By Mark Ellem

SMSFs with impaired tenants – ATO announces rent relief measures

The ATO has announced they will be taking no action in situations where an SMSF, which owns a business premise that is being leased to a related party, provides either a rent reduction or waiver of rent because of the financial impacts of the COVID-19 pandemic. This will be the ATO’s position for the 2019/20 and 2020/21 financial years.

SuperConcepts has been inundated with calls and emails from clients who have an SMSF which owns a business premise that is being leased to a related party. Concerns have been raised, due to the impact of COVID-19, that the related party can no longer afford to pay their rent. Charging a related party, a price that is less than market value or having rental terms that are not commercial, usually results in a contravention.

One of the unique and undisputed benefits of an SMSF is the ability for small business owners to lease a business premise owned by their SMSF. But with this comes the requirement to ensure all lease payments are on commercial arm’s length terms.

SuperConcepts fully supports this relief measure which provides certainty and much needed relief for a growing number of SMSFs, that own a business premise, and have been caught in the economic turmoil caused by COVID-19.

Is there a specific criteria for the ATO relief?

The ATO has stated that for the 2019/20 and 2020/21 financial years that they will not take action where an SMSF gives a tenant – who is also a related party – a temporary rent reduction. We understand that the ATO is taking a broad approach to this relief and is not requiring evidence that the agreement reached by the SMSF landlord and related party tenant is on arm’s length terms. However, for the relief to apply, the following must apply:

• The rent reduction is temporary – there should be a record of an agreed period, that is acknowledged as temporary for the form of rent reduction;
• The rent reduction only applies to rent – this is not an opportunity to seek other rental incentives, for example, the SMSF landlord to pay for an extension to the building. However, in our view, the rent reduction would also apply to any outgoings that the related party tenant is obliged to pay;
• The need for the rent reduction is linked to the downturn in the related party’s business, due to the COVID-19 pandemic and the consequential economic effect.

How much can the rent be reduced by?

This will be on a case by case basis. Again, the ATO’s relief appears to be quite broad. In an arm’s length landlord-tenant arrangement, it would be the tenant that would approach the landlord to advise of the financial difficulty they are facing and provide guidance on the level of rent relief sought during the period of financial difficultly.

There would be consideration given to the affect of the pandemic and Government restrictions, for example, has the business been forced to close down? Can it still operate? Maybe part of the business can be moved to online. This will be a primary indicator of the level of rent relief required by the related party tenant, which could result in 100% temporary rent relief.

The ATO’s position appears to accommodate any level of rent reduction, provided it fits into the criteria outlined above.

What form of rent relief can be provided?

The response from the ATO simply refers to providing a “temporary rent reduction” and again, our understanding is that relief has a broad application. In our view, a “temporary rent reduction” would cover the following scenarios:

1. Deferral of rental payments for a temporary period. For an agreed period of say, 6 months no rental payments are required, however, they are still accrued, to be paid at a later date when business recovers, subject to an agreed repayment arrangement. This is similar to the arrangement that lending institutions have put in place in relation to mortgage payments.

   Whilst there is a concern about the level of debt a business may be burdened with once the pandemic is over and recovery commences, this rent reduction arrangement provides for the eventual payment of the rent, at a later date. In the situation where the rent is reduced or completely waived, when the business recovers and wishes to make up for the unpaid rent, this would have to be achieved via use of the low contribution caps. This deferral arrangement would also allow the SMSF landlord and related party tenant to agree to waive the debt for the unpaid rent prior to 30 June 2021 or some later date, in the event the ATO extends their period of no compliance action.

2. Reduction in rent levied and paid. For an agreed period, again say 6 months, reduction of rental payments, say by 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, again say 6 months, no rent will be required to be paid by the tenant, nor would the amount be recovered at a later time.

The first and second options may be applicable where the tenant can still operate their business, but at a reduced capacity. The third option may apply in the situation 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 the reasons for the agreed temporary rent reduction arrangement.

What documentation is needed?

We are confident that the ATO would not envisage that SMSF trustees spending a lot of time of putting together documentation and evidence of similar commercial arrangements of rental reduction arrangements. Further, as noted above, the compliance relief appears to be quite broad. However, in our view, the following documentation should still be prepared:

• Record of approach by related party tenant to SMSF landlord for temporary reduction of rent due to financial difficulties caused by the COVID-19 pandemic;
• A record of the nature of the business of the related party and brief outline of the financial effect of the COVID-19 pandemic and Government restrictions on business operations (for example, turnover has reduced by 80% and/or Government restrictions have forced the business to close);
• A record that the lease agreement has been reviewed and it was agreed by both parties for the temporary rent reduction;
• The nature of the temporary rent reduction, the period it will be in place and that the arrangement will be reviewed at the end of the period.

What about the annual SMSF Audit?

There has been no comment to date by the ATO as to what changes, if any, SMSF Auditors will need to make to their audit approach. It is possible SMSF Auditors may still qualify Audit Reports and they may also lodge an Auditor’s Contravention Report (ACR), where the SMSF has provided temporary rent reduction to a related party tenant. However, in line with the ATO announcement, we expect the ATO will be taking no action in relation to any report qualifications that relate to a temporary reduction in rent, due to the financial effect of the COVID-19 pandemic. However, this may not be the case if it is discovered that the rent reduction was not temporary, included other lease incentives or was not linked to the financial effects of the COVID-19 pandemic. Further, we expect that SMSF Auditors would continue to report other types of reportable contraventions and that the ATO would take compliance action for such contraventions.

Business real property leased via non-geared unit trust

The ATO’s comments appear to only apply to the situation where the property, that is leased to the related party, is owned directly by the SMSF. Where the property is held by a non-geared unit trust, also known as a 13.22C unit trust, it’s not the SMSF that provides the temporary rent reduction, but the trustee of the unit trust. Further, a non-geared unit trust is exempt from the in-house asset rules provided it complies with SIS regulation 13.22C and more importantly, doesn’t have what is known as a SIS regulation 13.22D event. If such an event occurs, then the non-geared unit trust is forever tainted and treated as in in-house asset and subject to the 5% limit.

In my view, there are two potential 13.22D events that could cause the non-geared unit trust to be forever tainted and no longer exempt from the in-house asset rule. These are:

• 13.22D(1)(b)(ii) – ‘…the following becomes an asset of the …. unit trust: a loan to another entity, unless the loan is a deposit with an authorised deposit-taking institution within the meaning of the Banking Act 1959’.

  The unpaid rent could be seen as a loan from the unit trust to the related party.

• 13.22D(1)(l) – ‘the ……. trustee of the unit trust, conducts a transaction otherwise than on an arm's length basis’.

The temporary reduction in rent would need to be substantiated as being on an arm’s length basis.

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 welcomed if the ATO could clarify whether the temporary rent reduction would not be treated as a 13.22D event.

Business real property leased to related party under an LRBA

A temporary rent reduction may cause the SMSF to have cashflow issues in relation to meeting loan repayments. If that’s the case, where the loan is from an arm’s length or commercial lender, an approach should be made to the lender for loan repayment relief. The desired outcome would be for a temporary suspension of loan repayments, without default interest being applied, even though interest will still be accrued causing the loan balance to increase.

However, where the loan is from a related party and the safe harbour rules have been utilised to ensure that the LRBA arrangement is not subject to the non-arm’s length income (NALI) rules, any relaxation of loan terms, even if temporary, could result in the net income from the LRBA being treated as NALI. Again, it would be welcomed if the ATO could advise as to their position in this scenario. Further, consideration should be given to the safe harbour interest rate, currently 5.94% for the 2019/20 financial year. Given the official RBA rate is 0.25% and most variable home loans start with a two, relief could also be provided with a revision of the interest rate to something a little more in line with current rates, not the rates that existed in May 2019, when the rate was set for the 2019/20 financial year.

UPDATE: In an interview with Dana Fleming, Assistant Commissioner – SMSF Segment ATO conducted by John Maroney, CEO of the SMSF Association on 2 April, 2020, Dana advised that there will be an update to the ATO’s COVID-19 Frequently Asked Questions page for SMSFs to address this issue. It was explained during the interview that where the SMSF had borrowed from a related party and the related party, as lender, gave relief to the SMSF, as borrower, similar to what is being offered by arm’s length lenders, that the ATO would also not take any compliance action in relation to the 2019/20 and 2020/21 financial years. It was also noted that in addition to the loan relief provided by the related party lender to the SMSF borrower being similar to what is being offered by a commercial lender, that the relief should be documented, including that the reason for the relief is due to the financial effects of the COVID-19 pandemic.

SuperConcepts welcome these comments and once again fully supports such relief measures. We will provide further details in a separate article once the ATO’s COVID-19 webpage has been updated for this specific issue.

Want to keep up to date on the issue?

The SuperConcepts Technical & Education team have been analysing and continue to analyse the announcements and changes made that affect SMSFs. We will be regularly sending alerts, posting articles, like this, as well as making available eBooks and conducting webinars to keep our clients up to date with developments and evolving issues. Keep an eye out for our next notification to hit your inbox.