As an auditor, I am passionate about the need for simplicity and reducing red tape where possible, and yet when it comes to lease agreements, I believe it should be best practice for auditors to insist upon a written agreement for transactions with related parties.
There are some within the SMSF sector that may believe a written lease agreement to be an unnecessary document, especially if a verbal agreement has already been made and because there is currently no legislative requirement from the trustee perspective for the written agreement to exist.
For those trustees using the asset held by the fund – property that is being leased as business premises, for example – a written lease agreement might also seem to be irrelevant as a trustee is highly unlikely to terminate themselves.
However, there is a compliance requirement from the ATO that auditors ask for and have written lease agreements on file.
I appreciate this might not be a great enough incentive for trustees to spend time and money on having a written lease agreement drawn up, however, there is another reason why such a document is important and why auditors should insist on its existence, and that is around proving an agreement has been made at arm’s length.
Arm’s length is the requirement any parties dealing with each other make decisions based on their own self-interest rather than personal connection and are negotiating on an equal footing.
It’s a core principle of SMSF transactions and if not adhered to, can result in potential contravention and/or penalty.
Given the high stakes then, a written lease is an easy way to prove the agreement is developed appropriately, including outlining the rights and obligations of all parties, terms and conditions and relevant penalties and breach procedures where applicable.
Further to this, a commercial property is exempt from in-house asset rules, provided the property is used wholly and exclusively for business purposes.
A written lease agreement will clearly state the intended use of the property, whether that be for an office, medical centre or restaurant, for example, and it is this detail that supports the ‘wholly and exclusively’ threshold when there is a minor, insignificant or trifling non-business use of the property.
It is clear then how a written lease agreement can be a useful tool in minimising non-compliance risk and ensuring the substance of transactions is correct.
Some may argue a terms sheet would be sufficient documentation to satisfy an auditor, but I beg to differ.
A terms sheet, while practical, simply isn’t comprehensive enough to satisfy the arm’s-length terms or the ‘wholly and exclusively’ threshold.
Whether or not a written lease agreement is truly required from a trustee perspective is an interesting argument and one often sparking discussion at industry conferences and workshops. However, when considering it from an arm’s-length perspective, it makes sense for trustees to ensure a document of this type is drawn up and for auditors to insist upon its existence.
Naz Randeria is managing director of Reliance Auditing Services.