Rental relief and SMSFs
How can trustees join the 'Team Australia' effort without breaching their legal obligations?
The self-managed super fund sector is feeling the effects of the COVID-19 pandemic, including trustees with property investments.
Amid the pressure from government to show leniency to tenants, how can trustees join the “Team Australia” effort without breaching their legal obligations?
The shutdown of business to contain the coronavirus has sparked predictions that Australia is facing its deepest recession in decades. The Reserve Bank of Australia expects the jobless rate will double to around 10 per cent by June, in the fastest contraction since the Great Depression.
Shrinking household income, reduced population growth and weaker investor demand will hit the property market too. Commercial property values could fall by about 10 per cent as businesses shut and rental growth stalls, with the retail sector particularly exposed.
For residential property, ANZ Research projects a peak-to-trough decline in prices of 10 per cent on average in the year ahead, led by Sydney, Melbourne and Hobart (down 13 per cent each), followed by Brisbane (down 7 per cent) and Adelaide (6 per cent lower).
SMSFs are exposed to the property downturn, given that an estimated 12 per cent own non-residential property, usually their business premises. The ATO’s latest data for the September 2019 quarter shows SMSFs had nearly $65 billion invested in non-residential real property, accounting for 8.7 per cent of total assets.
Yet any move by trustees to reduce rent or provide other concessions could risk contravening their legal requirements, particularly if it is a related party, due to regulations such as the sole purpose test and in-house asset provisions.
Fortunately though, the ATO has joined the collective effort against the coronavirus, advising trustees will not be penalised should they choose to show leniency.
Compliance relief
“Our compliance approach for the 2019-20 and 2020-21 financial years is that we will not take action if an SMSF gives a tenant—even one who is also a related party—a temporary rent reduction, waiver or deferral because of the financial effects of COVID-19 during this period,” the ATO advises on its website.
“If your SMSF holds an interest in an interposed entity such as a non-geared company or unit trust and that interposed entity leases property to a tenant, we will not treat the investment in the interposed entity as an in-house asset for the current and future financial years as a result of a deferral of rent being provided to the tenant due to the financial effects of COVID-19.
“If there are temporary changes to the terms of the lease agreement in response to COVID-19, it is important that the parties to the agreement document the changes and the reasons for the change. You can do this with a minute or a renewed lease agreement or other contemporaneous document.”
For SMSF auditors considering whether rental relief has been provided on an “arm’s length basis,” the ATO suggests referring to the “National Cabinet Mandatory Code of Conduct for commercial leasing principles” together with information on the Australian Banking Association’s website for commercial loan relief.
The ATO has also given SMSFs another reprieve, applying an automatic deferral for lodgement of the 2019 SMSF annual returns due on 15 May and 5 June to 30 June for all trustees.
Rules to follow
SMSF specialist adviser Liam Shorte advises a number of key rules for trustees seeking to provide rental relief or other concessions due to COVID-19:
* Follow the guidance for rental relief in your state or territory—don’t push the limits
“For example, in Victoria if you have a residential property and offer rental relief then your tenant may qualify for support under the Covid19 Rent Relief Grant to pay rent,” he says (refer https://www.housing.vic.gov.au/help-renting/rentrelief).
* Document the agreement properly so it satisfies the fund auditor—a number of accountants and administrators have documentation packs available for this purpose (eg. https://smartersmsf.com/documenting-the-temporary-rental-relief/)
* Check your lease as it may already have provisions for rent reductions under certain circumstances.
“If not, you may need to amend the lease to reflect the changes and ensure what you do is legal. If you are offering rental relief then you should be looking to extend the length of the lease for a similar period, as a quid pro quo,” says Shorte, director at Verante Financial Planning.
* When dealing with a related party tenant, be more stringent on the documentation concerning the relief agreed.
DBA Lawyers suggests the trustee obtain advice from an experienced real estate agent concerning the prevailing market conditions for the particular lease. The trustee should also gather any evidence supporting the proposed course of action and consider alternatives.
'Sit down, talk to each other and work this out': Trustees considering eviction action against tenants should be mindful of a six-month moratorium imposed by Scott Morrison
LRBA implications
SMSFs that have acquired property under a leveraged recourse borrowing arrangement (LRBA) face further implications, with DBA Lawyers suggesting appropriate arm’s length evidence be obtained, together with accounting and legal advice.
Should the related party lender provide relief not benchmarked to arm’s length terms, there is a risk of the ATO applying its “non-arm’s length income” (NALI) rules to any net income and net capital gain derived from the property “for the entire period of ownership,” DBA Lawyers warns.
However, the ATO has stated that “if the repayment relief reflects similar terms to what commercial banks are currently offering for real estate investment loans as a result of COVID-19, we will accept the parties are dealing at arm’s length and the NALI provisions do not apply.
“For example, these terms currently include temporary repayment deferrals for most businesses of up to six months, with unpaid interest being capitalised on the loan.
“The parties to the arrangement must also document the change in terms to the loan agreement and the reasons why those terms have changed. It is also expected that there is evidence that interest continues to accrue on the loan and that the SMSF trustee will catch up any outstanding principal and interest repayments as soon as possible.
“Any further repayment relief needed due to the continued effects of COVID-19 should be reviewed at the end of the agreed deferral period and remain in line with what the commercial banks are offering at that time.”
Insurance issues
Another potential headache for trustees is the insurance implications. EBM Rentcover advises that landlords that reduce rent cannot claim for the difference in payments. Nor would any move to suspend rental payments be covered.
Advisers suggest landlords consider implementing a payment plan with any tenants facing genuine financial difficulties, while approaching their lenders about a potential mortgage holiday.
Eviction warning
Trustees considering eviction action against tenants should be mindful of a six-month moratorium imposed by Prime Minister Scott Morrison, who has urged the relevant parties to “sit down, talk to each other and work this out”.
Shorte has a word of caution here: “Think about how hard it will be to replace the tenant,” he says.
“You should check your insurance policy as it may be invalid if the property is vacant for a period. It could also be an increased target for vandalism, fires, burst pipes and other maintenance issues”.
The SMSF Association has praised the ATO for its “constructive” approach to the issues faced by trustees during the COVID-19 pandemic. Such pragmatism will be essential in finding solutions, given the impact of the coronavirus across all sectors of the economy.