SMSF trustees who do not plan on providing COVID-19 rent relief to a related-party tenant should be aware such a move may render any rental income as non-arm’s-length income (NALI) and subject to 45 per cent tax, according to a legal firm.
The warning was given by Townsends Business and Corporate Lawyers, which pointed out the ATO’s decision not to engage in compliance action for the 2020 and 2021 financial years where an SMSF gave a tenant a temporary rent reduction, waiver or deferral did not mean compliance breaches would be ignored.
“There has been no formal change in the requirements as provided in the superannuation and tax legislation relevant to a SMSF providing rent relief,” the firm stated in an update on its website.
It added the ATO’s compliance approach “is certainly not an excuse for trustees to deviate from their ongoing responsibilities and obligations under the existing superannuation and tax laws”.
For SMSFs that act as tenants, the NALI provisions had remained unchanged and were still in operation, it pointed out.
At the same time, the ATO’s temporary compliance approach regarding rent relief did not cover a fund that had not provided rent relief to a related-party tenant who suffered financial distress as a result of the COVID-19 pandemic.
The firm used an example of two trustees who were members and directors of the corporate trustee of their fund, and where the latter owned a commercial warehouse rented to the trustee’s business.
The income of this business had been reduced, due to COVID-19-related economic stress, compared to the same period in the previous year and the trustees had decided not to give any rent relief to the business, and, as Townsends notes, “are effectively pumping up their super instead”.
It pointed out NALI, in relation to SMSFs, is broadly defined and aims to capture any income derived from an arrangement that is not on arm’s-length terms.
This includes where the income is higher than that which would be received if the parties were dealing at arm’s length, where any loss, outgoing or expenditure in producing income was lower than expected if the parties were dealing at arm’s length, or if in producing the income, there is no loss, outgoing or expenditure that might have been expected to be incurred if the parties were dealing at arm’s length.
Returning to the example, Townsends stated that if the same lease had been given to an unrelated tenant, “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 national cabinet’s mandatory code of conduct”.
It added that under the arrangements cited, NALI could be assessed, but the fund could adopt a workaround to prevent this taking place.
“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.
“The NALI risk could be mitigated if [the trustees] 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 a temporary compliance approach is not in the form of a binding advice and also doesn’t cover all circumstances.
“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’.”
SMSFs offering rent relief to tenants are required to provide commercial justification for any decreases or waivers of rent and also document those changes and retain those records.
