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Self Managed Super Funds (SMSF)

Have a property in your SMSF? COVID-19 relief could be on the table

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

COVID-19 and possible rent relief for SMSF property tenants

As the COVID-19 pandemic continues to affect our lives, SMSFs are impacted by its financial consequences. Not only do we see the downturn in share markets worldwide, but related or third parties who have leased property from SMSFs may end up having to default on rent. But what can be done where a business has been required to shut its doors or there is a huge drop in business?

Rent relief for tenants?

One of the benefits of having an SMSF is that small business owners can lease the business premises from their SMSF. But the superannuation legislation says that all the rent and expenses must be on arm’s length commercial terms. This is not easy as SMSFs and the tenants become caught by the current economic downturn.

So, where does that leave SMSFs? Is it ok for SMSF trustees to simply forgive or reduce rent and offer a related party or arm’s length tenant a rent-free period or some other form of financial relief? Or, will they run the risk of breaching the law because the fund assets have not been maintained on an arm’s-length basis?

My understanding from recent statements by the regulators is that the tenants need to demonstrate whether any adjustments to the lease is justified. It is then up to the SMSF trustee to accept, modify or reject any offer depending on whether it is justified in the circumstances. In addition, the trustee needs to be certain that any lease that is adjusted continues to be on arm’s length commercial terms.

What is arm’s length can depend on the particular property and what it is used for. As an example, a restaurant which has been required to close may have its total rent deferred by the trustee. However, a restaurant that continues to serve on a take-away basis may be only able to warrant a reduction in rent. And remember, there are some businesses which have had a substantial increase in business such as those in the IT, health and food industries. Those businesses would not be able to justify any reduction in rent in most situations, especially where the landlord was a related party.

As the list of industries impacted by compulsory government shutdowns grows by the day, the number of landlords accepting rent reductions, rent-free periods or rent deferrals is fast becoming the norm. However, a carte blanche reduction in rent by SMSF trustees is something that should be carefully considered.

What happens if an SMSF can't repay its LRBA?

SMSFs which have borrowed from a related party for purposes of a limited recourse borrowing arrangement (LRBA) and are impacted by the economic downturn may be in a similar position to the inability of tenants to pay rent.

An SMSF no longer receiving lease payments from a related party tenant because they are unable to pay, may experience cash flow issues and unable to service the loan which is consistent with the ATO’s safe harbour guidelines. Will this mean the fund could run into problems with the non-arm’s length income legislation in future years or when the property is sold? In these situations the fund needs to retain any documents relating to the current situation in case the reduction in rent was every questioned by the fund’s auditor or the ATO.

Whether the non-arm’s length income provisions could be applied will depends on whether the SMSF trustees can demonstrate the decision to adjust loan repayments is on a commercial arm’s length basis.

Practical steps for an SMSF to demonstrate arms-length terms

On the positive side there are some practical steps SMSF trustees can take to support arrangements with related party tenants and/or related party lenders are on commercial arm’s length terms. Here’s a checklist of some possible steps:

  1. Check your documents such as the lease agreements and/or loan documents. This will give you a better idea of what can be adjusted or modified. A well drafted document may allow variation to the lease and may even include a ‘force majeure’ clause.
    A force majeure clause allows parties to a contract to suspend or terminate its terms when certain circumstances beyond the control of one or more of the parties arise. This includes the situation where carrying out the particular term is inadvisable, commercially impracticable, illegal, or impossible. In the current situation it would usually be instigated by the tenant (related party or not) setting out the reason for not being able to carry out the terms of the lease, for example, government enforced social distancing impacting a restaurant business.

  2. The SMSF trustee as landlord would consider the tenant’s request including any alternatives that could be available. This may include eviction and replacement of the tenant, but this may not be in the best interests of the fund. Evicting a related party may cause issues and finding a replacement tenant may be very difficult in the current environment.

  3. The trustees then need to work out how they will vary the agreement based on the prevailing circumstances and any possible alternatives. This may include a waiver, reduction or deferral of the rent payable as well as specifying a period or trigger for the change to the relief (e.g. the lifting of crowd restrictions). Any agreed change should be documented and accepted by both the trustees and the tenant, whether a related party or otherwise.

Where the property involves a limited recourse borrowing arrangement the SMSF trustee, as borrower, should contact the lender to see what concessions may be available under the loan agreement.

We may see further concessions announced to cope with the Coronavirus and the related economic downturn. But at the moment the important thing is that any variations to leases or limited recourse borrowing arrangements are supported by documents that justify the arm’s length nature of the change with clear justification of how it is in the best interests of the SMSF.

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Graeme Colley, Executive Manager, SMSF Technical and Private Wealth, SuperConcepts
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