Business real property can be a great investment for self managed superannuation funds but there is one big potential problem that you need to be on top of.

Let’s assume your SMSF owns commercial property and rents this to your business, which is run by you personally. (Your business affairs aren’t conducted via a company or through a partnership.)

Suppose that for a period of time business hasn’t been great and to solve the cash flow issues you have failed to pay rent to your super fund.

The rules breached

This is a fairly common scenario and one that needs some careful analysis to determine the extent of the problem.

Potentially under the super laws the following rules may have been breached:

• Sole purpose test
• Prohibition on lending money or providing financial assistance to members or their relatives
• Arm’s length dealings
• In-house assets

Let’s look at each of these rules in turn:

Sole purpose test – this says that your super fund must be primarily run to provide its members with retirement benefits or your beneficiaries with benefits on your death. Any benefit from the assets of the fund prior to retirement or death must be incidental to either of those two objectives.

Clearly the non-payment of the rent means your business – and therefore indirectly you – have obtained a commercial benefit. The issues to consider are the dollar value of outstanding rent, the time period for failing to pay, any action you as trustee have taken to recover the unpaid money and the existence of a written lease agreement between you as tenant and the super fund as owner.

Prohibition on loaning money or providing financial assistance to members or their relatives – as the commercial property is leased to you as an individual then is the unpaid rent a loan and therefore a breach of the super laws?

Typically unpaid rent isn’t a loan as we normally understand it. It’s often seen as a normal commercial debtor and creditor arrangement.

However the longer the period of unpaid rent the harder it would be to maintain that some form of loan, by default, hadn’t been created.

Most property leases, including commercial leases, require that a bond be paid. If a bond has been paid then some of it could be used to cover for the unpaid rent.

In addition, if the trustee has done nothing to recover the unpaid rent then this may be seen as some sort of financial assistance.

Arm’s length dealings – the super law arm’s length dealing rule says that when two parties are involved in a transaction, then the super fund must receive at least the same that someone dealing at arm’s length would obtain.

Clearly unpaid rent means this isn’t a normal commercial relationship. A larger arm’s length dealing problem will occur if either or both of the following has occurred:

1. No bond has been paid.
2. The super fund trustee has done nothing to recover rent or apply penalties for non-payment as maybe provided for in the lease agreement.

In-house assets – this rule prohibits more than 5% of a super fund’s assets, valued at prevailing market values, from being invested in related parties of the super fund. You as a fund member are a related party. Real estate that satisfies the business real property test is exempt from this test. Is this rule activated by the unpaid rent?

If there is a loan or some other financial assistance then this would be an in-house asset and a test would need to be run to see if the value of that assistance is greater than the 5% permitted limit.

How do you solve this problem?

Much depends on the time period for non-payment and the action the trustee has taken to recover the unpaid money.

If your super fund’s auditor finds any super law breaches they will be reported to the ATO under the following circumstances:

• If your super fund is less than 15 months old, then any breaches valued at more than $2,000 must reported it to the ATO by your fund’s auditor.
• If the same breach occurred in the current financial year and a previous financial year.
• If your fund had a breach in a previous financial year and you didn’t fix it.
• If you breached a super law that has a statutory time limit (for example your auditor requested a document about your fund which you are expected to provide within 14 days) and you take more than 14 days, then your SMSF auditor will need to report that to the ATO.
• If the total value of all super law breaches is greater than 5% of a fund’s total assets.
• If the total value of all breaches is over $30,000.

In my view, the best way to solve this problem is, ideally, not to let it happen in the first place. But if it has occurred, then the best bet is to fix it promptly and ideally before your auditor reviews your fund.

Alternatively, you will need to work with your fund’s auditor and promptly implement any requirements they stipulate so that they can tell the ATO about the breach, but also say that it’s under control.

Important: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regards to your circumstances.

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