The effects of the Novel Coronavirus (COVID-19) pandemic on property, rentals, and values is a concern to self-managed superannuation Fund (SMSF) trustees who hold property. For advisors and accountants who look after these SMSFs, their role is to assist affected SMSF clients negotiate through the issues arising from this pandemic. During the webinar these issues were discussed, including looking at several different scenarios as well as the effect on year-end financial statements, return preparation and audit.
Below we answer questions that were asked by attendees during the webinar.
Why do you need evidence that the turnover reduction was a result of COVID-19?
There are two reasons:
- The National Cabinet Mandatory Code of Conduct (National Code) applies where the tenant of a commercial leasing arrangement has been financially affected by the COVID-19 pandemic. From a negotiating perspective, the first step for the SMSF landlord, after the tenant has requested rent relief would be to ensure that the reduction in turnover of the tenant’s business is a direct result of the financial effects of COVID-19.Consequently per the National Code (and similar State and Territory rules for residential properties), proportionate rent relief is to be provided.
- The Australian Taxation Office (ATO) has stated that they will not take action where the SMSF landlord provides rent relief to a tenant (whether unrelated or related) even though such relief may give rise to compliance issues. For example, compliance with Superannuation Industry (Supervision) Act (SIS) section 109 - Investments of superannuation entity to be made and maintained on arm's length basis. However, this is subject to such relief being:
- due to the financial effects of COVID-19; and
- documenting the temporary changes and the reasons for the changes to the lease.
It would also be expected that the SMSF auditor would wish to verify that any rent relief provided to a tenant (whether unrelated or related) was a direct result of the financial effects of COVID-19 on the tenant’s business.
If a landlord and tenant is agreeable on rent relief terms other than per the National Code (proportional reduction with at least 50% waiver), is it still OK?
In short yes. Where the National Code applies, it sets down the principles of negotiating amendments, in good faith, to existing lease arrangements, of rent relief. The National Code further sets out a principle of proportionality for rent relief, however it also notes that the circumstances of each landlord, tenant and lease are different and that they should agree tailored, bespoke and appropriate temporary arrangements for their particular situation. For example, the National Code notes that the tenant may waive the requirement for a 50% minimum wavier by agreement. Consequently, different rent relief arrangements could be agreed upon, provided that such arrangements have been negotiated in good faith and are appropriate for the particular circumstances. However, where temporary rent relief is sought by a related party (of the SMSF landlord) tenant and such relief is provided on a basis other than proportionality, there needs to be third party evidence that such a temporary arrangement is commercial. This could be by way of evidence provided by a Real Estate Agent of COVID-19 temporary rent relief arrangements between other landlords and unrelated tenants.
Is there a need to assess if the tenant is eligible for JobKeeper? If so, what documentation needs to be obtained? If their revenue falls by 20%, are they still eligible?
The National Code is to be applied for the purpose of negotiating temporary proportional rent relief where the tenant, subject to a commercial lease, is in financial stress or hardship. Financial stress or hardship is defined in the National Code as a business’s inability to generate sufficient revenue as a direct result of the COVID-19 pandemic that causes the tenant to be unable to meet it financial and/or contractual (including retail leasing) commitments. Further, tenants who are eligible for the JobKeeper Payment are automatically considered to be in financial distress under the National Code.
So, it’s not necessary for the tenant to be eligible for the JobKeeper Payment for the National Code to apply and for the tenant to seek temporary rent relief. However, from a negotiating perspective, the landlord may wish to confirm that the tenant’s business has been financially affected by COVID-19 to ascertain the extent of the effect on the business turnover, and consequently the potential proportional temporary rent reduction. The landlord may also wish to confirm the tenant’s eligibility for the JobKeeper Payment, as this confirms that they are automatically regarded as being in financial distress and the National Code applies in relation to negotiating temporary rent relief.
Such evidence, as outlined in the National Code, could include:
- Information generated from an accounting system. For example, a report comparing turnover in 2020 versus same reporting period in 2019. This is similar to the decrease in turnover eligibility requirement for JobKeeper;
- Information provided to and/or received from a financial institution.
Further, evidence may be in the form of a letter from the tenant’s accountant stating that they are eligible for the JobKeeper Payment or that their turnover has been reduced due to the financial effects of COVID-19 and the extent of that reduction. Evidence may also be as simple as understanding the nature of the tenant’s business and a physical inspection of the premises. For example, the business is closed due to COVID-19 and has posted signage advising of such.
Deferred rent – do we book in as debtor and rent in the SMSF financial statements?
Where the SMSF landlord provides temporary rent relief to the tenant and a portion of that rent relief is in the form of a waiver, then that amount will never be recovered and consequently would not be brought to account in the SMSF financial statements.
In relation to the portion of the temporary rent relief that is in the form of rent deferral, one accounting approach is not to bring the deferral to account in the SMSF financial statements, for the following reasons:
- There is no guarantee that the deferred rent will be recovered. This will depend on the ability of the tenant to re-commence trading and to generate sufficient turnover to meet “normal” lease payments, plus any deferral;
- The other side of the entry (to record deferred rent) is a debtor or amount receivable, which is an asset on the SMSF’s Statement of Financial Position. Consequently, the amount recorded is subject to SISR regulation 8.02B, which requires all SMSF assets to be stated in the annual financial statements at ‘market value’. There could be market value substantiation issues with the requirement for this type of asset; and
- An SMSF discloses income in the annual return on a cash basis and consequently the deferred amount would need to be backed out of the return.
Where an SMSF is registered for GST, if a tax invoice is issued to the tenant for the deferred rent there could be a GST liability if the SMSF GST basis is the accruals method.
Some suggestions include:
- Do not record the deferred amount of rent in the annual financial statements. The deferred amount can be recorded outside of the financial statements and would be reflected in documentation recording the temporary rent relief provided - including any lease amendments.
- Disclose in the summary of significant accounting policies note that the SMSF has provided temporary rent relief to the property tenant, due to COVID-19 and note the terms of the rent relief for example:
- Percentage/amount of rent relief;
- Portion/amount that is waived;
- Portion/amount deferred;
- Period of temporary relief;
- When the deferral is expected to be recovered;
- That the deferred amount has not been brought to account due to uncertainty of recoverability and consequently market value of any amount disclosed in the financial statements - deferred amounts will be brought to account when payments are made by the tenant and received by the SMSF.
- Where the SMSF is registered for GST, only issue a tax invoice for the deferred amount when the tenant can make such payment and the amount of the tax invoice should reflect the expected amount of each payment.
When requesting temporary rent relief, must there be a letter from the tenant or is an email ok?
The form of the request can be written or verbal, however for evidentiary purposes written is better. An email or letter are both forms of written communication. Where the tenant is a related party of the SMSF it would be prudent for the request to be in the form of a written letter rather than an email effectively to themselves.
An SMSF records rent receivable from a related party tenant because the tenant is unable to pay the rent on time for some time now due to cash flow issues. Will this rent receivable be treated as an in-house asset?
A lease of business real property by an SMSF to a related party is exempt from the in-house asset rules provided, amongst other requirements, that the lease agreement is enforceable by legal proceedings. Consequently, where the related party tenant falls behind in rent the SMSF should act as they would if the tenant was unrelated and apply the relevant terms of the lease agreement to recover the unpaid rent. If this is not applied, the potential SIS compliance issues would include:
- Section 109: Investments of superannuation entity to be made and maintained on arm's length basis.
- Section 65: Prohibition on providing financial assistance to a member of the SMSF or their relative. This would apply where the structure of the related party’s business is a sole trader or where the SMSF member is a partner in the partnership that conducts the business.
- In-house asset rules: The ATO may treat the amount of rent owing as an in-house asset. However, this would depend upon whether the rent owing was considered to be a loan from the SMSF to the related party. SMSFR 2009/4 provides, amongst other things, the ATO’s view of the meaning of ‘loan’ in the context of the in-house asset rules. The explanation in this section of the ruling the ATO states that the “Commissioner accepts that payments for goods on normal commercial terms will not amount to a ‘loan’, nor will late payments which are not agreed to by the trustee of the superannuation fund”. It also provides an example of late payment of rent in example 1, paragraph 73 of the ruling. However, a condition is that the late payment is not part of an arrangement between the (related) parties, as this could be evidence that it is a financial accommodation of provision of credit and thus a loan.
- Section 62: Sole purpose test. Where the SMSF is not enforcing the terms of the lease in relation to unpaid rent, the purpose of the SMSF maintaining the asset may be called into question.
Prima facie, the back rent, not due to the financial effects of COVID-19, would not be subject to the ATO’s compliance relief. However, provided the SMSF landlord has applied the provisions of the lease for collection of unpaid rent, prior to the commencement of the COVID-19 pandemic period. If the related party tenant is unable to pay the pre COVID-19 back rent due to the financial effects of COVID-19, there may be a case to argue that its non-collection during the COVID-19 period falls within the ambit of the ATO guidance.
Can more than 50% of the temporary reduction be a waiver (e.g. 100%)?
Under the National Code, applying the proportional approach, at least 50% of the temporary rent reduction is to be in the form of a waiver. The National Code allows the tenant to agree to waive the waiver. Consequently, the landlord could provide a waiver of greater than 50%, noting that any amount of waiver is rent that will never be recovered by the landlord. However, where the tenant is a related party, if the waiver provided is more than 50% (per the National Code), there would need to be a commercial reason for this. It would also be prudent to obtain third party evidence of similar situations where the level of waiver is 100%. For example, a similar business who have be unable to trade at all and where the level of deferred rent would compromise the ability of the affected tenant to recover from the crisis.
Is rent relief not available if the tenant isn't eligible for JobKeeper?
The National Code has been issued to assist landlords and tenants negotiating such rent relief using a set of good faith principles. The National Code is to apply to all commercial tenancies where the tenant is suffering financial stress or hardship. Financial stress or hardship is defined in the National Code as a business’s inability to generate sufficient revenue as a direct result of the COVID-19 pandemic that causes the tenant to be unable to meet its financial and/or contractual (including retail leasing) commitments. Further, tenants who are eligible for the JobKeeper Payment are automatically considered to be in financial distress under the National Code. The National Code provides a disputes resolution process, as do the States and Territories, in relation to residential property leases.
So, it’s not necessary for the tenant to be eligible for the JobKeeper Payment for the National Code to apply and for the tenant to seek temporary rent relief and for the landlord to provide relief.
ATO says deferral of rent for interposed entities - doesn't mention rent waiver. Can a rent waiver be given to tenants of a property held by an interposed entity?
Firstly, it is implied that this ATO relief measure is referencing an interposed entity that is generally referred to as a “non-geared unit trust or company” under Division 13.3A of the SIS regulations – a “13.22C unit trust or company”. It is specifically concerning the issue of a temporary rent relief having the potential for there to be a regulation 13.22D event, that would cause the “non geared unit trust or company” to be treated as an in-house asset forever.
Where the property held by the interposed entity is a commercial lease, the National Code will apply in relation to the negotiation of any temporary rent reduction, which includes the requirement for at least a 50% waiver of any temporary rent reduction. Consequently, it is anticipated that where an interposed entity was providing rent relief, including both deferral and waiver, per the National Code or other a commercial arrangement, the ATO’s compliance relief would apply.
If the compliance measure offered by the ATO, for a property held by an interposed entity did not include a waiver of rent, then effectively there would be a different set of rules for a property held by an SMSF directly versus a property held via an interposed entity (that interposed entity being a “non-geared unit trust or company”). This is not expected to be the intent of the ATO compliance measure, and whilst the guidance on the website, for an interposed entity, only refers to a deferral of rent, it is anticipated that it also includes a waiver of rent.
Could you please explain what do you mean by 'at least 50% waiver'?
The National Code principles includes a waiver of at least 50% of the temporary rent reduction. This would mean that the amount or portion of the temporary rent reduction that is waived would not be recovered later by the landlord. This is compared to a deferral of a portion of the temporary rent reduction, which can be recovered later by the landlord from the tenant.
If parties are unrelated, but there is no written lease agreement in place, (just a month by month agreement) is this a breach of SIS?
It is not uncommon for a lease to be on a month to month basis and it would be expected that the monthly rental amount would reflect this casual arrangement, as compared to a lease over a longer period, for example three years. Whilst an agreement can be verbal or written, from an evidentiary perspective, written is preferred. SMSFR 2009/4 discusses the term ‘lease’ and ‘lease arrangement’ and notes that in section 10(1) of the SIS Act that there can be a lease arrangement “whether or not the agreement, arrangement or understanding is enforceable, or intended to be enforceable, by legal proceedings”.
It would be expected that the SMSF auditor would wish to confirm that the tenant is not a related party, as well as the reason why a written lease, on at least a month to month basis, has not been executed. A reason could be that the tenant has refused to sign a lease and the after various enquiries with real estate agents, the rental market for the area for the type of property, is very depressed, with many vacancies, and with many tenancies being casual with no written lease agreement. It would also be prudent for the SMSF trustee(s) to record this in minutes at the time the lease arrangement was entered into. However, where the tenant is a related party and the property subject to the lease meets the definition of ‘business real property’ in the SIS Act, for the lease not to be treated as an in-house asset, the lease or lease arrangement needs to be “enforceable by legal proceedings”. Further, it needs to comply with SIS Act section 109, that is, the terms of the lease are commercial. Generally, subject to alternate third-party evidence, a lease of business real property would require a written lease agreement, setting out the terms of the lease to provide audit evidence of compliance with SIS Act section 109 and not to potentially be treated as in-house asset.
How about residential property rent relief? Are there any specific guidelines on this? Can we apply the commercial guidelines to a degree, e.g. rent deferral, rent waiver?
The National Code that applies to commercial leases would be an initial reference point for providing temporary rent, particularly the proportionate rent reduction approach. For residential property owned by an SMSF, it would be expected that such leases would be to unrelated tenants as generally, residential property does not satisfy the definition of ‘business real property’. Consequently, temporary rent relief negotiated would be regarded, prima facie, as being on commercial terms, thus providing no SIS issues.
In short, any rent relief offered should be:
- Requested by the tenant;
- Due to the financial effect of COVID-19 on the tenant's ability to meet normal rental payments;
- Reasonable (given the circumstances of the tenant and landlord); and
There are residential rent relief measures announced by the various State and Territory Governments, which should be referred to for any specific measures that apply. In relation to the National Code, it states that it is not intended to supersede such State and Territory legislation but aims to compliment it during the COVID-19 crisis period. Links are provided below:
When reduction in tenant business turnover was only 35%, does the minimum 50% rent reduction waiver still apply?
Applying the principles in the National Code, the minimum 50% waiver applies to the portion of the total temporary rent reduction. That is, if the total temporary rent reduction is 35%, proportionately matching the tenant's reduction in turnover, then 50% of the reduced amount is to be in the form of a waiver. This would mean that of the 35% rent reduction, at least 17.5% would be in the form of a waiver (being 50% of 35%) and 17.5% would be in the form of a deferral.
The National Code notes that the tenant may waiver the requirement for a 50% minimum waiver by agreement.
Commercial lease arrangement, where the tenant's turnover had been reduced by 40%, however they only offer to pay 50% of rent, per the lease agreement, but promises to pay the balance in due course. Landlord wants to be paid 60% (proportionate reduction), i.e. not they are not willing to provide a 50% rent relief. ls that allowed?
It is assumed that this is an unrelated tenant. Consequently, this is not a SIS compliance issue, but a negotiating issue. Assuming the property is subject to a commercial lease and applying the National Code, the proportionate reduction in rent requested is not in line with the proportionate reduction in business turnover of the tenant. However, the tenant appears to be waiving the requirement for a 50% minimum waiver. Under the National Code it is intended that landlords will agree tailored, bespoke and appropriate temporary arrangements for each tenant, taking into account their particular circumstances on a case by case basis.
So, is the arrangement offered by the tenant allowed? In short, yes. There would be no SIS compliance issues as the parties to the negotiations are unrelated. However, whilst such an arrangement would be allowed, whether agreement on the arrangement can be reached is a separate question. Note, that if agreement cannot be reached, it can be referred and subjected to applicable state or territory leasing dispute resolution process for binding mediation. Further, the National Code states that landlords and tenants must not use mediation processes to prolong or frustrate the facilitation of amicable resolution outcomes.
Is there any ATO Compliance relief in relation to required minimum pension draw down if due to rent relief members are unable to draw the required reduced minimum pension for 2019-20 and 2020-21, for example 2.5%, instead of 5% for a member aged 65 – 74?
In short, no. Where the cash flow of the SMSF is not sufficient to meet the reduced minimum pension requirement, due to temporary COVID-19 rent relief provided by the SMSF to a tenant, there is no further relief available. However, the following can be considered:
- Whether other assets of the SMSF could be sold to provide sufficient cash to ensure the reduced minimum pension is paid for the income year. The sale proceeds would have to be deposited to the SMSF’s bank account and the required amount paid to the member by 30 June.
- The use of the temporary borrowing rule under SIS Act section 67(2). This allows a superannuation fund to borrow for the purpose of making a benefit payment, provided the period of borrowing does not exceed 90 days and the total amount of the borrowing does not exceed 10% of the value of the assets of the fund. From a practical perspective this would be useful close to the end of an income year where it is determined that the SMSF will not be in a cash position to meet the minimum pension requirement and where the member had sufficient cash funds outside of super, but was unable to contribute to the SMSF, either due to the contribution acceptance rules or their prior 30 June total superannuation balance meant a non-concessional cap of zero. Relevant loan documents would need to be prepared.
- Where the pension is an account-based pension, it can be fully commuted, but retained within the SMSF in the relevant member’s accumulation account. This will mean that there is no ongoing minimum pension standard to comply with, however, the SMSF must pay a pro-rata minimum pension payment prior to the full commutation to meet the pension standards for the income year. Further, the SMSF will not be able to claim Exempt Current Pension Income (ECPI) in relation to the pension from the date is was fully commuted. Ceasing a pension may also have Centrelink entitlement ramifications, particularly if the pension was a grandfathered pre 1 January 2015. Consequently, this should be taken into consideration.
- A member with an account-based pension could, after ensuring a pro-rata minimum payment is made, fully commute the pension back to their accumulation account and restart the pension at a lower balance such that a reduced minimum pension can be funded by the SMSF’s reduced cash flow for the remainder of the year. Note, that this same outcome cannot be achieved where there is a partial commutation of the pension as the minimum pension for an existing pension is based on its value at the start of the income year and a partial commutation does not cause the existing pension to cease.
Where the pension is commuted, and also if re-commenced, there will be Transfer Balance Account transactions with relevant Transfer Balance Account Reports (TBARs) required to be lodged. Given the expected downturn in property values, the TBA debit would be expected to be much lower than the original credit (earliest being 1 July 2017) in relation to that pension. Earnings on pension capital that has been commuted back to the member’s accumulation account will be assessed against the member’s Transfer Balance Cap (TBC) once a new pension is commenced from benefits in their accumulation account.
Further, some pensions simply cannot be commuted back to a member’s accumulation account. These include old legacy defined benefit pensions and market linked pensions (also known as term allocated pensions). In respect of the market linked pensions, fortunately the 50% reduction to the minimum pension also applies to them, so that will assist with meeting the relevant minimum pension. However, in respect of the old legacy defined benefit pension, the decrease in market value of fund assets may cause a solvency certificate issue and a problem for those SMSF members for which the pension is treated by Centrelink as a 100% Asset Test Exempt (ATE) pension.
This category includes death benefit pensions. Whilst the death benefit pension may be an account-based pension and can be commuted, the cashing requirements of a death benefit mean the commuted amount must be withdrawn from the super system, that is, the commuted amount cannot be kept within the super system in the member’s accumulation account. SMSFs with these types of pension should be reviewing their cash flow to formulate a strategy to ensure the at least the reduced minimum pension amount can be paid each year.
Is the proportionate method based on a month by month basis or is it determined on an agreed month?
When applying the proportionate approach to rent relief, this would be based on the tenant’s turnover at the time they seek such relief. For example, if the tenant sought relief in April 2020, they may substantiate their request for a specific percentage reduction in rent by comparing turnover for the previous four weeks to the corresponding four week period from 2019. They may also compare turnover from 1 January 2020 to the last six months of the 2019 calendar year to substantiate the percentage of rent reduction requested. However, it may also unfortunately be a situation where the tenant has been required to shut their doors and turnover has been reduced to zero – no comparison required.
It is up to the landlord and the tenant to negotiate an appropriate level of temporary rent relief, given the particular circumstances of the tenant and landlord.
For an SMSF that has recently purchased a new commercial property, which is to be leased to a related party, should they get a lease agreement done up now with current (reduced) market value or should they wait until September and then get a lease agreement drawn up with 'back to normal' market value of rent at that time?
Assuming the commercial property meets the definition of ‘business real property’, is in accordance with the SMSF’s Investment Strategy and there are no sole purpose issues, a lease agreement should be executed at the time that the business commences tenancy of the property. However, the terms of the lease could reflect the COVID-19 period in that there is an immediate rent reduction, requested by the tenant, based on the proportionate approach outlined in the National Code. It would be prudent to seek legal advice on the preparation of the commercial lease with such terms. Further, as the lease is one of business real property to a related party, the level of “normal rent” would need to be substantiated, which then would be the reference for the temporary rent reduction.
If there is no current lease in place, should this be corrected asap and then tenant can apply for rent relief from related SMSF? If the lease is not current, does this mean that the tenant cannot request rental relief?
No current lease agreement in place does not prevent the tenant, either unrelated or related, from seeking rent relief. The need for a current written lease agreement between a related party tenant and an SMSF landlord is to substantiate that the terms of the lease are arm’s length in compliance with SIS Act section 109 and that the lease is enforceable by legal proceedings (a requirement not treated as an in-house asset).
If a tenant approaches a landlord for rent relief based on a reduction in their turnover of 40% but then their business picks up in one- or two-months’ time, can the tenant continue with rent relief? Does it need to be looked at monthly?
Any rent relief agreed to will generally cover the COVID-19 pandemic period, which aligns with the duration of the JobKeeper Payment, which runs until 27 September 2020. The National Code also refers to allowing the tenant an appropriate recovery period to facilitate the resumption of normal trade. Whether there would be any adjustment to the rent relief provided during the COVID-19 pandemic period, due to an improvement in the tenant’s turnover, should be dealt with as part of initial negotiations of the rent relief and documented accordingly. However, any increase in rent back to the “normal” level should be considered in light of the longer-term viability of the existing tenant and the recovery of any deferred rent, compared to looking for a new tenant.
The information on this article is provided by Mark Ellem ABN 69 989 271 960 and Accurium Pty Limited ABN 13 009 492 219 (Accurium). It is factual information only and is not intended to be financial product advice, legal advice or tax advice, and should not be relied upon as such. The information is general in nature and may omit detail that could be significant to your particular circumstances. The information is provided in good faith and derived from sources believed to be accurate and current at the date of publication. While all care has been taken to ensure the information is correct at the time of publishing, superannuation and tax legislation can change from time to time and Mark Ellem ABN 69 989 271 960 and Accurium is not liable for any loss arising from reliance on this information, including reliance on information that is no longer current. We recommend that you seek appropriate professional advice before making any financial decisions. Links to third-party websites are inserted for your convenience, but do not constitute endorsement of material on those sites.