Time for an annual review for related-party lease arrangements
With various SMSF changes happening at the end of the financial year, funds can start reviewing their related-party lease arrangements to ensure these are good health and make sure associated income and gains can be concessionally taxed, according to a technical specialist.
In a recent online technical update, Heffron senior SMSF technical specialist Annie Dawson said there are potentially a lot of good reasons to start reviewing related-party lease arrangements, especially with the ongoing and incoming changes seen across the financial year.
This includes many funds changing auditors as a result of the independence requirements along with the end of the ATO’s compliance approach on COVID-19 rent concessions offered to related parties on 30 June 2021. Meanwhile, the work the ATO is undertaking on non-arm’s length income (NALI) is also 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,” Ms Dawson said.
“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.”
Ms Dawson noted SMSFs will need to make sure the fund’s documentation is in correct order.
“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,” she said.
“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.”
Meanwhile, it will also be important to consider if the tenant wants to bring forward a tax deduction this year, according to Ms Dawson.
This is because a prepayment of rent may be permitted subject to the lease agreement, but it will be important that trustee minutes or a resolution should record why the prepayment was appropriate and on arm’s length terms.
However, 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,” she explained.
“As Melbourne goes through 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)”.
While the ATO did not require auditors to report breaches of section 65 (financial assistance) and section 84 (in-house asset rules), Ms Dawson noted 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.
“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 (e.g. accountant not charging their fund accounting fees),” she explained.
“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-arm’s 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.”