House of Representatives

Tax Laws Amendment (2007 Measures No. 4) Bill 2007

Taxation (Trustee Beneficiary Non-disclosure Tax) Bill (No. 1) 2007

Taxation (Trustee Beneficiary Non-disclosure Tax) Act (No. 1) 2007

Taxation (Trustee Beneficiary Non-disclosure Tax) Bill (No. 2) 2007

Taxation (Trustee Beneficiary Non-disclosure Tax) Act (No. 2) 2007

Explanatory Memorandum

(Circulated by authority of the Treasurer, the Hon Peter Costello MP)

Chapter 3 Investment in instalment warrants by superannuation funds

Outline of chapter

3.1 Schedule 3 to this Bill inserts an exception to the borrowing restriction contained in section 67 of the Superannuation Industry (Supervision) Act 1993 . This will 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.

3.2 It also inserts a new provision in the in-house asset rules contained in section 71 of the Superannuation Industry (Supervision) Act 1993 . This will provide that an investment in a related trust forming part of an instalment warrant arrangement which meets the requirements of the borrowing exception will only be an in-house asset where the underlying asset would itself be an in-house asset of the fund if it were held directly.

Context of amendments

3.3 Section 67 of the Superannuation Industry (Supervision) Act 1993 prohibits superannuation fund trustees from borrowing money (with certain exceptions, primarily relating to short term liquidity). The borrowing prohibition has been in place since the 1980s, and is one of a number of rules in superannuation legislation designed to limit risk in superannuation fund investment.

3.4 Sections 82 and 83 of the Superannuation Industry (Supervision) Act 1993 prohibit superannuation fund trustees from retaining or acquiring in-house assets representing more than 5 per cent of the value of all the fund's assets.

3.5 Subsection 71(1) of the Superannuation Industry (Supervision) Act 1993 states that an investment in a related trust of the fund is an in-house asset of the fund (subject to the exceptions set out in Part 8 of the Superannuation Industry (Supervision) Act 1993 ).

3.6 Regulation 13.14 of the Superannuation Industry (Supervision) Regulations 1994 states that a trustee must not give a charge over, or in relation to, an asset of the fund. This does not apply in relation to certain charges specified in Regulation 13.15A, however these relate only to options and futures contracts provided the superannuation fund meets certain conditions.

3.7 Over a number of years instalment warrants have been marketed to superannuation funds, particularly self-managed superannuation funds. Instalment warrants are a derivative-based investment product, in that they derive their value from the underlying asset. Traditionally, such arrangements provide the investor with the right, but not the obligation, to buy the underlying asset through the payment of instalments. Investors in instalment warrants have a beneficial interest in the underlying asset, subject to a security interest held by the issuer that secures the payment of later instalments. Once the investor has made the first instalment they are likely to be entitled to income from the underlying asset (eg, dividends from shares).

3.8 The Commissioner of Taxation (Commissioner) (responsible for regulating self-managed superannuation funds) and the Australian Prudential Regulation Authority (APRA) (responsible for regulating other superannuation funds) have come to the view that these arrangements constitute a borrowing for the purposes of section 67 of the Superannuation Industry (Supervision) Act 1993 .

3.9 The Commissioner 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 the Superannuation Industry (Supervision) Act 1993 .

3.10 The Government has decided to legislate to legitimise investment by superannuation funds in instalment warrants. The precise scope of this measure has been determined following consultation with industry. This Schedule gives effect to that decision.

3.11 Funds that invest in instalment warrants must continue to comply with other legislative requirements. Furthermore, fund trustees are still required to demonstrate the appropriateness of including instalment warrants in their investment strategy.

Summary of new law

3.12 An exception to the prohibition on borrowing in section 67 of the Superannuation Industry (Supervision) Act 1993 will allow a superannuation fund trustee to borrow money in accordance with an arrangement that has the following features:

·
the borrowing is used to acquire an asset that is held on trust so that the superannuation fund trustee receives a beneficial interest and a right to acquire the legal ownership of the asset (or any replacement) through the payment of instalments;
·
the lender's recourse against the superannuation fund trustee in the event of default on the borrowing and related fees, or the exercise of rights by the fund trustee, is limited to rights relating to the asset; and
·
the asset (or any replacement) must be one which the superannuation fund trustee is permitted to acquire and hold directly.

3.13 In addition, the in-house assets rules are amended to provide that an investment in a related trust forming part of an instalment warrant arrangement which meets the requirements of the borrowing exception will only be an in-house asset where the underlying asset would itself be an in-house asset of the fund if it were held directly.

Comparison of key features of new law and current law

New law Current law
Subsection 67(4A) of the Superannuation Industry (Supervision) Act 1993 will provide an exception to the borrowing prohibition for borrowings that meet certain conditions commonly found in instalment warrant arrangements. Section 67 of the Superannuation Industry (Supervision) Act 1993 prohibits superannuation fund trustees from borrowing money except in limited circumstances, primarily related to short-term liquidity.
Subsections 71(8) and (9) of the Superannuation Industry (Supervision) Act 1993 will provide that an investment in a related trust forming part of an instalment warrant arrangement which meets the requirements of the borrowing exception will only be an in-house asset where the underlying asset would itself be an in-house asset of the fund if it were held directly. Section 71 of the Superannuation Industry (Supervision) Act 1993 defines 'in-house assets' to include an investment in a related trust of the fund.

Detailed explanation of new law

3.14 An exception to the prohibition on borrowing in section 67 of the Superannuation Industry (Supervision) Act 1993 will allow a superannuation fund trustee to borrow money in accordance with an arrangement that has the following features:

·
the borrowing is used to acquire an asset that is held on trust so that the superannuation fund trustee receives a beneficial interest and a right (but not an obligation) to acquire the legal ownership of the asset (or any replacement) through the payment of instalments;
·
the lender's recourse against the superannuation fund trustee in the event of default on the borrowing and related fees, or the exercise of rights (typically a put option) by the fund trustee, is limited to rights relating to the asset at the time of the action. These rights may include taking possession of, or disposing of, the asset; and
·
the asset (or any replacement) must be one which the superannuation fund trustee is permitted to acquire and hold directly. The asset may be any asset (eg, real property, works of art in certain circumstances or listed securities) a fund would be permitted to invest in directly. The existing investment restrictions, such as those on in-house assets and acquiring certain assets from a related party of the fund, continue to apply.

[Schedule 3, item 1, subsection 67(4A) of the Superannuation Industry (Supervision) Act 1993]

3.15 An investment in a related trust forming part of an instalment warrant arrangement which meets the requirements of the borrowing exception in subsection 67(4A) of the Superannuation Industry (Supervision) Act 1993 will only be an in-house asset under section 71 where the underlying asset would itself be an in-house asset of the fund if it were held directly. [Schedule 3, item 2, subsections 71(8) and (9) of the Superannuation Industry (Supervision) Act 1993]

3.16 This means an investment in an instalment warrant will not be automatically counted against the in-house asset limit. However, the new provisions will not allow fund trustees to circumvent the existing in-house asset rules. Where the underlying asset would have been an in-house asset had the superannuation fund invested in it directly, an investment in the instalment warrant will be an in-house asset. Where the acquisition of such an asset would breach the in-house asset rule if it were held directly, the investment in an instalment warrant over that same asset will not be permitted.

Example 3.1: Limited recourse ABC shares currently trade for $2.The T. Do Super Fund (the Fund) buys an instalment warrant over an ABC share for $1.10 from Bank X (the Issuer) on 1 January 2007.The completion payment is $1 to be paid on 1 January 2008.The Issuer acquires an ABC share for $2, effectively loaning the Fund the completion payment on a limited recourse basis. The share is held by a separate security trust.The extra 10 cents the Fund paid constitutes a pre-payment of the interest on the $1 loan and charges to cover the Issuer's risk.During the year, the Fund receives all dividends that ABC pays to its shareholders.On 1 January 2008 the Fund has the option to pay the completion payment of $1 and gain full ownership of the ABC share.Alternatively, the Fund can choose not to pay the $1 final instalment, in which case the issuer could sell the share and pay the Fund any excess in proceeds over the $1 loan. Should the ABC share sell for less than $1 (the value of the loan) the Issuer cannot recover the shortfall from the Fund.As the rights of the Issuer are limited to the rights relating to the ABC share, the requirements of subsection 67(4A) of the Superannuation Industry (Supervision) Act 1993 are satisfied.

Example 3.2: In-house asset restriction Five per cent of the Fields Family Super Fund's assets are in-house assets for the purposes of section 71 of the Superannuation Industry (Supervision) Act 1993 .The trustee of the fund is prohibited from acquiring further in-house assets by section 83 of the Superannuation Industry (Supervision) Act 1993 .Therefore, the trustee can not use an instalment warrant arrangement to acquire a beneficial interest in another in-house asset, for example, an investment in an instalment warrant over a share in a company controlled by a member of the Fields Family Super Fund, as this would breach the in-house asset restriction.However, the trustee can use an instalment warrant arrangement to acquire a beneficial interest over an unrelated asset, for example, listed shares in an unrelated company. As the underlying asset would not be an in-house asset if held directly, the investment in the instalment warrant trust will not be an in-house asset and there will be no breach of the in-house asset restriction.

Example 3.3: Replacement asset The Lees Family Super Fund buys an instalment warrant over shares in RK Company from Little Lender.RK Company merges with JF Company. RK Company shares are reissued as shares in RKJF Co as a scrip for scrip roll-over.The instalment warrant continues with shares in RKJF Co as the replacement asset.This arrangement is covered by subsection 67(4A) of the Superannuation Industry (Supervision) Act 1993 .

Giving a charge over an asset

3.17 'Shareholder application' style instalment warrants generally involve the use of a fund's existing equity holdings (traditionally, but not limited to, listed shares) to purchase instalment warrants. That is, the fund trustee transfers the legal title of an existing asset to a security trustee in exchange for instalment warrants over that asset. The fund trustee may also receive cash, generally the difference between the price of the warrant and the market price of the asset.

3.18 The Commissioner and APRA, in their roles as regulators of superannuation funds, have determined that such an arrangement involves the fund trustee placing a charge over an asset of the fund (Joint Press Release of 16 December 2002). The operating standard set out in Regulation 13.14 of the Superannuation Industry (Supervision) Regulations 1994 prohibits a trustee from giving a charge over, or in relation to, an asset of the fund.

Application and transitional provisions

3.19 These amendments will apply from the day this Bill receives Royal Assent.

3.20 Existing technical breaches will continue to be managed through the discretionary powers of the Commissioner and APRA.


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