Can my SMSF grant rent relief during the COVID-19 crisis?

COVID-19 has placed significant economic stress on businesses and individuals. Naturally, the government is encouraging landlords and tenants to come together to reach an agreement on how rent is to be paid during this time, including the possibility of short-term rent reductions. However, if the rented property is owned via your self managed superannuation fund (SMSF), granting such rent relief may put your fund at risk of incurring significant penalties under the Superannuation Industry (Supervision) Act 1993 (Cth) (SIS Act) and the Superannuation Industry (Supervision) Regulations 1994 (Cth) (SIS Regulations), particularly where the tenant and SMSF trustee (which is the landlord) are considered related parties.

In light of this, the Australian Tax Office (ATO) issued an update on 27 March 2020 on how it proposes to treat such rent reductions.

ATO’s temporary approach

On 27 March 2020, the ATO updated its website to state the following under the heading ‘Temporarily reducing rent’:

Question: My SMSF owns real property and wants to give my tenant – who is a related party – a reduction in rent because of the financial impacts of the COVID-19. Charging a related party a price that is less than market value is usually a contravention. Given the impacts of the COVID-19, will the ATO take action if I do this?

Answer: Some landlords are giving their tenants a reduction in or waiver of rent because of the financial impacts of the COVID-19 and we understand that you may wish to do so as well. Our compliance approach for the 2019–20 and 2020–21 financial years is that we will not take action where an SMSF gives a tenant – who is also a related party – a temporary rent reduction during this period.

Where 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. This could be by way of a minute or a renewed lease agreement or other contemporaneous documentation. 

This update allows the SMSF trustee to grant the tenant rent relief during COVID-19. However, it is important to note the following:

• this update is not binding on the ATO;
• the ATO’s concession only applies to temporary rent reduction;
• the reduction needs to relate to the financial impacts COVID-19 has had on your particular tenant, so any rent reduction should be reasonable and measured with respect to those specific financial impacts; and
• applying the practical approach the ATO has taken when issuing similar updates in the past, it will not actively seek out contraventions of the law, but where contraventions are discovered through normal processes, such as data collection, audits and reviews, it will strictly apply the law. Therefore, there is still a risk that the ATO will penalise a SMSF where the trustee provides the tenant a temporary rent reduction.

Therefore, without legislative intervention to the contrary, we highly recommend that you continue to comply with the SIS Act and SIS Regulations. As seen below, the legislative approach is much more stringent when the tenant is a related party of the trustee.

The usual legislative position

Non-related parties

Where the trustee and tenant are not related the trustee can grant the tenant rent relief if they can prove such relief is in the best interests of the fund. This will be considered an ‘arm’s length’ transaction, meaning there will be no contravention of the SIS Act or SIS Regulations.

There are many reasons a trustee may grant temporary rent relief during COVID-19. For example, it may help the fund continue to receive rental income from the property as the prospects of obtaining new tenants in the near future may be relatively low, or it may allow the tenant to remain competitive in its industry, meaning they can pay increased rent in the future. Whatever the reasons are, it is important to ensure that they are evidentially viable and properly documented.

Related parties

Where the trustee and tenant are related parties, it is very difficult to provide the tenant with rent reduction without contravening the SIS Act.

Generally speaking, the trustee can grant rent relief to a tenant if they can demonstrate that granting such relief is consistent with what arm’s length parties would agree to do and it is in the best interests of the fund and its members.[1] The level of proof required to show the transaction will benefit the members is much higher than that for non-related parties. The trustee should collate and document any evidence that supports the rent reduction, and make sure they consider other alternatives assuming the tenant was a non-related party in those particular circumstances. This should include an examination of the rental market (including rental prices, demand and supply in your particular location) and formal written advice from real estate agents.

Additionally, even if the rent reduction is provided on an arm’s length basis, it may be considered a loan or financial assistance to the related party, which would contravene other provisions of the SIS Act.[2]

The ATO may impose substantial penalties on your fund for breaching these provisions, including a civil penalty of up to $504,000 and, in extreme cases, if the fund is found to be non-complying, a 45% tax on the fund’s opening account balance of the year.

The lease agreement

It is also important to consider the terms of your lease agreement, as this may already provide for rent reduction in certain circumstances, or may otherwise need to be varied to reflect the temporary rent reduction.

Conclusion

We will continue to watch the situation closely and share more thoughts on this rapidly changing situation.

However, if you have recently provided, or are considering providing, a rent reduction in relation to a property owned via your SMSF, we strongly encourage you to seek legal advice. The short term costs in doing so may far outweigh the potential penalties that could be imposed by the ATO for breaches of the SIS Act or SIS Regulations.

Please do not hesitate to reach out to us to discuss ways in which we can help you.

[1] Section 62 of the SIS Act provides that the sole purpose of the fund is for the benefit of its members; section 109 of the SIS Act provides that all investment transactions involving the fund must be made and maintained on an arm’s length basis.
[2] Section 65 of the SIS Act provides that the fund is prohibited from lending or providing financial assistance to a member or relative; part 8 of the SIS Act provides that the non-payment of rent by a related party tenant will likely be considered a loan from the fund to the tenant, and if the loan exceeds 5%, then an in-house asset contravention may arise.