According to law firm Townsends Business & Corporate Lawyers, the situation could arise based on the ATO’s compliance approach to rent relief to not take action for 2019–20 and 2020–21.
The law firm said that while the ATO’s approach may please SMSF trustees and professionals, this temporary and general compliance approach should not be mistaken as “a perfect cure to any potential compliance breaches”.
“There has been no formal change in the requirements as provided in the superannuation and tax legislation relevant to an SMSF providing rent relief, meaning the ATO’s FAQ section is certainly not an excuse for trustees to deviate from their ongoing responsibilities and obligations under the existing superannuation and tax laws,” it said.
The example of Bruce and Linda
Townsends uses the example of Bruce and Linda, who are members/directors of the corporate trustee of the B & L SMSF.
The fund owns a commercial warehouse that is rented to Bruce and Linda’s business. Due to COVID-19 economic stress, their business income has been significantly reduced when compared to the same period in the previous year.
The business is a small- to medium-sized business with annual turnover less than $50 million and is eligible for the JobKeeper payment. Bruce and Linda aren’t considering giving any rent relief to their business and so are effectively pumping up their super instead.
According to Townsends, the ATO’s temporary compliance approach regarding rent relief does not cover Bruce and Linda’s situation where a fund has not provided rent relief to a related-party tenant who suffered financial distress as a result of COVID-19.
But had the same lease been given to an unrelated tenant, the law firm said it is likely that the net rental income earned by the fund from the lease would have been lower for the income year due to rent relief negotiation between the parties in accordance with the applicable government measures, including the national cabinet’s mandatory code of conduct.
“On this basis, the Tax Office could arguably assess the rental income from the property for the current income year as NALI to be taxed at 45 per cent,” it said.
According to Townsends, the NALI risk could be mitigated if Bruce and Linda took their member/trustees’ hats off and conducted themselves as if their business was an arm’s-length tenant unrelated to the fund.
“The ATO’s announcement of temporary compliance approach is not in the form of a binding advice and also doesn’t cover all circumstances,” the law firm said.
“For prudent trustees, this message from the regulator should be conceived as ‘we trust you will do the right thing during this period’ rather than ‘you can ignore the compliance rules during this period’.”
If their business is significantly affected by Covid 19 one would assume that the related party would need to apply for rent relief anyway.
If they don’t then the business must not be suffering as expected, or the payment of rent is part of a greater organised ‘scheme’ to increase super benefits. The latter surely being somewhat less likely in time such as these…
To qualify for a reduction under state legislation, you need to satisfy the relevant criteria. Under the Vic legislation it appears in many cases involving SMSF landlords, the related party tenant is not eligible for the protection under the legislation and the National Code is merely a wish not law (which is why the states/territories need to provide legislation). Thus, I do not see Townsends comments as accurate and it is one thing to pay above the market rent but when the market declines but you are committed to a lease, then I see difficulty in then jumping to the conclusion that NALI applies. I recommend expert advice be obtained.
NALI and s.109 need to be considered both when rent is dropped and when it isn’t. Kym’s argument contains one major flaw – NALI is triggered by applying the test of: IF the parties operated on an arm’s length basis would the benefit gained have been different to what was received? It is a test that replaces BOTH parties and examines what independent people would do in their situation and what the outcome would be. Hard to defend a situation which diverges from broader community behaviour when this test is applied as drafted eg. a tenant didn’t ask for a rent drop when their income has tanked because reality is that nearly everyone is asking for a drop even when their income hasn’t gone down (just ask any estate agent!). You can keep the rent up, but only provided you have the evidence that the tenant’s request could be fairly denied under the code.
Whilst I agree with the sentiment of the article, it overlooks the key component of the Code – it applies if a tenant requests some form of rent relief due to decreased economic position flowing from CV-19. The SMSF trustee is required to conduct transactions at ‘arm’s length’ however, is the related party?
It could be argued, the SMSF is not required to approach the tenant but, the Code ensures that if the tenant does, they are obliged to respond. A SMSF trustee is a separate entity to the underlying individuals that wear the tenant hat.
This confirms what I have been telling my accountant clients. Look at everything in a broad, practical sense, and document everything, including the reasons why decisions are made. At least that way, if the ATO disagree, evidence can be supplied, which will assist in reducing any risks.
Great. Damned if you do & damned if you dont. That is what I love about law – it is just shades of grey and costs a motza to untangle and even then it is often wrong. Just depends on the way the wind is blowing.
Good comments by Townsends. Agree 100%