Rent relief due to the financial impact of COVID-19 is being extended throughout the SMSF sphere — to tenants both related and unrelated — in relation to property held in the fund or by Div 13.3A entities.
There have been questions about how this relief should be reported in the financials; also questions about implications of this relief for the SMSF audit.
The good news: there are answers.
Rent relief – financial assistance but no reportable contravention
Where an SMSF extends rent relief due to COVID-19’s financial impact upon a tenant, the ATO will not take compliance action provided three requirements are satisfied:
- Rent relief is extended on commercial terms;
- Relief is extended as a result of the financial impacts of COVID-19; and
- Relief is appropriately documented.
This is excellent news, because sometimes a compliance contravention is unavoidable.
For example, if the Bob & Sally Superannuation Fund extends rent relief to Bob’s picture framing business, the SMSF has provided financial assistance to the members in contravention of the SIS Act section 65 — even if this assistance is provided indirectly through Bob’s business and complies with the ATO’s three requirements.
What will the audit report look like?
SMSF auditors are not excused by the ATO from their obligations in forming an audit opinion.
Auditors must form an opinion in line with the auditing standards. Ultimately, it’s up to the SMSF auditor to assess the materiality (both qualitative and quantitative) of a section 65 breach. If the breach is material, auditors will qualify their Part B compliance opinion. And any breach of section 65, material or not, must be communicated to the trustees in the management letter. This does not mean the SMSF is in trouble. It’s just the rules.
Reporting rent relief – deferrals v waiver
In extending relief to a tenant, an SMSF may grant either a waiver or deferral of rent. In the case of a waiver, the rent is foregone. The fund will never receive this amount. The “lost” rent will not appear in the fund’s financial statements.
In the case of a deferral, the receipt of rent is delayed. This is a form of financial accommodation, the deferral of an entitlement. It is, in fact, a loan. According to SIS Act section 10(1), a “loan” includes the provision of credit or any other form of financial accommodation. SMSFR 2009/4 paragraph 11 further suggests that a “loan” will include arrangements for the deferral of paying an entitlement.
So, it is expected that rent deferrals as a result of COVID-19 will generally appear as loan receivables in the SMSF’s financial statements.
Is the loan receivable an in-house asset?
Loans to a related party would ordinarily fall within the meaning of an in-house asset in SIS Act section 71. So, if an SMSF has a rent receivable “loan” to a related party, does the fund have an in-house asset?
Further, what happens if a Div 13.3A related trust or company extends a deferral of rent to its tenant due to COVID-19? The provision of loans by such entities is prohibited by regulation 13.22D. A single breach of the requirements permanently ruins the entity as an exception to the in-house asset rules and generally leaves the SMSF investor with a significant headache.
This was a legislative problem and the legislative cavalry have come to assist in the form of draft legislative instrument SPR 2020/D2.
This draft instrument considers the deferral of rent due to COVID-19 in two situations:
- An SMSF landlord permits the deferral of rent by a related-party tenant.
- An SMSF holds an ownership interest in a Div 13.3A trust or company, which in turn permits a deferral of rent by its tenant (related or otherwise).
The instrument provides that where the deferral of rent in each case:
- Is permitted under a lease,
- On arm’s length terms,
- Due to the financial impacts of COVID-19,
the loan receivable will not be considered an in-house asset.
It’s important to note that the legislative instrument applies to the deferral of rent in either the 2019–20 or 2020–21 financial years, as this is the period in which COVID-19 is expected to affect such tenancies.
So what will the auditor need to see?
When dealing with a related tenancy, the trustees should provide a current lease agreement that permits the rent arrangement. This is particularly important when dealing with rent deferrals, as the legislative instrument specifically requires compliance with a lease to satisfy this carve-out of the in-house asset rules.
It’s also important to demonstrate that a rent reduction is proportionate to the tenant’s decline in turnover due to the virus. This evidence should take the form of an email or letter from the tenant, describing:
- The tenant’s business type (i.e. restaurant)
- How COVID-19 has impacted their business (dine-in facilities closed)
- Percentage of the business’s turnover reduction due to COVID-19
In the case of unrelated tenancies, there is a presumption that arm’s-length dealing has been observed and that the trustees are acting in the fund’s best interests. Auditors will usually only ask for an explanation of what has happened in terms of rent relief, supported by an email trail or minute.
Conclusion
The course requirements for SMSFs extending rent relief due to COVID-19 are now well laid down.
Those SMSF trustees that comply with the guidelines and provide their auditor with evidence to substantiate their actions should fly through the hurdles without difficulty.
As always, touch base with your auditor in advance with any questions regarding rent relief or evidence required for the audit file.
