What is an Instalment Warrant?

An instalment warrant is an agreement that enables someone to purchase an asset over time.

Under such an agreement, the person makes an initial part payment, and then pays the remaining instalment(s) plus interest and the cost of setting up the loan to fund the asset.

At any time, the person can default and forfeit:

• The asset being purchased under the agreement; and
• Any payment(s) which have already been made.

Once all of the instalments under the warrant have been paid the asset is transferred.

Legislation Changes

Until recently, because instalment warrants involve a borrowing, super funds could not technically invest in them without breaching the law.

However, from 24 September, 2007, changes to the law mean that super funds can now invest in some instalment warrants.

Borrowing conditions.

Under the new provisions, an SMSF trustee is allowed to borrow as long as the arrangement meets the following conditions:

• The trustee borrows money )or maintains a borrowing of money);
• The money is or has been applied for the acquisition of an asset;
• That the asset (or replacement asset) is held in trust so that the SMSF trustee acquires a beneficial interest in that asset or the replacement;
• The SMSF trustee has a right to acquire legal ownership of the original asset or the replacement by making one or more payments after acquiring the beneficial interest; and
• The rights of the lender against the SMSF trustee for default on the borrowing (and related charges) are limited to rights relating to the original asset or the replacement (i.e., the loan is a limited-recourse loan).

Note(*): The SMSF cannot use this exception to acquire an asset which it would otherwise be prohibited from acquiring. That is, existing investment restrictions, such as those on in-house assets and acquiring certain assets from a related party of the fund still apply.

The main reason the Government has allowed this type of borrowing is because the lender can only recover an outstanding amount via the relevant asset (or any replacement).

For example, they might repossess or dispose of the asset.

However, the lender cannot recover money through the fund’s other assets.

The in-house assets rule

The ATO has stated that, if an SMSF invests in an instalment warrant, it is not automatically counted against the in-house asset limit.

However, if holding the asset directly would breach the in-house asset rule, the SMSF must not invest in an instalment warrant for that asset.

Administrative treatment of existing investments

The ATO recognises that SMSF’s may have invested in instalment warrants prior to the law being changed, meaning that they technically may have breached the investment restrictions.

It has set out the following administrative treatment in respect of such investments:

• If an SMSF invested in an instalment warrant before 24 September, 2007 that the new law allows, the ATO will not issue a notice stating that the fund is a non-complying fund solely on the basis of this investment;
• However, if the SMSF invested in an instalment warrant product before 24 September, 2007 that breaches the new law, the ATO will decide on a case-by-case basis what the fund must do to become compliant. For example, the ATO may impose a penalty, or, where possible, require the trustee to rectify the contravention.
  Examples of products that may not comply with the law are those where:
• There is a charge over a fund’s existing asset – for example, an SMSF cannot take a loan against an asset the fund already owns; or
• Investments restrictions mean the SMSF could not normally have acquired the asset – for example, non-business real property a member owns.