Implications of COVID-19 on SMSF property investments

• Good faith leasing principles

• Negotiating rent reduction

• Proportionate basis

National Cabinet Mandatory Code of

Conduct

• Unrelated or Related tenant (BRP)

• Unable to pay rent per lease

• SIS concerns

ATO compliance relief

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Negotiating principles vs Compliance relief

State based rules for residential

property

No compliance action by ATO for 2019-2020 & 2020-21 re

temporary rent reduction due to financial effects of COVID-19

Applies:

- Commercial leases

- 4 April 2020 for duration of Jobkeeper (27 September 2020)

- Tenants whose business is an eligible business for Jobkeeper

11 Overarching principles to guide landlords to agree tailored, bespoke and appropriate arrangements for

tenants

14 Leasing principles to apply when negotiating and enacting appropriate temporary arrangements

under the Code

Binding mediation where landlords and tenants cannot reach agreement, only as a result of the COVID-

19 pandemic

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National Cabinet Mandatory Code of Conduct

Proportionate rent reduction

- % reduction in business turnover = % temporary reduction in rent

- At least 50% of temporary reduction must be a waiver

- Balance can be deferred

- Deferred amount paid back over balance of lease, but not less than 24 months, unless shorter

period agreed to

- Waiver can be waived by tenant by agreement

Landlord cannot access rental bond or guarantee set aside for non-payment of rent

Tenant to be afforded opportunity to extend lease during COVID-19 period + recovery period

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National Cabinet Mandatory Code of Conduct

Scenario 1

Tenant can’t pay rent (commercial/unrelated)

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Tenant can’t pay rent (commercial/unrelated)

Negotiating principles:

Approach by tenant to SMSF landlord

Review lease for variation power & process

Evidence that tenant is eligible for Jobkeeper

Evidence of % reduction in turnover

Temporary period agreed upon

Rent reduced proportionately

- At least 50% waiver

Rent relief documented

- Variation of lease

- Exchange of letters

SIS Act implications:

SMSF Trustee minutes to record negotiations

- Reduction in rent

- Temporary

- Due to financial effects of COVID-19

- Negotiated per National Code

- Sole purpose adhered to

- Evidence for SMSF auditor

- Reduction due to COVID-19

- Temporary

- No other lease incentives

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Leasing principle 8

- “Landlords should where appropriate seek to waive recovery of any other expense (or outgoing payable) by a tenant, under lease terms, during the period the tenant is not able to trade. Landlords reserve the right to reduce services as required in such circumstances”.

Leasing principle 10

- No fees, interest or other charges should be applied with respect to rent waivers and deferrals (including recovery of deferrals).

Rent reductions likely apply only to net rent

- May still recover outgoings, but landlords should consider waiving recovery where tenant is unable to trade

- Any relief granted to landlords for land tax, council rates or insurance premiums should be applied to recovery of such outgoings from tenants

- Other occupancy costs in name of tenant, e.g. electricity, for tenant to negotiate with service provider

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Issue 1 - Outgoings

Audit evidence that shows:

Tenant requested rent reduction

- Copy of letter/communication

Tenant’s business affected by financial effect of COVID-19

- Nature of business; forced to close due to social distancing; customer orders dropped off etc

The temporary rent reduction/relief provided

- Per National Code

- Evidence of RP tenant’s proportional reduction in turnover due to COVID-19

- Nature of temporary reduction/relief – deferral v waiver

- Period of temporary reduction/relief

Documentation for temporary reduction/relief

- Amendment to lease or exchange of letters

- Copy of lease to ensure variation process followed 8

Issue 2 – what needs to provided to the SMSF auditor?

Scenario 2

Tenant can’t pay rent (commercial/related)

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Tennant can’t pay rent (commercial/related)

Negotiating principles:

Tenant & SMSF landlord the same, but…

Rent reduction is initiated by tenant

Reduction is due to financial impact of COVID-19

Rent reduction is commercial

Per lease agreement

- letter from tenant to landlord

- Per National Code – proportionate approach

- Other 3rd party commercial evidence

- Is there a re current one?

SIS Act implications:

- S.109 – dealing on arm’s length terms

- S.65 – financial assistance

- S.82 – IHA rules

- S.62 – Sole Purpose Test

ATO compliance relief, but

- Relief is temporary

- Due to financial effects of COVID-19

- Reasonable given tenant’s business

- Commercial (per Code or other evidence)

- Changes to lease documented

- There is a lease! 10

S. 109 – Investments of a super fund must be maintained on arm’s length basis

Is the rent relief provided on arm’s length terms?

- Is it warranted?

- The tenant’s business has been financially affected by COVID-19

- Reduction/relief based on National Code

- Proportionate reduction

- At least 50% of reduction waived → never to be recovered by SMSF landlord

- Deferred rent → can be recovered over remaining term of lease, but not less than 24 months

- Reduction/relief based on other commercial arrangements

- Evidence from 3rd party that arrangement is commercial

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Issue 1 – Type of rent relief

Any rent waived is forever lost to the SMSF

Any “catch-up” of retirement savings later → via contributions & relevant caps

National Code “Tenants may waive the requirement for a 50% minimum waiver by agreement”, but also

intention of Code is not to burden business with debt as they enter the recovery period

ATO compliance relief runs until 30 June 2021

- Review of any deferred rental reduction prior to assess if waiver required

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Issue 2 – Deferring all the rent reduction

RP tenant’s business affected by COVID-19, but able to continue to pay rent per lease terms

Is this a NALI issue? → NO!

- ATO relief is provided where less than market value rent is paid (due to COVID-19)

- NALI applies where greater than market value rent is paid

- Rent paid = market value rent → no ATO relief required & no NALI

- Would also not apply where 100% of rent reduction is deferred for recovery later

Continuing to pay rent per lease = continue to build retirement without need for use of contribution caps

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Issue 3 – What if RP tenant does not request relief?

Audit evidence that shows:

Related party tenant requested rent reduction

- Copy of letter/communication

Related party’s (tenant) business affected by financial effect of COVID-19

- Nature of business; forced to close due to social distancing; customer orders dropped off etc

The basis for the temporary rent reduction/relief

- Per National Code

- Evidence of RP tenant’s reduction in turnover due to COVID-19

- Other commercial rent reduction/relief

- Property manager/real estate agent advice of relief offered by other landlords in similar situation

Trustee minutes/resolutions

Amendment to lease or other lease variation documentation14

Issue 4 – what needs to provided to the SMSF auditor?

Scenario 3

SMSF with LRBA(commercial lender)

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Unrelated tenant (commercial or residential property)

Tenant seeks rent relief

- Commercial tenancy → apply National Code → proportional reduction

- Residential tenancy → apply relevant state based COVID-19 measures

SMSF landlord seeks relief from lender

- Australian Banking Association (ABA) COVID-19 Commercial Landlord Relief Package

- Six-month deferral of loan payments

- Interest continues to be charged → capitalised → loan payments will be increased, or loan term extended

- Undertaking not to evict tenant or terminate lease for COVID-19 rent arrears

- SMSF (borrower) was not in arrears 90 days prior to applying

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SMSF with LRBA (commercial lender)

Unrelated tenant (commercial or residential property)

Leasing principle 7:

- “A landlord should seek to share any benefit it receives due to deferral of loan payments, provided by a financial institution as part of the Australian Bankers Association’s COVID-19 response, or any other case-by-case deferral of loan repayments offered to other Landlords, with the tenant in a proportionate manner”.

Questions:

1. What is the benefit?

- Bank continues to charge interest → no waiver of interest → collects more interest

2. Is the lender a member of Australian Banking Association?

- No COVID-19 relief offered

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Issue 1 – relief provided to tenant

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Issue 2 – disparity in cash flow

Cash In

Rent relief to tenant:

• Period of reduced/no rental income

• Permanent loss of any rent waived

Contributions reduced or ceased (temporary)

Cash out To lender

Temporary period:

• (6 months)

• No loan payments

• Interest capitalised

Deferral of loan repayments period ceased

Interest charged and capitalised during deferral period = loan balance is higher

Loan repayments increase; or

Term of loan extended

Consider cash flow of SMSF:

Tenant paying rent at pre COVID-19 temporary relief?

- Recovery of deferred rent

Level of contributions from members or thier employer

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Issue 3 – Post COVID-19 loan and cash flow decisions

Scenario 4

SMSF with LRBA

(RP Loan)

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Unrelated tenant (commercial or residential)

- National Code or State or Territory based relief measures

Related party tenant (Business Real Property)

- National Code or other commercially substantiated relief measures

SMSF (borrower) to approach RP lender for relief

- Relief sought due to financial effects of COVID-19

- Rent relief sought by or granted to tenant

RP lender grants similar relief to commercial banks

- 6 months mortgage repayment

- Interest capitalised

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SMSF with LRBA (RP Loan)

ATO will continue to accept SMSF & RP are dealing at arm's length → no NALI

- Relief due to financial effects of COVID-19

- Relief reflects similar terms offered by commercial banks

- Change in loan terms must be documented & reasons for change

- Evidence that interest continues to accrue

- SMSF (borrower) will catch-up P & I loan payments asap

If further repayment relief required (due to COVID-19)

- Review at end of deferral period

- In line with commercial banks

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Issue 1 – Will NALI provisions apply?

Extend term of loan?

- Safe harbour maximum loan term (PCG 2016/5)

- Property – 15 years

- Stock exchange listed shares or units – 7 years

Increase loan payments

- Spread over remaining loan term (does that = asap?)

Catch-up loan payments

- Within 6 months

- By a stipulated date (similar to introduction of safe harbour rules in PCG 2016/15)

Cashflow considerations

- Permanent loss of waived rent

- Ability of tenant to make 'normal' rental payments

- Contributions from members and/or their employer

- Other fund assets that may be sold 23

Issue 2 – catch-up P & I loan payments

Safe Harbour Loan assistance measures

(what would be welcomed further relief)

• Extend maximum term of loan by period of loan relief

• Expected measure by commercial banks

• Review rules for setting of interest interest

• 2019-20 - 5.94% (property) 7.94% (listed stocks)

Scenario 5

Property held via interposed entity

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SMSF owns property via non-geared unit trust or company

- Complies with either SIS reg 13.22B or 13.22C

Property tenant suffers financial effects of COVID-19

- Requests rent relief

Non-geared unit trust or company provides rent relief

- Lower distribution/dividend to SMSF unit holder/shareholder

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Property held via interposed entity

13.22D(1)(l)

- "the company, or a trustee of the unit trust, conducts a transaction otherwise than on an arm's length basis."

Reg 13.22B/13.22C ceases to apply→ IHA......forever!

ATO compliance relief:

- "If your SMSF holds an interest in an interposed entity such as a non-geared company or unit trust and that

interposed entity leases property to a tenant, we will not treat the investment in the interposed entity as an in-

house asset for the 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."

COVID-19 rent relief approach the same as if the SMSF owned the property directly.

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Issue 1 – SISR 13.22D event

Year-end financial statements & annual

return issues

SMSF Property affected by COVID-19

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Accounting:

Record deferred rent separately – outside of financial statements

- Unsure of actual recovery

- Note in statement of accounting policies re rent relief provided + deferral not brought to account until

recoverable

Record deferred rent in financial statements

- Amount owing – separate from other debtors and receivables

- Note in statement of accounting policies re rent relief provided + deferral

- Subject to SIS regulation 8.02B - market value + recoverability

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COVID-19 rent relief - Deferred rent portion

Income Tax:

SMSF discloses income on cash basis (present entitlement for trust distns)

Deferred rent included in financial statements

- DR – amount owing (Asset) CR – Rental Income (Income)

- Not assessable income until received by the SMSF

Rental income receive by rental property agent and held at 30 June

- Assessable in year received by agent

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COVID-19 rent relief - Deferred rent portion

GST (SMSF registered + commercial property):

SMSF – GST cash basis

- No GST for SMSF to remit - No GST input credit for tenant to claim

SMSF – GST accruals basis

- Merely accrued (no Tax Invoice issued)

- No GST for SMSF to remit - No GST input credit for tenant to claim

- Tax Invoice issued (separately or on regular Tax invoice)

- SMSF liable for GST portion of deferred amount – Input credit available for claim by

tenant

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COVID-19 rent relief - Deferred rent portion

SMSF – GST cash basis

- No GST for SMSF to remit - No GST input credit for tenant to claim

SMSF – GST accruals basis

- Merely accrued (no Tax Invoice issued)

- No GST for SMSF to remit - No GST input credit for tenant to claim

- Tax Invoice issued (separately or on regular Tax invoice)

- SMSF liable for GST portion of deferred amount – Input credit available for claim by tenant

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COVID-19 rent relief - Deferred rent portion

Do not bring to account in SMSF's Operating Statement & Statement of Financial Position

Disclose in Summary of significant accounting policy notes

Do not issue Tax Invoice for deferred amount or include in Tax invoice

- Other lease documents will confirm rent relief arrangement and deferral

Post COVID-19

- When tenant can commence repayment of deferred rental relief

- Issue Tax Invoice for each payment made by tenant

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Deferred rent relief - Suggested approach

Interest is charged and capitalised to loan

- Per ABA COVID-19 relief measures

- Per ATO compliance relief measures

Accounting

- Recorded as expense and increase to loan in SMSF's financial statements

Tax

- Deductible in income year charged/capitalised to loan

GST

- No input tax claim as financial supply

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Interest charged on loan during relief period

SISR reg 8.02B requires assets of an SMSF to be disclosed at 'market value' in year end financial

statements

"market value" , in relation to an asset, means the amount that a willing buyer of the asset could

reasonably be expected to pay to acquire the asset from a willing seller if the following assumptions were

made:

(a) that the buyer and the seller dealt with each other at arm's length in relation to the sale;

(b) that the sale occurred after proper marketing of the asset;

(c) that the buyer and the seller acted knowledgeably and prudentially in relation to the sale.

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Year end market value

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ATO market valuation guidelines

Significant event

natural disastermacro-ecomonic

eventsmarket volatility

changes to the character of the asset

Need to consider market value each year, but do not need external valuation for all assets each year, e.g. property, unless significant event occurred since last valuation

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ATO market valuation guidelines – Real property

Consider use of 'qualified independent valuer'

Value of the asset represents a significant proportion of the fund's value

Nature of the asset indicates that the valuation is likely to be complex or difficult

"When valuing real property assets for SMSF financial reports, the valuation may be undertaken by anyone as long as it is based on objective and supportable data. A

valuation undertaken by a property valuation service provider, including online services or real estate agent would be acceptable."

Valuation options – factors to consider:

Portion of total assets in property

Reliability of valuation options

Independence

Specific knowledge and expertise

Nature of disclaimers

Supported by recent sales data & other searches

Evidence required by SMSF Auditor.

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Market value of property – financial statements

A valuation may be undertaken by:• registered valuer• professional valuation service provider• member of a recognised professional valuation body• person without formal valuation qualifications but who has

specific experience or knowledge in a particular area.

Valuation principles:Valuation arrived at using 'fair and reasonable' process:• it takes into account all relevant factors and considerations

likely to affect the value of the asset• it has been undertaken in good faith• it uses a rational and reasoned process• it is capable of explanation to a third party.

Minimum pension amounts for account based pensions

Minimum/maximum pension range for market linked pensions

Minimum/maximum pension range for transition to retirement pensions

SIS and Centrelink solvency requirements for defined benefit pensions

Prior 30 June Total Super Balance

- Non-concessional contribution cap ($1.4m - $1.6m)

- Catch-up concessional ($500k)

- Recently retired work test exemption rule ($300k)

- Whether an SMSF can use the segregated method to claim ECPI ($1.6m)

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Year end market values affects for next income year

+ 50% reduction to minimum pension

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The information in this presentation has been prepared by Accurium Pty Ltd ABN 13 009 492 219 (Accurium). It is general information only and is not intended to be financial product advice, tax advice or legal advice and should not be relied upon as such. Whilst all care is taken in the preparation of this presentation, no warranty is given with respect to the information provided and Accurium is not liable for any loss arising from reliance on this information. Scenarios, examples and comparisons are shown for illustrative purposes only and should not be relied on by individuals when they make investment decisions. We recommend that individuals seek professional advice before making any financial decisions. This presentation was accompanied by an oral presentation, and is not a complete record of the discussion held. No part of this presentation should be used elsewhere without prior consent from the author.

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