SMSFs that own and lease business real property to a related-party tenant may face the potential risk of tainting the fund’s assets with non-arm’s-length income (NALI) if they accept lease payments exceeding a 12-month period, a technical specialist has noted.
Accurium head of education Mark Ellem advised practitioners and trustees to exercise caution when coordinating a lease agreement for business real property as what may be considered a commercial lease charge for NALI purposes today may not be considered an arm’s-length arrangement in a year’s time.
“As long as the amount of annual rent paid is a commercial amount, then there should not be a NALI issue. The real question is why is the rent paid 12 months in advance?” Ellem said.
“Is it a pre-payment in June to bring forward a tax deduction for the related-party tenant? I’d be comfortable with the 12-month pre-payment, but not anything over that as it then may attract the NALI provisions.”
In this regard, he examined whether an arrangement involving upfront lease payments offers any tax advantages for an SMSF and recommended opting for monthly lease payments to minimise the risk of the fund incurring NALI.
“If we’re receiving rent in year one, like in May or June, and it’s covering the rent period for the next income year, while the related-party tenant might be getting a tax advantage of pre-payment deduction, those pre-payment rules can’t go out 12 months,” he said.
“From the SMSF perspective, we’re going to be paying tax on rent earlier than what we would pay had it been paid on a monthly basis. So who’s getting the benefit here when it comes to the lease of business real property to a related-party tenant?
“With the lurking in the background of the NALI rules, I’d like to err on the side of caution and keep related-party leases to be more like the majority of commercial leases, that is, monthly lease payments. I’m comfortable with 12 months in advance but no more, as long as you show that it’s all commercial and it meets those pre-payment rules.”