Clarifying ‘arm’s length’ crucial in COVID-19 rent relief
SMSFs should be able to provide rent relief provided it can be done on “arm’s length” commercial terms. However, the unprecedented nature of the COVID-19 outbreak has led to uncertainties on what “arm’s length” means, according to SuperConcepts.
In a blog, SuperConcepts general manager for technical services and education Peter Burgess said it doesn’t matter what the terms are when agreeing to rent relief as a result of COVID-19, as long as the trustees can demonstrate the arrangement is on arm’s-length commercial terms.
However, since the last global pandemic was the Spanish flu back in 1918, Mr Burgess said there is no modern-day precedent or a complete set of rules to guide what constitutes a commercial arm’s-length basis in the current environment.
“With the list of industries impacted by compulsory government shutdowns seemingly increasing by the day, the evidence of rent-free periods and rent assistance packages is fast becoming the norm throughout the entire community,” Mr Burgess said.
“So, you would think we are not that far away from having a complete set of rules, or acceptable understanding, which SMSF trustees can use to demonstrate their decision to offer a related-party tenant some rent relief that is consistent with a commercial arm’s-length arrangement.”
Mr Burgess said it’s a similar situation for SMSFs which have borrowed funds using a related-party LRBA to acquire a business premise which is leased to a related party.
“If the fund is no longer receiving lease payments from the related party and is therefore unable to service the related-party loan at a rate, and in a manner, consistent with the ATO’s safe harbour parameters, does this mean the sale proceeds will be taxed as non-arm’s-length income if the fund is forced to sell the business premise?” he said.
“Again, it depends on whether the SMSF trustees can demonstrate the related-party lender’s decision to waive or reduce the loan repayments is consistent with a commercial arm’s-length arrangement.”
Steps to demonstrate arm’s-length terms
Mr Burgess said there are some practical steps trustees can take to help demonstrate arrangements they have with related-party tenants and/or related-party lenders are on commercial arm’s-length terms:
1. Check documentation such as lease agreements and/or loan documents.
According to Mr Burgess, this will give trustees a better idea of the extent to which the existing arrangement can be altered, and a decently drafted document will have agreement variation provisions and probably even force majeure clauses.
“A force majeure clause (French for ‘superior force’) is a contract provision that allows a party to suspend or terminate the performance of its obligations when certain circumstances beyond their control arise, making performance inadvisable, commercially impracticable, illegal, or impossible,” he said.
“The process would be instigated by the tenant (related party or not) outlining the reason why the rental obligations cannot be met (e.g. government-enforced social distancing).”
2. Consider the ramifications of the request including what the alternatives may be.
Mr Burgess said that in normal circumstances, one such consideration would be the eviction and replacement of the tenant.
However, if the circumstances would preclude either finding a new tenant or the same issues being faced by a new prospective tenant, Mr Burgess said eviction may not be a prudent step or in the SMSF’s best interest.
3. Determine the way trustees will vary the agreement based on these factors and then propose an alternative arrangement.
Mr Burgess said this may take many forms including rental waiver, reduction or deferral as well as specifying a period or trigger for the termination of the relief (e.g. the lifting of crowd restrictions).
He said the outcome should be documented and accepted by both the trustees and the tenant.
Where there is a lender involved in the transaction, such as a rental property purchased via an LRBA, Mr Burgess said the SMSF trustee, as borrower, would need to approach the lender for application of concessions under the loan agreement in a similar way.
“We may see concessions announced to deal with situations where an SMSF or a related entity has been impaired due to the economic turmoil caused by the coronavirus pandemic. And given the current environment, providing financial relief is an inevitable commercial reality,” Mr Burgess said.
“But while we wait for further announcements and commercial norms to be established, documenting relief arrangements with related parties, and providing a commercial justification with clear reasoning as to why such an arrangement is in the best interest of the SMSF, is a good start.”
Adrian Flores is the deputy editor of SMSF Adviser. Before that, he was the features editor for ifa (Independent Financial Adviser), InvestorDaily, Risk Adviser, Fintech Business and Adviser Innovation.