At the Tax Institute’s recent superannuation conference, ATO director Kellie Grant said that the lack of lease agreements in the files of approved auditors has been identified as part of the reviews the ATO conducts to ensure auditors carry out a proper and adequate audit.
Grant said of the 41 auditors the ATO referred to ASIC during the 2024-25 income year, 17 of them didn’t have a copy of the lease agreement on the audit file, which means the ATO was unable to determine if the auditor had formed an opinion on whether the lease agreements complied with the relevant provisions of the SISA.
“It is relatively common in ATO audits of SMSFs to find either no lease agreement in place or parties failing to adhere to the terms of an agreement, especially if the arrangement is between related parties,” Grant said.
“SMSF trustees need to ensure they are dealing on arm’s length terms with other parties and provide evidence of this to their auditor.”
Peter Johnson, founder of Advisers Digest, said there is certainly a requirement in superannuation law that an SMSF deals with a related party on terms that are the same as if they are dealing at arm’s-length.
“This is contained in Section 109. Worse, if the fund is not dealing at arm’s-length then any income of the fund would be considered non-arm’s-length income and taxed at 45 per cent,” Johnson said.
“If the fund was under-charging on rent then it would also be providing financial assistance to that related party and that is a breach of Section 65 of the law. It is very important for a fund to be able to demonstrate that it is dealing with any related party tenant of its property that it is dealing on an arm’s-length basis.”
Johnson continued that to comply it is imperative that the fund provides evidence to the auditor that the lease terms are arm’s-length in nature which would usually be by way of an independent valuation of the rent.
“Further, under the in-house asset provisions found in section 71 the law initially states that an asset subject to a lease to a related party is an in-house asset and is limited to five per cent of the total assets of the fund,” he said.
“It would need to be a very big fund to have a property being less than five per cent of the value of all the assets of the fund. The law then goes on to provide an exemption for an asset that is ‘business real property’ that is leased to a related party to be considered as being an in-house asset.”
However, he added, the exemption is for business real property that is “subject to a lease, or to a lease arrangement enforceable by legal proceedings, between a trustee of the fund and a related party”.
“The problem here is the bit that says it is enforceable by legal proceedings. The ATO has interpreted that clause to state that there must be a current lease in place for the property,” he said.
“As an auditor of the fund you need to ensure that the property is not an in-house asset of the fund and that means you need to confirm that there isn’t a current lease in place. Failure to ensure there is a current lease in place is a failure to correctly perform the audit and we are seeing the ATO taking issue with auditors not requiring evidence of a current lease.”
He said it is also very important to check when the lease ends.
“Some leases have a specific term that then moves to a month-by-month ongoing lease. Others have a specific end date. If there is a specific end date you need to execute a new lease on market terms,” he said.
Leases are negotiated based on the prevailing market conditions at the time of entry into the lease. Benchmark evidence at that time is key. Leases typically have some review to market or an indexing built in too.
The suggestion that the absence of a signed lease means there is no lease is legally incorrect. In NSW, a tenancy can arise without a written document. In that scenario you have an equitable lease, which remains enforceable and can support litigation. The issue is evidentiary quality and priority, not the lease’s existence. See Ideal Business Centres Pty Ltd v Violin Holdings Pty Ltd [2018] NSWSC 1249.
Likewise, the mere act of signing a lease does not establish arm’s length behaviour. Arm’s length is demonstrated by how the parties conduct themselves: consistent rent payments, enforcement of terms, market support, and commercial discipline. A lease can be fully documented and still non-arm’s-length if the behaviour is compromised.
The real tension is when market conditions move. If the rent was market at commencement but becomes misaligned over time, what then? Commercial landlords often don’t renegotiate mid-term simply because the market shifts. Yet ATO commentary sometimes implies a need for continuous re-benchmarking.
So which principle governs?
Do we respect the commercial integrity of the existing lease (as with unrelated parties), or are trustees expected to re-price mid-term to “maintain market”?
Has the ATO provided a definitive position on this, or are auditors still left to infer it?