Lending to SMSFs a minuscule fear
Several readers have supported David Murray’s Financial System Inquiry proposal to ban direct borrowing by self-managed super funds (SMSFs), arguing that, particularly for smaller funds, direct property holdings are low-yielding, high-maintenance, bulky, illiquid investments.
But the FSI was commissioned to report on the integrity and risks to the financial system, not to engage in judgmental assessments of what and what are not suitable investments for individual Australians. Lending to SMSFs is a minuscule part of the financial system, and one where there are tight controls affecting both borrowers and lenders.
The controls include restrictions on the improvement of the property and its possible uses, as well as annual scrutiny by auditors to ensure compliance with the regulations. Only a foolhardy SMSF investor or adviser would contemplate entering into a limited recourse borrowing arrangement (LBRA) without closely studying the severe restrictions set out in Tax Office Ruling SMSFR 2012/1. These constrain the possible uses of borrowed funds precluding their use for improvement or development of the property.
More importantly, it severely limits the potential for maximising the profits from purchasing geared investments inside an SMSF.
If the FSI’s concern is that allowing SMSFs to borrow has opened up fertile ground for the snake-oil merchants to exploit vulnerable investors and encourage excessive borrowings, this demonstrates blissful ignorance of just how much more important gearing outside super is to the designing and selling of tax shelters to high marginal rate taxpayers.
In his classic article on tax shelters, Columbia law professor George Cooper explained how easily the minds of otherwise rational people quickly turn to mush when presented with the opportunity to pay no tax, especially in transactions involving modest cash outlays.
The tragedy for both the economy and the tax-shelter purchasers is the resulting enormous waste of resources, as evidenced in our history by the failure of the many heavily promoted negative-gearing transactions and a host of other tax shelters, including private jet financing, films, cattle embryos, wildflowers and, most recently, timber plantation schemes.
For today’s investors, the booming property market — assisted by the ability to borrow all the funds required, including the tax-deductible expense of prepaying up to 13 months’ interest — has made negative gearing a far more attractive tax shelter than borrowing in an SMSF.
For higher-income taxpayers, unlimited deductions also make negative gearing a far more attractive option for generating wealth now that the tax deductions for super are capped at a maximum of $30,000 and $35,000 annually and subject to contributions tax of 15 per cent or 30 per cent (for incomes above $300,000 annually). Since deregulation in the mid-1980s, lending to borrowers outside super is subject to no controls and lenders have little incentive to investigate the merits and viability of the project being funded.
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