One of the biggest challenges a self-managed super fund (SMSF) can face is when the tenant of a highly valuable, fund-owned commercial property fails to pay the rent.
Much of the fund's financial wellbeing may depend upon regular payment of rent – particularly if a heavily geared property is the fund's sole or dominant asset.
The fund, of course, would be expected to take all necessary action to try to recover the overdue rent and, if necessary, remove the financially-troubled tenant from the premises.
But imagine how the difficulties for your fund may escalate if the wayward tenant is your family business.
Be warned, many family SMSFs and family businesses are at risk of becoming embroiled in such inter-family disputes.
"Many of the businesses we see now see are struggling," says Martin Murden, a director of Partners Group, financial services provider to accountants.
Before entering a landlord-and-tenant arrangement between your business and your super fund, Murden, an SMSF specialist and author of How to invest in property through your self managed super fund, urges his clients to think about what could go wrong.
It is a common practice for a family SMSF to own the business premises of the family business in order to gain a range of retirement, tax, business, and asset-protection advantages.
Your family business pays a commercial rent to your family SMSF. And your fund claims tax deductions for interest on the loan to buy a typically geared property.
Further, the property is generally out of the reach of creditors if individual fund members are declared bankrupt – subject to claw-back provisions in the Bankruptcy Act.
And if your SMSF sells the property once fund assets are backing the payment of a pension, no capital gains tax is payable on the sale.
It can, however, be a matter of conflicting loyalties and pressures if your business strikes financial problems and fails to pay its rent.
On one side, the family business may require those premises to keep operating in the hope that profits will return. (In a many cases, a business than cannot pay rent to its own SMSF will struggle to pay rent to another landlord – even for poorer quality premises.)
Yet on the other side, the fund's trustees – who are the same people as the business owners in these circumstances – are legally obliged to maintain the fund with the sole purpose of providing member retirement benefits.
In any case, Murden says SMSFs with commercial properties generally have to borrow to buy and require regular rent to meet their loan repayments.
Businesses experiencing financial difficulties usually become slower to pay their creditors. And Murden says a decision is sometimes made, consciously or unconsciously, that the last creditor to pay is their owner's self-managed super fund.
He stresses that if a members' business is not paying its rent to the family SMSF, the retirement savings of the members are being jeopardised.
Here are eight key points to consider involving a family business renting its premises from the family's SMSF.
1. Think about what could go wrong before entering the arrangement
There would be a natural tendency to concentrate on the positives.
Plenty of other problems may arise apart from the family business being unable to pay its rent.
Peter Bobbin, a principal of Argyle Lawyers, emphasises that the SMSF might be forced to sell the premises to pay benefits to members following a marriage break-up, death or disability. Indeed, the marriage of a couple who are both business partners and SMSF members may end in divorce.
In turn, the forced sale of the premises to pay member benefits may damage the family business.
2. Don't let possible tax advantages dominate your decision-making
"Understand the commercial and legal risks," advises Bobbin, who describes tax-dominated decisions as "misguided". (Bobbin's specialties include SMSFs, tax and family businesses.)
3. Understand the fund's obligations to pursue unpaid rent – even from its members' own business
"A super fund must use all usual means to collected unpaid rent," says Bobbin, "and commonly should have personal guarantees for any arrangement with a business.
"And if the business fails, the fund will need to press the personal guarantees – even with the members' themselves," he adds.
4. Recognise what actions the SMSF regulator could take over unpaid rent by the fund members' business
Murden says possible actions for breaching the Superannuation Industry (Supervision) Act include fines, the trustees being disqualified or the fund being declared non-complying.
The market value of non-complying funds is taxed at the top marginal rate, less any non-concessional or undeducted contributions. In short, this can wipe out almost half a fund's assets.
5. Understand your fund could lose ownership of geared property
Murden says that if your business can't pay rent to your SMSF, your fund could fail to make instalments on its investment loan. "If your fund can't meet its loan instalments, the bank will want its money back [plus its costs]."
And Murden says the fund could lose its investment and the family business could lose the use of its premises.
6. Question whether your SMSF can really afford to gear a commercial property – no matter whether your own business will become the tenant
Murden says funds should take into account the levels of debt already being carried by the SMSF, the business and the business owners in a personal capacity.
And he suggests that funds should consider the effect that the next halving of the standard cap on concessional contributions for super fund members over 50 could have on their fund's cashflow and ability to make loan repayments. (This cap will fall to an indexed $25,000 from July next year.) Many funds require the cashflow from high concessional contributions to meet all of their loan obligations.
Funds should also assess the impact of future interest rate rises on the ability to make loan repayments, says Murden.
7. Decide whether your business may be better off renting its business premises from an unrelated landlord
Murden says funds shouldn't rent business premises to their own businesses simply because it is allowed under superannuation law.
Some SMSFs would be tougher with an unrelated tenant than a related one. And that approach may not be in the fund members' best interests.
8. Ensure your fund is adequately diversified if possible
This will mean that the fund members' savings are not overly dependent on the profitability of a single costly asset, namely your business premises.
