There have been numerous SMSF advisers putting forward their views on whether an SMSF trustee needs to pass on rent relief to a related party tenant in view of the COVID-19 impact on the economy.
The two main opposing views that have captured recent press publicity are summarised as follows:
- Unless rent relief is provided, the usual rent the SMSF receives will be non-arm’s length income (‘NALI’) given there are many landlords currently providing rent relief.
- There is no need to provide rent relief as a lease binds the parties to the lease agreement and the tenant’s business may not require any relief.
So who is correct and what is the correct view?
A lease binds a tenant
The starting point here is that a lease does bind the parties to the terms and conditions in the lease agreement including the rent and outgoings payable. Moreover, the terms and conditions in a lease agreement involving an SMSF trustee and a related party should have been benchmarked to prevailing arm’s length conditions at the time the lease was entered into. Furthermore, those terms and conditions should be maintained on an arm’s length basis throughout the lease term. In particular, leases for business real property typically include an annual indexation to the amount of rent such as an annual increase of a certain percentage (eg, 3% or CPI). Indeed, if there has not been compliance with the rent being increased each 12 months or compliance with other terms and conditions in the lease by the related party, then there may be potential for the ATO to apply s 109 of the Superannuation Industry (Supervision) Act 1993 (Cth).
However, a lot has transpired since the COVID-19 pandemic commenced.
The National Cabinet Mandatory Code of Conduct
The National Cabinet Mandatory Code of Conduct –– SME Commercial Leasing Principles During COVID-19 (‘Code’) establishes good faith leasing principles that apply to commercial, retail and industrial tenants with an annual turnover under $50M that qualify for JobKeeper support (usually at least a 30% reduction in turnover).
The Code itself is not legislation but is a policy document designed to support legislation that the states and territories introduce to deal with commercial leasing. The Code is best viewed as non-binding guidance for negotiations between commercial landlords and tenants.
Despite this fact, numerous SMSF commentators have been referring to the Code as having the force of law and the same effect as legislation that must be followed (admittedly, some may be misled by the term ‘Mandatory’ placed in front of the words ‘Code of Conduct’ in the Code’s title which suggests that it is binding as law).
However, the Federal government does not have constitutional power in relation to private property and leases. The enforcement of the leasing principles in the Code is therefore left to the state and territory governments who have the relevant law-making power and have recently introduced legislation to cover certain COVID-19 issues arising between commercial landlords and tenants.
Which tenants qualify for rent relief under state or territory legislation?
The short answer here is that not all tenants qualify for rent relief. The starting point is that you need to carefully check the specific legislation (including regulations) of each state and territory.
For example, under the Victorian regulations (ie, COVID-19 Omnibus (Emergency Measures) (Commercial Leases and Licences) Regulations 2020 (Vic)), a related tenant that is a body corporate and an SMSF trustee is generally not covered by the Victorian legislation (ie, COVID-19 Omnibus (Emergency Measures) Act 2020 (Vic)) and therefore there is no legislative obligation on an SMSF landlord to grant rent relief to a related party tenant that is a body corporate. The Code provides guidance in the form of suggested leasing principles that the parties can refer to guide their negotiations.
The situation in New South Wales is covered by the Retail and Other Commercial Leases (COVID-19) Regulation 2020 (NSW) (‘NSW Regulations’) under the Retail Leases Act 1994 (NSW) which give effect to certain leasing principles in the Code in New South Wales. The NSW Regulations offer similar protections to Victoria with some key differences.
Both Victoria and NSW regulations apply to small to medium enterprises (SME) with an annual turnover under $50M that qualify for JobKeeper support. Indeed, most other states and territories in Australia have passed legislation to deal with commercial leases in relation to SMEs in view of the COVID-19 pandemic implementing their own unique points.
Thus, where there is a lease in place it remains a binding legal agreement and SMSF trustees and related parties must continue to act at arm’s length and abide by it unless there is some legislative basis that dictates otherwise.
A party to a lease cannot simply unliterally vary a lease. A variation typically requires a deed of variation agreed to by both the landlord and tenant that is prepared by a lawyer. An exchange of emails or letters, even if supported by trustee resolutions, is unlikely to be sufficient. It should also be noted that there are many different aspects to varying a lease and unless careful consideration is given to each factor, a number of risk exposures may arise.
Where a tenant is covered by state or territory legislation, typically the tenant needs to initiate rent relief by a written request to the landlord.
So might a tenant that is not covered by state or territory legislation not have any right to rent relief?
Correct and it is then up to the parties whether they can negotiate any rent relief. The Code can assist in guiding the parties in their negotiations but the leasing principles in the Code are not mandatory in a legal sense without state or territory legislation to provide the enforcement mechanism.
As noted above, in Victoria many related party tenants leasing business real property from an SMSF will not be covered by the Victorian legislation and therefore any rent relief will be dependent on negotiations between the parties that should be conducted in good faith and with regard to the leasing principles in the Code.
Naturally, when an SMSF trustee is determining whether to provide any rent relief to a related party tenant, they would have due regard to the ability of the related party tenant to continue meeting its obligations under the lease. If the related party tenant’s business is struggling and unable to satisfy its ongoing operating costs, then it might be appropriate for the tenant to initiate rent relief negotiations with the SMSF trustee (landlord). In this instance, the related party tenant should provide whatever benchmark evidence is available on what an arm’s length adjustment to its rent should be for its landlord to consider. The Code is then relevant and in broad terms suggests that a proportionate reduction to rent in line with the tenant’s business turnover should be negotiated in good faith.
However, if a related party tenant does not initiate any rent relief request, then there is no sound basis for arguing that the net rent payable under that lease should be taxed as NALI (ie, and taxed at 45% after relevant deductions) as suggested recently in media coverage on this topic.
Indeed, this is no different to the situation where the rent established at the commencement of a lease is set to align with the prevailing market rental and several years later the market value of rent for those premises in that location increases substantially. On first blush, it appears the tenant is paying substantially below the prevailing market value in say years 4 to 5 of that lease but that rent is still reflective of market value provided that tenant’s rent has been adjusted in accordance with the review criteria in the lease of an annual increase of say 3% or CPI. A subsequent change in market conditions does not alter the fact that the 5-year lease was set to market with annual adjustment at the commencement of that lease.
Moreover, not all businesses are adversely impacted by COVID-19 and many tenants can thankfully continue to meet their normal commitments. In particular, a business typically would want to continue to satisfy its obligations under a lease agreement by paying rent on an ongoing regular monthly basis. If it does not, it may place its continued occupation of the premises at risk and the landlord may seek to utilise the security bond or rent guarantee towards any outstanding payments subject to any protection afforded to the tenant under state or territory legislation.
A senior ATO officer in the superannuation division at the ATO was also recently quoted as agreeing with the view that NALI is not invoked if no rent relief is provided by an SMSF to a related party tenant.
Can an SMSF adviser prepare documents varying a lease?
SMSF advisers who are not qualified lawyers but who provide assistance in relation to leases should be mindful that they do not undertake any legal work and do not breach the relevant state or territory legislation that only allows a lawyer in that jurisdiction to provide legal services. As discussed above, preparing a deed to vary a lease is complex legal work which must take into account a range of legal and commercial issues and is likely to constitute legal work. Thus, an unqualified person preparing such documentation could therefore be subject to significant penalties and be liable in negligence if they do not undertake the work to the same quality that a lawyer would.
In particular, we have already come across a number of non-qualified suppliers providing lease variation documents for SMSFs of questionable legal effectiveness with no warning of the risks involved.
NALI is not automatically invoked if rent relief is not provided by an SMSF trustee to a related party that is continuing to comply with its obligations under the lease agreement.
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This article is for general information only and should not be relied upon without first seeking advice from an appropriately qualified professional.
Note: DBA Lawyers hold a range of SMSF CPD training online. For more details or to register, visit www.dbanetwork.com.au or call Natasha on 03 9092 9400.
12 May 2020