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Suzanne Sloan

Oct 29, 2021

No lease agreements for rental deposits

in SMSF Technical Forum

I am auditing a fund that has no lease agreements in place for the fund's residential property. The Trustees say the tenants are short term and the property is let on a per room basis and the SF gets a better return on its investment by letting the property out per room. I can see lots of deposits into the bank account from different sources (and some are just annotated "rent" and there are also some that are just cash deposits)... there are also deposits from 1 source that are made regularly for more than 8 months. The trustees are reluctant to put lease agreements (even short term/per room ones) in place because they don't want the hassle... They manage the rental property themselves.

My view is that i need to insist on them putting short-term per room lease agreements in place so that i can check the deposits against the lease agreements to ensure all rent due has been deposited or note if there are arrears or if there are any deposits that are not actually rent.

How do i deal with this from an auditor perspective? Should i lodge an ACR for this issue? I think i should also include it in the Management Letter and qualify the audit report... do you agree?

Many many thanks

Suzanne

3 answers0 replies

Comments (3)

Stephen Chiang

Nov 01, 2022

On further reading of this case, is the fund exposed to NALI/NALE if the trustee of the SMSF manages a residential property himself, without engaging a licensed property manager? The trustee has to pay the council rates, arrange insurance, co-ordinate with the tenant and repairers etc. This is merely a cost saving strategy.

Stephen Chiang

Oct 31, 2022

Hi Suzanne

I have a similar situation where a site manager (not a licensed property manager) manages a number of short term holiday units. No lease agreements ever exchanged with no annual rental statements produced. The only audit evidence I had was the bank statements of the SMSF. There was no corresponding confirmation of the rental income for a given audit year.

In that situation, a Part A qualification and management letter could cover the auditor for work file quality.

THE AUDITORS INSTITUTE

Nov 01, 2021

Hi Suzanne

It would be great to get other member's views re this query.

If there are no lease agreements or paperwork to support the deposits then as a starting point I would issue a Part A audit qualification as arguably you are not able to verify / audit the rental income being received.

Yes I would raise it as a management letter item and consider a compliance / Part B qualification & consider lodging an audit contravention report. If you have been unable to verify / audit the income received then you are unable to complete your compliance audit.

Given the NALI / NALE requirements I would also be concerned that they are managing the rental property themselves as this may create concerns depending on how this has been structured. That is if there is NALI/ NALE the rental income will be NALI (& taxed at 45%) and any resulting capital gain resulting from a disposal of the property would be NALI (& taxed at 45%).

Law Companion Ruling LCR 2021/2 "Non-arm's length income - expenditure incurred under a non-arm's length arrangement" gives guidance:

"66. Trang does not charge the SMSF for the work undertaken in respect of the second SMSF rental property.

67. In this instance, Trang's use of the tools of her trade will not be considered minor, infrequent or irregular in nature. Considering all her activities, she will be considered to be undertaking these services in her individual capacity, rather than as trustee for her SMSF.

68. For the purposes of subsection 295-550(1), the scheme involves the SMSF obtaining the services from Trang and deriving the rental income. Trang not charging the SMSF for the services provided constitutes a non-arm's length dealing between the SMSF and Trang, which resulted in the SMSF incurring expenditure in gaining or producing rental income that was less than would otherwise be expected if those parties were dealing with each other at arm's length in relation to the scheme.

69. As such, there is sufficient nexus between the non-arm's length expenditure and the rental income derived from the second SMSF rental property. The rental income will therefore be NALI. The non-arm's length expenditure will also result in any capital gain that might arise from the subsequent disposal of the second SMSF rental property being NALI."

As a result of the above as auditor you will also need to consider the NALI / NALE impact if the trustees manage the rental property.

Thanks

SMSF AAA