Leases to related parties – problems still exist

SMSFs owning business real property which is rented to a related party continues to be a risk area for us.

Unbelievably we continue to see SMSFs that do not have a lease agreement in place.  Failing to have a lease agreement could be a compliance disaster due to an often-forgotten requirement of section 71 of SISA.

As stated in sub-section 71(1)(g) of SISA, a lease arrangement between an SMSF and a related party is only exempt from being an in-house asset if the property is business real property and the property is subject to a lease, or lease arrangement enforceable by legal proceedings.  From an audit perspective, we are not able to conclude a lease arrangement is enforceable by legal proceedings if no lease agreement can be provided. 

Where no lease agreement exists, the property is classified as an in-house asset and, as it is normally a significant asset of the SMSF, a material compliance breach will have occurred.  The trustees then face the prospect of having to dispose of the property if the ATO does not accept that simply implementing a lease agreement meets the disposal requirements of section 82 of SISA.

Therefore, it is imperative that lease arrangements with related parties are documented at the beginning of the tenancy.

To assist our clients meet their compliance obligations in relation to related party leases, we highlight the following considerations:

WHEN A LEASE ARRANGEMENT BETWEEN SMSF AND RELATED PARTY COMMENCES

• The trustee should obtain an independent expert opinion of the market value of the annual rental.  This should include a contemplation of whether a rent-free period and additional charges for car parks are appropriate.
• A commercial lease agreement needs to be prepared, setting out the terms and conditions of the arrangement.
• Details of the outgoings should be documented within the agreement with these marked to market.

DURING THE LEASE TERM

• The trustee doesn't have to annually justify the commerciality of the lease arrangement to the SMSF auditor.  For example, if the parties have entered into a 5-year agreement, the trustee wouldn't have to obtain a rental assessment until such time as the lease amount needs to be renegotiated.
• The trustee has to ensure the parties are adhering to the terms of the lease agreement.  This would include that the correct rental amount is being paid, at the correct time.  Consistently short-paying or late-paying rental is not an arm's length dealing. 
• In good faith alterations to the terms of the agreement during the lease term could be contemplated.  However, it is important that variations are justifiable and documented.

As always, we encourage you to contact the team at Baumgartner Super in Melbourne on 1300 04 SMSF (1300 047 673) with any queries or comments you may have regarding this or any other audit issue.