Senior SMSF Technical Specialist
It’s that time of year. Lots to do, not much time to do it in. But it’s still important to check under the hood of your SMSFs’ related party lease arrangements.
There are potentially a lot of good reasons to do so:
- many funds are changing auditors as a result of the independence requirements,
- the ATO compliance approach on COVID-19 rent concessions offered to related parties is due to end on 30 June 2021, and
- the work the ATO is undertaking on non-arm’s length income (NALI) is ongoing.
A little bit of time spent now getting things right may save you (and your client) time and resources by avoiding having to fix issues up later on.
Many funds lease commercial property to a related party. And the key to helping clients get these arrangements right is to ensure their super funds are dealing with related entities as if they were a third party. This needs to happen at all times – from when the property is first leased, right through to when the property is vacated or sold. And it doesn’t only apply to the rent but also any expenses or outgoings.
Documentation. Auditors ask for it, the ATO expects it. Trustees need to demonstrate the lease of the business real property is on arm’s length terms. Check you have a current written lease agreement in place, that it is based upon a third party rental appraisal and the terms of the lease are complied with. Be careful to note if the market price estimate of rent quoted is inclusive of GST and outgoings. If the tenant wishes to exercise an option to renew, ensure the notice requirements outlined in the lease agreement are followed.
Does the tenant want to bring forward a tax deduction this year? A prepayment of rent may be permitted (subject to the lease agreement) but trustee minutes or a resolution should record why the prepayment was appropriate and on arm’s length terms, for example, was a discount offered, or was a longer term secured as a result?
But what happens when the tenant can’t pay?
The financial impact of COVID-19 on industry and businesses continues to play out. If the trustees of the fund agreed to offer a related party a rent deferral, ensure the fund has received the outstanding rent as agreed. For a refresher on the original announcements/concessions offered, the Super Companion, our on-line tech resource, has all the details along with frequently asked questions.
As Melbourne remains in lockdown and some industries have been slow to recover, there may be related party tenants who continue to struggle to remit the rent due. In the absence of any further announcements by the ATO, we expect trustees will need to obtain third party evidence to justify the commerciality of any continued arrangements beyond 30 June 2021.
Any arrangements which are not commercial could trigger a breach of a number of SIS provisions including the arm’s length rules, sole purpose test, prohibition on providing financial assistance to members or relatives and in-house asset rules (a rent deferral could amount to a loan to the tenant).
Whilst the ATO did not require auditors to report breaches of section 65 (financial assistance) and section 84 (in-house asset rules) if they were a result of rental relief due to COVID-19 (provided the arrangement was on commercial terms and appropriately documented), no extension on this compliance approach beyond 30 June 2021 has yet been offered.
And don’t forget expenses. The ATO is still working on finalising their view on how they will apply the NALI rules to expenditure of a general nature that is not at arm’s length (eg accountant not charging their fund accounting fees). Accordingly, they will not commit resources to reviewing these types of expenses prior to 1 July 2022, however, this transitional compliance approach does not apply where the fund incurs non-arms’ length expenditure that directly relates to the fund deriving particular ordinary or statutory income (such a property expenditure).
As such, closely review property expenses and outgoings to ensure the correct entity is incurring the expense and on commercial terms.
Owning commercial property remains a popular investment for SMSFs. Ensuring lease arrangements for the year ahead are in good health will ensure the associated income and gains will continue to be taxed concessionally. An ounce of prevention is better than a pound of cure.
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