Examining the draft determination on the in-house asset exclusion
The ATO’s draft legislative instrument for the in-house asset exclusion for SMSFs providing rental relief poses some questions which may require further clarification from the ATO.
On 3 August 2020, the ATO released draft legislative instrument Self Managed Superannuation Funds (COVID-19 Rental Income Deferrals – In-house Asset Exclusion) Determination 2020 for industry consultation.
The determination is intended to protect SMSF trustees from adverse compliance problems under the in-house asset rules where, due to COVID-19, a rent deferral arrangement has been put in place for tenants in the 2019–20 and 2020–21 financial years.
This article examines why the new instrument is required where rental relief is provided by an SMSF trustee. It also poses some questions that ought to be clarified by the ATO in relation to the scope of the exclusion in the current draft language.
The problem of rent deferrals in an SMSF context
In the ordinary course, an SMSF trustee providing a rent deferral to a related-party tenant is likely to give rise to in-house asset concerns. This is because s 10(1) of the Superannuation Industry (Supervision) Act 1993 (Cth) (SISA) defines loan to broadly include:
… the provision of credit or any other form of financial accommodation, whether or not enforceable, or intended to be enforceable, by legal proceedings.
Further, in SMSFR 2009/4 –, the ATO expressly confirms that instalment payment arrangements and arrangements for the deferral of payment of debts or entitlements can fall within this extended definition of loan.
Thus, a rent deferral provided to a related-party tenant can give rise to loan to a related party which naturally falls within the definition of an in-house asset under s 71(1) of the SISA.
A similar problem arises where an SMSF is invested in a non-geared company or unit trust that owns real estate and the rent relief is provided via that interposed entity (we refer to these interposed entities as “div 13.3A entities”). In that case, any deemed loan that occurs due to rent relief being provided is likely to trigger reg 13.22D of the Superannuation Industry (Supervision) Regulations 1994 (Cth) (SISR) and thereby cause the fund’s unitholdings/shares to become in-house assets.
More specifically, the regulatory exemption will be lost if the non-geared company or unit trust has “a loan to another entity” that is not a deposit with an authorised deposit-taking institution [SISR reg 13.22D(1)(b)(ii)]. Accordingly, this problem can arise for div 13.3A entities even if the tenant is not a related party.
The triggering of reg 13.22D of the SISR is a serious concern because the loss of this regulatory exemption under s 71(1)(j) of the SISR is regarded by the ATO as being permanent for the SMSF. More specifically, in SMSFD 2008/1 , the ATO states:
… Therefore, from that time those investments are in-house assets of the SMSF. Further, the existing investments and any future investments in that particular related company or unit trust can never again be excluded from being in-house assets under subparagraph 71(1)(j)(ii) of the SISA even if the circumstance that caused the event to happen no longer exists …
This means that rent deferrals (indirectly) provided by SMSF trustees through div 13.3A entities will broadly result in the structure being permanently tainted, and the SMSF may be required to dispose of its interests in the company or unit trust to stay within the mandated 5 per cent limit for in-house assets.
The draft determination provides the following compliance relief in relation to the in-house asset rules and rent deferrals:
For the purposes of paragraph 71(1)(f) of the Superannuation Industry (Supervision) Act 1993, where during the 2019–20 or 2020-21 financial years the fund:
(a) allows a related-party tenant a deferral of rental income under a lease (on arm’s length terms) due to the financial impacts of the coronavirus known as COVID-19, or
(b) holds an interest in a related party which is exempt from being an in-house asset due to the operation of regulation 13.22B or regulation 13.22C of the Superannuation Industry (Supervision) Regulations 1994, and that related party allows a tenant a deferral of rental income under a lease (on arm’s length terms) due to the financial impacts of the coronavirus known as COVID-19
the resulting asset is not an in-house asset of the fund.
Matters requiring clarification — the scope of the exclusion
The language in the draft determination could be clearer regarding certain aspects of the scope of the exclusion. In particular, it should be noted that the following matters should be considered by the ATO prior to the final language being settled for the determination:
- Paragraph (b) of the determination refers to reg 13.22C which sets out the conditions that must be satisfied by companies and unit trusts at the time the shares or units are initially acquired by the SMSF. However, it not does not expressly cover reg 13.22D which sets out the triggering events which will (subsequent to the original investment) cause shares in a non-geared company or units in a non-geared unit trust to become in-house assets.
- The determination does not expressly state that shares in a company or units in a unit trusts covered by the exclusion will continue to enjoy this exclusion indefinitely — i.e. assuming no other triggering events have occurred aside from the rent deferral. This is an important point in light of the ATO view set out in SMSFD 2008/1 that triggering a condition in reg 13.22D of the SISR will mean the exclusion under s 71(1)(j) of the SISA can never again operate for the SMSF even if the circumstance that caused the event to happen no longer exists.
The ATO has provided reasonably clear guidance on these issues and their overall compliance approach in non-binding channels, such as the “COVID-19 – frequently asked questions” webpage, and in the latest addendum to the auditor contravention report instructions for SMSF auditors.
For example, in the ATO’s “Addendum: Auditor contravention reporting instructions specific to the 2019–20 and 2020–21 financial years due to the impacts of COVID-19”, the ATO states the following in relation to a rent deferral being provided by div 13.3A entities:
We have said we will not treat the investment in the interposed entity as an in-house asset in current and future financial years as a result of a deferral of rent being provided to the tenant due to the financial effects of COVID-19. This means we won’t take compliance action against the breach in the current and future financial years.
This means you do not need to report an in-house asset contravention for current and future financial years providing the above three requirements are met. That is, if the rental relief is on commercial terms, is due to the impacts of COVID-19 and is adequately documented. We plan to make a determination by way of legislative instrument under paragraph 71(1)(f) of the SISA to exclude the fund’s investment in the interposed entity from being an in-house asset. This is so you can avoid informing trustees about this breach during the annual audit on an ongoing basis.
This is on the basis that:
- the relief offered by the SMSF trustee or div 13.3A entity is on commercial terms;
- the relief has been offered due to the adverse financial impacts of COVID-19; and
- the relief arrangement has been adequately documented.
However, on the basis of the current language in the draft determination, we consider that the position of SMSF trustees and auditors is not adequately clear. Indeed, auditors may be obliged to report in-house assets concerns in relation to SMSFs with investments in div 13.3A entities that have provided a rent deferral for future financial years.
By William Fettes, senior associate, and Bryce Figot, special counsel, DBA Lawyers