LRBAs and related party leases: what you need to know
A common strategy implemented by business clients is to buy a commercial property (usually the premises from which their business is run) via their SMSF and then lease this property back to the related party. Borrowings are often used to finance the acquisition. The complexity arises when the related party tenant wants to make changes or improvements to the property, as the borrowing rules typically prevent property improvements.
Alistair is the sole director and shareholder of a company that runs a dentist surgery, and he has found retail premises to suit the rapidly expanding business. Alistair establishes an SMSF, enters into a Limited Recourse Borrowing Arrangement (LRBA) and borrows to acquire the retail premises. Following settlement, the SMSF leases the premises to the related company on arm’s length terms. So far so good.
However as would typically be the case, the company requires a special fit out to suit the surgery requirements, including a minor design makeover, new walls, cabinetry, lighting and other equipment requiring installation.
Alistair is naturally concerned that the installation of the fit out will affect the superannuation law compliance of the acquisition.
Prohibition against related party acquisitions:
The starting position is that if an object is affixed to a property, it will form part of the property. This means that any item the company attaches to the property will be treated as an acquisition by the trustee of the SMSF. This is an acquisition from a related party which is also prevented under Superannuation Law and the ATO has confirmed this view. However agreements can be structured in such a way so as to provide the tenant with the “right of removal”. In fact agreements should go further and stipulate that items that the tenant affixes to the property remain the sole property of the tenant and the tenant must then remove the items at the expiry of the lease. Whether or not the items are removed at the end of the lease would seemingly be less important so long as the intent of the landlord and SMSF Trustee was not to acquire those new assets.
SMSF Borrowing Rules:
SMSF Trustees too are not allowed to improve or change the nature of assets whilst borrowings are in place. However, so long as the changes outlined above are not funded using borrowed funds, and that lease agreements contain “retention of ownership” and “make good” clauses ensuring the property assets remain with the tenant, there should be a case for allowing the changes.
Identity of Payee:
When implementing a strategy as outlined above, it is really important that all purchases are made by the related party tenant and not the SMSF itself. If the SMSF was to pay for some of these expenses, a number of compliance issues would arise subjecting the Fund to a myriad of financial penalties.
The above has been adapted with thanks from an article by Tina Conitsiotis and Daniel Butler at DBA Lawyers, with their permission. As always, please talk to us if you intend on entering into any such complex transactions.