SMSFs and rent relief due to COVID-19 — Part 1
SMSFs that own property are facing the prospect of tenants falling behind in their rent payments and their other obligations under the lease due to the economic stress arising from COVID-19.
Australian states and territories will put a six-month moratorium on evictions for both residential and commercial tenants during the coronavirus pandemic, Prime Minister Scott Morrison announced on 29 March 2020.
“Now there is a lot more work to be done here and my message to tenants, particularly commercial tenants and commercial landlords, is a very straightforward one: We need you to sit down, talk to each other and work this out,” the PM said.
The states and territories have yet to provide detail on the arrangements that are proposed.
The ATO has provided a non-binding practical approach of broadly not applying resources to this issue for FY2020 and FY2021.
From a legal perspective, if these cases are not carefully managed and documented, SMSFs and their trustees/directors could potentially face the risk of significant penalties under the Superannuation Industry (Supervision) Act 1993 (Cth) (SISA) and the Superannuation Industry (Supervision) Regulations 1994 (Cth) (SISR).
This article examines the position of an SMSF leasing business real property to an arm’s-length tenant and to a related-party tenant and provides recommendations for those who wish to ensure they minimise downside risk and can position themselves with a sound legal position.
SMSF and arm’s-length tenants
If the tenant has no direct or indirect relationship with the SMSF trustee (who is the landlord), then the SMSF trustee may be in a position to grant rent relief without contravening the SISA. Under this scenario, the parties probably would be dealing at arm’s length and, as outlined below, there may be various factors supporting a rent reduction in whole or in part as being in the best interests of fund members. For example, the following reasons could support rent relief:
- The tenant may have a better chance of successfully trading out of its current predicament, especially as many other landlords are being requested to grant relief due to the economic stress arising from COVID-19.
- The tenant may also be in a position to continue to cover holding costs such as council rates, land tax, regular maintenance of equipment and insurance subject to any applicable law (e.g. the Retail Leases Act 2003 [Vic] may preclude a landlord from recovering land tax). Note that, generally, a vacant property is not covered by insurance and having a tenant occupy premises, by itself, can be a significant advantage to a landlord who’s otherwise at risk without insurance.
- There may be further risks of having a vacant property, such as break-ins and fires and other damage arising while a property remains vacant and not maintained.
- There may also be little prospect of obtaining another tenant in the near future until the economy recovers after COVID-19, which some predict may take years.
The states and territories’ arrangements may provide some detail on what changes, if any, are required to be made to a lease agreement, as the states and territories have the power to override any lease agreement with a direction or order when a state of emergency is declared.
Subject to further developments, a lawyer should be consulted in relation to the terms and conditions in each lease agreement, as some may include a “force majeure” clause that allows a party to suspend or terminate the performance of its obligations if certain events occur such as an act of god.
Note that since a lease confers a form proprietary interest in relation to the land, the usual contractual law rules such as “frustration” of a contract may not necessarily apply. This area of law is being well researched and commented on by many property law experts.
SMSF and related-party tenants
If the tenant is a related party of the SMSF trustee, it is very easy to contravene the SISA provisions and extreme care in handling these situations is required.
Where an SMSF wants to grant any concession under a lease to a related-party tenant, they should, after taking appropriate accounting and legal advice, be careful to follow the appropriate steps and gather relevant evidence.
Some of the key issues that an SMSF dealing with a related-party tenant will need to deal with include:
- The sole purpose test – s 62 of SISA. Is the SMSF trustee merely reacting to assist a related party rather than acting in accordance with what an arm’s-length landlord would do? As noted above, an arm’s length landlord may decide to grant a concession to an unrelated tenant where that is in the landlord’s best interests.
- The in-house asset test – pt 8 of SISA. Non-payment of rent is likely to give rise to a loan by the SMSF to the related party, and if that loan exceeds 5 per cent, then an in-house asset contravention may arise. Note also that the terms of the lease may apply a penalty interest rate to the amount owed.
- The prohibition against lending or providing financial assistance to a member or relative – s 65 of SISA. If the SMSF is leasing to a member or relative of an SMSF, then there is a potential contravention of s 65 if the arrangement is not on arm’s-length commercial terms.
- The arm’s-length test – s 109 of SISA. Broadly, all investments and transactions involving an SMSF must be made and maintained — on an ongoing basis — on arm’s-length terms.
As you can appreciate from the above, an SMSF trustee will need to demonstrate that granting any concession is consistent with what arm’s-length parties would agree to do and is in the best interests of the fund and its members.
They should also examine all available options and obtain advice from an experienced real estate agent with regard to the prevailing market conditions for that particular lease in that location and determine whether another tenant can be obtained and when etc.
Additionally, the SMSF trustee should gather any evidence that supports the course of action taken after considering other alternatives, assuming the tenant was an arm’s-length tenant (rather than a related-party tenant) in those particular circumstances.
A detailed review of the lease should be undertaken as soon as practicable and advice taken on what variations may be needed to be made to the lease to reflect any concession that may be granted. Naturally, any variation to the lease agreement should be varied by an experienced and qualified lawyer.
Note that even though the SMSF trustee may gather evidence that the outcome of the concession granted to a related-party tenant under the lease reflects arm’s-length terms, that may not necessarily protect them from contraventions of the SISA occurring if, for instance, there is a loan or financial assistance that invokes ss 65 or 109 of SISA.
Daniel Butler, director, and Bryce Figot, special counsel, DBA Lawyers