Real Estate

A how-to guide for rent relief, SMSFs and preventing adverse tax outcomes

By Graeme Colley
Executive Manager, SMSF Technical and Private Wealth - SuperConcepts Sydney, Australia

Whether you or someone else is leasing a property from your SMSF, the current economic situation is concerning, especially if you have experienced a downturn in business. Worse still, you may be required to shut up shop and can’t afford to pay business expenses. As trustee of your SMSF, how do you solve the cash flow problem if the fund is not receiving rent or it can’t make repayments on any limited recourse borrowing it has taken out? Thankfully, recent announcements from the ATO may provide a solution to funds that find themselves in difficulty.

Failure of an SMSF to comply with the Superannuation Industry (Supervision) Act may lead to the trustees being penalised, disqualified or the fund being taxed as a non-complying fund. This is a convincing argument for trustees to comply with the legislation and its interpretation by the regulators. However, as a result of the economic impact of the COVID-19 virus, trying to maintain a complying fund can prove a real challenge. But luckily, the government and regulators recognise the gravity of the situation with practical solutions for your SMSF to stay complying. This applies if your SMSF provides rent relief to tenants or it has difficulties making repayments on limited recourse loans.

Rent relief for tenants and landlords

One of the unique and undisputed benefits of having an SMSF is for small business owners to lease a business premise owned by their SMSF at arm’s length commercial rates. However, in the current environment if the business has fallen on hard times or is required to close it may not have the cash flow to pay rent to the SMSF. This can result in compliance issues for the fund, potential penalties for the trustees and the possibility of the fund being treated as non-complying.

However, if the tenant is unable to pay the rent, the ATO has announced they will be taking no action where an SMSF provides a rent reduction or waiver of rent to a tenant because of the financial impacts of the COVID-19 pandemic. This will be the ATO’s position for rent reductions or waivers made during the 2019/20 and 2020/21 financial years where the tenant can justify they have been impacted by the economic effects of COVID-19.

What is the criteria for rent relief?

My understanding is that the ATO will be taking a broad approach to any rent relief provided and will not require evidence where any agreement reached by the landlord (SMSF) the tenant, whether a related or unrelated party is on arm’s length commercial terms. However, relief applies where:

  • The rent reduction is temporary which means that records of the reduction should be kept for the period agreed on;
  • The agreed reduction applies only to rent and does not provide an opportunity to seek other rental incentives, for example, for the SMSF landlord to make extensive improvements to the premises or waive any outgoings required to be paid by the related party, and;
  • Any impacts in the downturn of the related party’s business are linked to the economic effects of the COVID-19 pandemic.

A reminder that proper documentation for reasoning of any changes is necessary.

How much can the rent be reduced by?

The reduction in the rent payable depends on a case by case basis. While the ATO’s approach appears to be broad brush for an arm’s length landlord-tenant arrangement it’s up to the tenant to contact the landlord and provide details of the financial difficulty being faced. They should also give the landlord some idea of the level of rent relief sought during the period of expected financial difficultly.

Factors to be considered by the landlord in reducing or waiving rent should related to the effect of the pandemic and government restrictions placed on the tenant’s business. For example, has the business been forced to close down or reduce its business activity significantly? Is it able to operate? Are there possible alternatives that will help the business trade such as moving on line or converting to a take away or home delivery business. These features will be a primary indicator to the landlord of the rent relief required by any related party tenant. The more severe the situation the greater the level of relief.

What form of rent relief can be provided?

The ATO’s guidance refers simply to providing a “temporary rent reduction”. My understanding is that relief provided can cover a broad range of issues which could cover:

  1. Deferral of rental payments for a temporary period. For an agreed period of say, 6 months no rental payments are required. But the unpaid rent would be accrued to be paid, as agreed, at a later date when the business recovers. This has similarities to arrangements that banks and other lenders have in place for mortgage payments. The level of debt a business may be burdened with once the pandemic is over and recovery commences may be concerning. But the rent reduction can provide for the eventual payment of the rent over a pre-determined period. Any deferral arrangement could allow the SMSF landlord and related party tenant to waive the debt for the unpaid rent prior to 30 June 2021 or some later date, if the ATO extends the period during which they will take no compliance action.
  2. Reduction in rent levied and paid. For an agreed period, again say 6 months, rental payments could be reduced by, say, 50% or maybe greater. There would be no expectation of recovery of the difference between the normal rental amount and the reduced rental amount.
  3. Rent waived (rent free period). For an agreed period, say 6 months, the tenant would not pay rent nor would the amount be recovered at a later time.

The first two options could apply where the tenant’s business continues to operate, but at a reduced capacity. The third option could apply where the business income has been reduced to zero due to forced shutdown. Regardless, of the arrangement reached, it would be prudent for the SMSF trustees to record the particular circumstances of the tenant and any reasons for the agreed temporary rent reduction arrangement.

The annual SMSF audit and required documentation

It would be reasonable to expect that SMSF trustees would not spend a lot of time putting together documentation and evidence of similar commercial arrangements in support of any rental reduction or waiver. However, when contacting our auditors they will be reviewing the commercial nature of any rent reduction or waiver. This means trustees should be prepared to provide documentation and supporting evidence which includes:

  • The economic impact of COVID-19 on the business – this could include, closed as directed by the government or closed due to lack of business/loss of revenue/lack of supplies as they were coming from overseas etc.
  • Any financial implications for the business – such as cash flow implications, will the business still be a going concern?
  • What the fund is offering as far as discounts/ rent free periods or deferrals and why the trustees believe this is appropriate (trustees could refer to government guidelines and what is happening on other commercial arrangements which are non-related).
  • A set and agreed review period – e.g. 2 or 3 months. (since this is changing quickly as we go we don’t know how long this can go for but we don’t want to see a blanket rent free period).
  • We would still expect to have seen rentals to have been coming through to the SMSF as usual for at least from July 19 – Feb as most businesses have been impacted from March onwards.

So far, the ATO has not indicated what changes SMSF auditors will need to make to their audit program because of COVID-19. But as SMSF auditors are under a legal obligation to report breaches a Contravention Report (ACR) may still be lodged with the ATO, where a temporary rent reduction has been provided to a related party tenant. You could expect no action will be taken by the ATO where the reduction or waiver is reasonable and on commercial arm’s length terms.

However, it would be unlikely for the ATO to overlook any a rent reduction which is permanent, non-commercial or the trustee is unable to link the reduction to the effects of the COVID-19 pandemic. SMSF auditors would still report other types of contraventions in line with the ATO guidelines and leave it to the ATO to take compliance action if required.

Non-geared unit trusts and business real property leases

Where the real estate is owned by a non-geared company or unit trust any temporary rent reduction is provided by the company or trust and not the SMSF as shareholder or unit holder.

The benefit of these ungeared arrangements, also referred to as 13.22C companies or unit trusts, is that the investment is exempt from the in-house asset rules. This is on the basis that it continually complies with SIS regulation 13.22C and doesn’t fail any of the rules at any time which are in regulation 13.22D. if there is a breach, the fund’s investment in the company or unit trust will be included in the fund’s in-house assets which are limited to no more than 5% of the fund’s total assets.

The financial effect of the COVID-19 pandemic applies equally to SMSFs owning property directly and those SMSFs owning indirectly via a 13.22C unit trust. It would be appreciated if clarification could be provided whether any temporary rent reduction would result in the fund’s investment being treated as an in-house asset of the SMSF rather than remaining exempt.

Business real property leased to a related party under a limited recourse borrowing arrangement

A temporary rent reduction may result in an SMSF to have cashflow issues in meeting loan repayments under a limited recourse borrowing arrangement. In the event that the SMSF cannot repay the loan to a bank or other commercial lender the trustee should contact the lender to see what arrangements can be provided to defer the payment. Any arrangements may provide temporary suspension of loan repayments, without default interest being applied, but interest will continue to accrue causing the loan balance to increase.

For limited recourse loans provided to the fund from a related party where the trustee has complied with the ATO’s safe harbour rules there are a number of things for consideration. The first is that the ATO will not support a waiver or reduction in loan repayments but any concession given by the lender must be in line with commercial arm’s length lenders. This may involve a postponement of repayments with interest continuing to accrue on the outstanding loan. In addition, trustees should understand the rules applying to non-arm’s length income and expenses to avoid being the fund being taxed at penalty rates. Any relaxation of loan terms, even if temporary, could result in the net income from the limited recourse borrowing being treated as non-arm’s length income.

What to remember

These are difficult times but it’s good to see a regulator taking a practical approach in accepting that SMSFs may experience compliance issues which are out of the trustee’s control. The concessions come with the onus of proof on the trustee and others to justify any reductions or waivers in rent and any changes to loan repayments where limited recourse borrowings are involved. Documenting these changes is essential to keep everyone happy to maintain the fund’s complying status.

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Graeme Colley, Executive Manager, SMSF Technical and Private Wealth, SuperConcepts
  • Covid-19
  • Real Estate
  • SMSF News
  • Superannuation
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