loan When the shares are sold, the SMSF trustee(s) use the proceeds of sale to repay the loan. The trustee(s) then keep the balance of the proceeds of sale in cash or use them to buy another asset. However, the trustee(s) don't use the existing loan (for example, by redrawing on the loan) to buy another asset.
  3. Option 3 Arrange a new loan and combine the amounts to buy an asset
    When the asset is sold, the SMSF trustee(s) can combine the proceeds of sale with money from a new loan to acquire another asset. I'm thinking this is what is meant by the concept of a "replacement" asset in the legislation, see section 67(4A)(b).
Let me know if you think of any other options.
I'm working on some case studies, I'll post them in a few days. If you want us to let you know when we publish the case studies, send us an email at
More information, any questions
Let us know if you have any questions:
  • comment below
  • call 1300 307 343, if your questions are legal, we can refer you to the free legal helpline at our lawyers, Maddocks

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