Hello Jean, thanks for the question.

In the situation at hand, the fund received rent in relation to a property held by the fund member in their personal name, due to the fund member giving the fund’s bank account, accidentally and incorrectly to the real estate agent.

Section 52(2)(g) and section 52B(2)(d)(i)

Section 52(2) of the Superannuation Industry (Supervision) Act 1993 (SIS Act) lists the covenants that are required to be included in the governing rules of superannuation funds.

Section 52(1) says:

52(1) If the governing rules of a registrable superannuation entity do not contain covenants to the effect of the covenants set out in this section, those governing rules are taken to contain covenants to that effect.

Section 52(2) says:

52(2) The covenants referred to in subsection (1) include the following covenants by each trustee of the entity:

With subsection (g) stating:

(g) to keep the money and other assets of the entity separate from any money and assets, respectively:

(i) that are held by the trustee personally; or

(ii) that are money or assets, as the case may be, of a standard employer- sponsor, or an associate of a standard employer-sponsor, of the entity;

Section 52B of the SIS Act lists the covenants that are required to be followed by the trustee(s) of a self-managed superannuation fund. 

Section 52B(2)(d)(i) and (ii) effectively mirror what is required to be in the fund’s governing rules under section 52(2)(g)(i) and (ii) – as provided above.

In brief, there does seem to be breach of section 52B(2)(d)(i).

Interestingly, a breach of section 52B(2) is not listed in Table 1A of reportable breaches by the Commissioner. [Link to Table 1A]. 

Accordingly, this matter, as far as it pertains to section 52B(2)(d)(i), should be raised by the auditor in the Management Letter to the trustee of the fund. 

Given the facts as presented in the question, it would appear that money incorrectly received into the bank account of the fund, in relation to the fund member’s rental property, is effectively held by trustee of the super fund on some type of trust, perhaps a resultant trust, for the benefit of the fund member, in their capacity as the owner of the rental property that generated these payments to the fund’s bank account. 

At the risk of oversimplification, a resultant trust can arise where a party holds an asset (such as money) because of a mistake or a fraud.

Accordingly, where the trustee of the fund is holding money on behalf of the member of the fund in some capacity other than their status as member of the fund, (due to an accident/mistake), that money should not be reflected in the accounts of the fund.  

Naturally, the money should be returned to the fund member (if this has not already occurred).  This should be appropriately documented so it is clear that the fund trustee is returning to the fund member rental income that was never the fund’s income or money in the first place.

Failure to pay rent by Member’s business on commercial property leased from fund

It is noted from the facts that the “business stopped paying rent January 2022”. 

Whilst it may not be relevant to the situation at hand, consider if there was any possibility for COVID-19 rental relief to apply – noting that this relief came to an end as of 30 June 2022. 

Attached is a link to an ATO factsheet in relation to SMSFs and COVID-19 related rental relief.

https://www.ato.gov.au/individuals-and-families/financial-difficulties-and-disasters/covid-19/support-for-self-managed-super-funds#ato-Rentalrelief

Putting aside COVID-19 related rental relief, the trustee of the fund has an obligation to act in arm’s length manner in relation to its investments as required by section 109 of the SIS Act. 

The apparent failure of the fund to request payment of rent from January 2022 in a timely manner – something the fund would have done if the tenant was an arm’s length tenant – could amount to the provision of financial assistance to a member or a relative of a member of the fund.  

This could give rise to a contravention of section 65 of the SIS Act.

Provided below is an extract from SMSFR 2008/1 where the ATO addresses this matter:

   Delay in taking recovery action

111. If a trustee or investment manager delays in taking recovery action for a debt owed by a member or relative of a member, financial assistance is given to that member or relative. In determining whether there has been a delay it is appropriate to consider usual commercial practice for collecting a debt of that type from an arm's length party. Conversely, if the trustee or investment manager pursues a member or relative for a debt in accordance with usual commercial practice for a debt of that type, this indicates that the trustee or investment manager has not given the member or relative financial assistance even though there is an amount outstanding.

Example 5 - release from an obligation - financial assistance

112. West SMSF owns a property. The property qualifies as business real property and is leased to a member of the SMSF at a fair market rate. Rent is payable monthly in advance, although the trustee did not require a rental payment for a particular month.

113. The trustee has effectively released the member from the obligation to pay the rent by failing to enforce the payment. The failure to require payment of the rent is the giving of financial assistance to the member using the resources of the SMSF. The trustee therefore contravenes paragraph 65(1)(b).

114. Paragraph 65(1)(b) is also contravened if the trustee forgives the member's debt before it becomes due and payable or delays taking recovery action and the delay is inconsistent with usual commercial practice for collecting outstanding rental payments.

115. However, paragraph 65(1)(b) is not contravened if the member has failed to pay the rent in advance and the trustee is pursuing payment of the rent in a manner consistent with pursuing the payment of rent if the property were leased to an unrelated third party.

116. Other relevant considerations include the sole purpose test in section 62, the in-house asset rules in Part 8 including the 5% limit on the market value ratio of the SMSF's in-house assets and the exception in paragraph 71(1)(g) and the arm's length requirements in section 109.

The facts state that the property is rented by the “member’s business”.   This is taken literally in this instance.  It is noted that section 65 (provision of financial assistance to a member or their relative) only applies where the financial assistance is to a natural person (member or relative of member).

So, if “member’s business” was being used as a short-hand expression for a business conducted by an entity controlled by a fund member (such as a discretionary trust) then a breach of section 65 is not an issue for this audit. 

That said, section 109 (the requirement to undertake investments on an arm’s length basis) needs to be satisfied no matter who the tenant is.

Treatment of rent for 2023 FY

The facts state that for the 2023 FY no loan repayments were made on the LRBA and the “accountant offset the rent as being paid directly off the loan so that there is rent received and loan repayments made to be made on the LRBA.”

It is assumed from this observation that there was a set-off agreement entered into between the member of the fund (the provider of the LRBA) and the trustee of the fund in relation to both the rent owed by the member of the fund the repayment of the LRBA owed to the member of the fund.

Any such set-off agreement should be properly documented – even if that documentation is a series of letters between the fund member in his capacity as tenant to the SMSF and then another letter from the fund member to the SMSF in relation to the repayments of the LRBA.

There are other issues that need to be considered.  We need to be satisfied that the rent charged is genuine arm’s length rent.  If it is greater than arm’s length, then the rent may be taxable at 45% as non-arm’s length income under section 295-550 of the Income Tax Assessment Act 1997.  If it is less than arm’s length there is likely to be a breach of section 109 and possibly section 62 (sole purpose test) of the SIS Act.

If the level of the rent charged has been set to the amount of the principal and interest repayment on the LRBA, then this could be an indicator the rent is not arm’s length.

Put another way, whilst the level of loan repayments is certainly a factor a landlord might take into account when deciding if an investment in real estate is feasible, it is rarely the case that rent that can be charged to an arm's length tenant will be a perfect match for the P&I payments the landlord will be making to the financier.

It is noted that the facts did not state that the rent and loan repayments equalled each other. The above discussion has been included for the sake of completeness.

The LRBA should also be examined to ensure that it too does not give rise to NALI issues if the terms are too generous to the SMSF, or section 109 issues if they are too generous to the member of the fund who is the provider the borrowed money.     

In relation to interest rate and the terms of the LRBA the fund has in place with its member, consideration should be given to PCG 2016/5.