by John Wojtowicz (Director - Law Central Legal)

It is a common and popular investment for Trustees of an SMSF to purchase freehold property.

Often a small business owner may purchase the land through their SMSF and then have the fund lease the property back to the business. This bulletin focuses on the need to have such a transaction properly documented. Issues relating to the financing of the purchase by the SMSF will be addressed in a future bulletin.

What is a Commercial Lease?

A lease is a legally binding agreement between the landowner and the tenant that creates an interest in the land that is subject to the lease. The lease gives the tenant security of tenure and is essential to establishing the goodwill value of the business and its future resale value. In certain businesses this may be critical if the location is core to the value of the business - e.g. a lotto kiosk at a shopping centre.

Lease documents will, in nearly all cases, contain certain common terms - e.g. the term of lease, rent and outgoings payable, tenant obligations and landlord obligations. Other terms may include a redevelopment clause or a specific clause or clauses relating to the particular business leasing the land.

Certain legislation in each State may also affect what terms can be enforced in a lease. The most common example of this relates to a situation where the proposed tenant is a “Retail Shop” (the law on this area will be different from State to State).

Interest in Land - to be in writing

Under various State Acts, for an interest in land to be binding then such an interest needs to be in writing:

New South Wales - section 23C Conveyancing Act 1919

Victoria – section 53 Property Law Act 1958

WA - section 34 Property Law Act 1969

Queensland - section 11 Property Law Act 1974

South Australia - section 29 Law of Property Act 1936

Tasmania- section 60 Conveyancing and Law of Property Act 1884

In short a “hand shake” deal to create a binding lease will not be binding - it must be in writing. (In certain circumstances the court may enforce a verbal agreement under equitable principles. The law in this area is complex and the court decisions vary depending on the facts of each case).

Lease to be Registered

Some state legislation requires a lease to be registered with the relevant land titles department when the term of the lease is over a certain period of time.

The case of Alonso v SRS Investments (WA) Pty Ltd [2012] WASC 168 held that a guarantee contained in a lease may not be fully enforceable if the lease is not registered. Gold and Platinum members can read more about this point in the platinum section of this bulletin.

SMSF and Commercial Leases

If an SMSF wants to own freehold land and lease it back to a business that is a related party of the SMSF then the land or property in question must comply with the definition of “Business Real Property” (BRP) under the Superannuation Industry (Supervision) Act 1993 (SIS Act).

Section 66(5) of the SIS Act states the following definition of BRP:

“ "business real property", in relation to an entity, means:

1. any freehold or leasehold interest of the entity in real property; or
2. any interest of the entity in Crown land, other than a leasehold interest, being an interest that is capable of assignment or transfer; or
3. if another class of interest in relation to real property is prescribed by the regulations for the purposes of this paragraph--any interest belonging to that class that is held by the entity;

where the real property is used wholly and exclusively in one or more businesses (whether carried on by the entity or not), but does not include any interest held in the capacity of beneficiary of a trust estate.”

Liquidated Damages Clause in a Lease

There has been some commentary in the market place about “liquidated damages” clauses in a lease breaching superannuation laws.

A liquidated damages clause in a lease normally requires the tenant to pay compensation for breaching the terms of the lease; the liquidated component being a determinable or ascertainable amount.

For a ‘liquidated damages’ clause to be enforceable the amount of compensation payable under the clause must be proportional to the pre estimated loss. If the compensation required to be paid is non proportional to the pre estimated loss it may be considered to be a penalty and the clause becomes not enforceable. See the case of Andrews v Australia and New Zealand Banking Group Limited (2012) HCA 30.

Some commentary has been made that payments made under these clauses by tenants that are members of the SMSF landlord may breach contribution limits. This is not the case in our view if the “liquidated damages” clause is drafted to have the compensation proportional to the pre estimated loss. The ATO in Tax Ruling TR 2010/1 in paragraph 8 states in relation to contributions that:

“8.        A person will not normally have a purpose of benefiting a member of the fund if the transaction they carry out is in no way dependent upon the identity of the other party as a superannuation provider or they are simply fulfilling the terms of a contract or arrangement entered into on a commercial or arm's length basis.”

Fit – Out

It is possible that the SMSF as landlord may pay for the fit out of a tenancy for a tenant that is a related party. This must be done on commercial terms and the fund can only pay for items that come under the definition of business real property (see platinum section).

Gold and Platinum members read on for more detail on how the SIS Act interacts with Business Real Property and for more information regarding the enforceability of a guarantee in a lease that is not registered.

In summary, when an SMSF purchases property to lease back to a related party business it should:

1. have this investment contained in its investment strategy;
2. make sure that the property falls within the definition of a BRP under the SIS Act;
3. have a written commercial lease agreement in place – on commercial terms; and
4. ensure that the terms of the lease are complied with at all times.

Disclaimer: The content of this Bulletin is general information only. It is not legal advice. Law Central Legal recommends you seek professional advice before taking any action based on the content of this Bulletin.