4.6.6.30 Encumbrances & loans against assets

Summary

This topic discusses:

  • the effect of a charge or encumbrance (1.1.E.108) on the value of assets
  • unsecured loans
  • the effect of a charge or encumbrance secured against more than one asset, and
  • aggregating assets for primary producers (1.1.P.389).

Effect of a charge or encumbrance on asset value

The value of an asset is reduced by the amount of any outstanding charge or encumbrance over the asset.

Exception: A charge or encumbrance CANNOT be deducted from the value of an asset if:

  • it is for the benefit of a person other than the recipient or the recipient's partner, OR
  • it is a collateral security, OR
  • the asset it is secured against is disregarded under SSAct section 1118.

A charge or encumbrance for the benefit of a third party or a collateral security, are sometimes called excluded securities. A collateral security is a secondary agreement, supported by money or property, which is ADDITIONAL to the principal security for the same loan.

Example: A recipient's son borrows money for his business, secured against an investment property owned by the recipient. The charge or encumbrance against the investment property IS for the benefit of a person other than the recipient or their partner (in this case the recipient's son benefits). The value of the investment property is NOT reduced by the amount of the charge.

Example: A recipient borrows money to buy a block of land. The lender secures the borrowing by a charge over the land. In addition the lender secures the borrowing against an insurance policy owned by the recipient. The charge over the insurance policy is a collateral security. The value of the insurance policy is NOT reduced by the amount of the charge.

Act reference: SSAct section 1121 Effect of charge or encumbrance on value of assets

Unsecured loans

If a recipient has an unsecured loan AND provides evidence that the loan was specifically obtained to purchase the asset, the outstanding amount of the loan IS deducted from the value of the asset.

Exception: The value of an asset tested income stream CANNOT be reduced by the amount of an unsecured loan.

Charge or encumbrance secured against more than one asset

If a charge or encumbrance is secured against both an asset that is disregarded under SSAct section 1118 AND an assessable asset, the amount of the outstanding charge or encumbrance is shared between the assets in proportion to the asset values. The formula for this is set out in SSAct subsection 1121(4):

  • (value of the charge or encumbrance × combined value of the assessable assets over which there is the charge or encumbrance) ÷ value of all the assets over which there is the charge or encumbrance (includes both exempt and assessable assets used as security for the charge or encumbrance)

Example: A recipient has a charge of $100,000 secured against both their farm and principal home. The value of the farm is $180,000 and the value of the principal home is $60,000. The gross value of the farm and principal home combined is $240,000.

($100,000 × $180,000) ÷ $240,000 = $75,000

This means the net asset value of the farm is $105,000 ($180,000 MINUS $75,000).

Exception: The apportionment of encumbrance rules do not apply to PLS loans that are secured against both an asset that is disregarded under SSAct section 1118 and an assessable asset. The full value of a PLS loan is deducted from the value of the assessable asset.

Act reference: SSAct section 1121 Effect of charge or encumbrance on value of assets

Policy reference: SS Guide 3.4.5.20 Security for PLS

Aggregating assets for primary producers

Primary production assets and liabilities ARE aggregated.

Example: A recipient owns farmland worth $200,000. A mortgage of $50,000 is secured against the land. The recipient runs the farm in partnership with his son. The partnership owns plant, stock and machinery to the value of $100,000. The partnership has liabilities of $150,000. The recipient has:

  • primary production assets of $250,000 (his own land plus share of partnership assets), AND
  • primary production liabilities of $125,000 (encumbrance on land plus share of partnership liabilities).

Total assets of $250,000 MINUS total liabilities of $125,000 = net primary production assets of $125,000.

Act reference: SSAct section 1121A Effect of certain liabilities on value of assets used in primary production

Last reviewed: 1 July 2019