Plenty of businesses operate in premises which are owned by a related entity. The importance of having a proper lease in place between those entities is frequently misunderstood.
Often, such tenancy arrangements are informal – the land is owned by one entity and the business is operated by another – but because the same people are in control of both entities, there is no formal agreement in place for the use of the land by the operating entity. We see this most often with self-managed superannuation funds (SMSFs) – the land is held in the SMSF, and the SMSF members use the land to operate their business.
This scenario can prove problematic on many fronts – set out below are some of the reasons why you should consider putting a lease into place between related entities.
Compensation claims
In the recent case of Olde English Tiles Australia Pty Ltd v Transport for New South Wales, land in Annandale, NSW was owned by a family who used it to operate a tile business through a corporate entity. There was no formal lease in place.
The land was compulsorily acquired by the NSW Government and the business entity sought compensation for its business relocation costs. However, as there was no formal lease in place, the NSW Court of Appeal held that the business entity had no “interest” in the land for the purposes of the compulsory acquisition law, and therefore they were not entitled to be compensated for relocation costs.
Risk management
Leases serve an important function of allocating liability for costs and risk. If an accident occurs on the land and a claim is brought for personal injury, a proper lease will go a long way to determining who is responsible for the costs of meeting the claim by addressing matters such as risk and indemnity.
In the absence of a lease, there may also be difficulties with recovering an insurance claim if the building is damaged.
Security of tenure
Things don’t always run smoothly in families, and if there is a rift between those in control of the land and those who run the business from that land, this can have serious repercussions for the viability of the business, especially if the landowner decides to sell the land. A formal lease will ensure that the business operator has an enforceable right to continue their business on the land in these circumstances.
A lease (with the consent of any mortgagee) will also go a long way in protecting the operating business against the unfortunate circumstance were the bank might need to step in and conduct a mortgagee sale.
Sale of business
If the business is to be sold, any knowledgeable buyer will insist on there being a lease in place which entitles the business to use the land it operates on. Having a formal lease in place therefore adds value to the business.
Accounting/tax considerations
A properly drafted lease will clearly set out matters such as what rent is payable, when and how rent will be increased, and who is responsible for outgoings relating to the land.
This makes it much easier to justify payments and allocate liability for these matters when preparing the business and landowner accounts and tax reporting. Your accountant and auditor will always prefer you to have some kind of basis (like a signed lease) for setting rent payments at a particular amount.
SMSF rules
Self-managed superannuation funds are governed by the Superannuation Industry (Supervision) Act 1993 (Cth) and associated regulations. This Act requires all investments of a superannuation entity to be made and maintained on an arm’s length basis (commonly known as the “arms-length rule”).
To comply with this rule, any tenancy arrangements for property owned by the SMSF and occupied by a related party must be fully and properly documented. In practice, this means there must be a written lease in place, and the rent payable (and actually paid) under the lease must align with the market. Without a formal lease in place, it is likely the SMSF will be non-compliant.
How we can help
The team at Moores has extensive experience in handling these issues and can help you to quickly and easily get a lease into place between related parties, saving you the kinds of headaches we’ve outlined above.
If any of the above raises concerns for you, please get in touch with us and we’ll help you put into place a quick and effective solution.
Contact us
Please contact us for more detailed and tailored help.
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