29/04/2020

Non arms-length income (NALI) might arise if the fund does not provide a related party with rent relief.

So we’ve all heard now from the ATO that their compliance approach for the 2019-20 and 2020-21 financial years is that they will not take action if a SMSF gives a tenant (even if a related party to the fund) a temporary rent reduction, waiver or deferral because of financial effects of COVD-19. While the ATO’s announcement is pleasing to the ear of SMSF trustees and professionals, this temporary and general compliance approach should not be mistaken as a perfect cure to any potential compliance breaches. There has been no formal change in the requirements as provided in the superannuation and tax legislation relevant to a SMSF providing rent relief, meaning the ATO’s FAQ section is certainly not an excuse for trustees to deviate from their ongoing responsibilities and obligations under the existing superannuation and tax laws.

Let’s consider the example of Bruce and Linda who are members/directors of the corporate trustee of the B & L SMSF. The fund owns a commercial warehouse that is rented to Bruce and Linda’s business. Due to COVID-19 economic stress, their business income has been significantly reduced when compared to the same period in the previous year. The business is a small to medium sized business with annual turnover less than $50 million and is eligible for the JobKeeper Payment. Bruce and Linda aren’t considering giving any rent relief to their business and so are effectively pumping up their super instead.

The ATO’s temporary compliance approach regarding rent relief does not cover the above situation where a fund has not provided rent relief to a related party tenant who suffered financial distress as a result of the COVID-19.

In relation to SMSFs, NALI is broadly defined and could potentially capture any income derived from an arrangement that is not on arm’s length terms and where any one or more of the following applies:
-    the amount of the income is more than the amount that the entity might have been expected to derive if those parties had been dealing with each other at arm's length in relation to the arrangement;

-    in gaining or producing the income, the entity incurs a loss, outgoing or expenditure of an amount that is less than the amount of a loss, outgoing or expenditure that the entity might have been expected to incur if those parties had been dealing with each other at arm's length in relation to the arrangement; or

-    in gaining or producing the income, the entity does not incur a loss, outgoing or expenditure that the entity might have been expected to incur if those parties had been dealing with each other at arm's length in relation to the arrangement.

Had the same lease 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.  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%.  

The NALI risk could be mitigated if Bruce and Linda 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 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”.

For further information, please contact Townsends Business & Corporate Lawyers on (02) 8296 6222 or email info@townsendslaw.com.au to see how we can assist.