COVID-19 Changes to the SMSF Landscape – Part 3: Related Commercial Tenancies

The goal posts of commerciality are changing in the wake of COVID-19.

This has implications for:

  1.  SMSF related party tenancies affected by COVID-19
  2.  Related party limited recourse borrowing arrangements (LRBAs) affected by COVID-19

The SMSF audit is critical to the decisions trustees and their advisers make today.

No one wants a train wreck with their SMSF auditor.

What steps are required to navigate post COVID-19 territory with the auditor’s green light?

First, let’s have a look at the new audit landscape for related commercial tenancies.

The ATO has confirmed that it will not devote compliance resources to instances of related party rent reduction for the 2020 and 2021 financial years. This is good news; but remember – the SMSF auditor must assess a fund’s compliance with the Superannuation Industry (Supervision) Act 1993.

What the Auditor must do

For engagements in the 2020 and 2021 financial years, the SMSF auditor must:

  • Form an opinion as to the commerciality of a post COVID-19 related tenancy.
  • Request sufficient appropriate audit evidence from SMSF trustees to support this opinion.
  • If the tenancy is not conducted on commercial terms, recognise a contravention of SIS Act section 109 and communicate this to the trustees in the management letter.
  • If the contravention of section 109 is material, modify the Part B Compliance Audit Opinion.
  • If the contravention is reportable under the Regulator’s reporting criteria, report the section 109 contravention (and any other contraventions) as usual to the ATO.

Hold on – isn’t there compliance relief?

Yes. Provided the post COVID-19 tenancy reflects an arm’s length standard of dealing, the SMSF auditor is not required to report any contraventions arising from this tenancy to the ATO.  

However, though dealing with its tenant on arm’s length terms, an SMSF may find itself in breach of other provisions.  For example, by extending rent relief to a related party tenant, the fund may provide indirect financial assistance to its members or their relatives. The SMSF will therefore contravene section 65. In the current environment, this breach is not reportable.

How does the Mandatory Code of Conduct apply to SMSF related tenancies?

The Mandatory Code of Conduct for SME Commercial Leasing Principles During COVID-19 is both a safety net and a starting point for these discussions.

The Code applies to commercial tenancies that are eligible for the JobKeeper programme. In the SMSF environment, this relates to small businesses that have experienced a reduction in turnover of 30% or more due to COVID-19.

Key outtakes from the Mandatory Code are summarised below. These are requirements for any SMSF related party tenant that qualifies for the JobKeeper programme:

No termination of lease: The SMSF landlord must not terminate the lease due to non-payment of rent during COVID-19 pandemic period.

Freeze on rents: The SMSF landlord should generally freeze the increase of rent for the pandemic’s duration and a reasonable recovery period.

Waive expense recovery: The SMSF landlord should seek to waive outgoings payable by the tenant under the lease for any period in which the tenant cannot trade.

Pass on benefit of loan deferral: If the SMSF landlord has received a deferral in the fund’s loan repayments, this benefit should be passed on to the tenant.

Proportionate rent reduction: A reduction in rent must be proportionate to the tenant’s reduction in trade due to COVID-19, up to 100% of rent payable.

At least 50% of reduction should be a waiver: Of the rent reduction, at least 50% must be extended as a waiver of rent, unless the tenant chooses to forgo this privilege. The balance may be offered as a rent deferral.

Repayment of deferred rent to be staggered: Any deferred rent must be amortised over the balance of the lease term (or for a period of at least 24 months if the lease term is shorter), unless otherwise agreed by all parties. The repayment of deferred rent should not commence until either the conclusion of the COVID-19 pandemic or expiry of the lease, whichever occurs sooner.

Option to extend lease: The related party tenant should have the option to extend their lease for a period equivalent to the rent waiver or deferral period.

The lease is binding: The related party tenant must remain committed to the terms of their lease (subject to any negotiated amendments). Material failure to comply with the lease will forfeit the tenant’s protection under the Code.

But what if the tenant has a COVID-19 related downturn of 20% – does the Code apply?

Commercial tenancies suffering a 20% downturn are not covered under the Mandatory Code. Though not directly applicable, the Code provides an excellent yardstick for the new normal in commercial practice. Related tenants in this situation can certainly negotiate an arm’s length reduction in rent with their SMSF landlord. A couple of things to bear in mind:

Three golden rules for the SMSF landlord

  • Reduction in rent must be proportionate to the negative impact of COVID-19 upon the business. This may take the form of a rent waiver.
  • A freeze upon all rent increases may apply until the economic situation improves.
  • Reduce any unnecessary burden for the tenant. Don’t charge the tenant for overheads that no longer have a utility.  If possible, switch off the service altogether.

One golden rule for the related party commercial tenant

  • Stick to the lease, including any specific amendments relating to COVID-19. If the tenant fails the lease conditions, the arrangement may be considered non-arm’s length and in breach of section 109.

Preparing the SMSF for audit

If your SMSF has a related party tenant that qualifies for the JobKeeper programme, the auditor will require the following:

  • Evidence that the tenant is eligible for the JobKeeper programme.

This should include confirmation of the successful JobKeeper application, together with evidence supporting the decline in projected turnover.

  • A current executed lease agreement, together with any amendments contained in an addendum to the lease.

If your SMSF has a related party tenant that has experienced a significant downturn of less than 30% as a result of COVID-19, the auditor will need to see:

  • Evidence that the tenant has been negatively affected by COVID-19.

This should take the form of a letter from the related party tenant to the fund trustee, describing the negative impact of COVID-19 upon the business. The letter should request a reduction in rent proportionate to the virus’s financial impact upon the business. You must substantiate the estimated reduction in turnover and retain this evidence.

The SMSF trustee should confirm their acceptance of the new lease terms in writing. Email correspondence may take the place of letter-writing, if convenient.

  • A current executed lease agreement, together with any amendments contained in an addendum to the lease. The lease arrangement should reflect with the golden rules outlined above and must be complied with as though it were an arm’s length commercial arrangement.

Remember, this is a temporary agreement. There should be a trigger point for a return to normal commercial dealings.


The goal posts for commercial dealing have changed significantly post COVID-19.

While the ATO’s decision not to apply compliance resources to related commercial tenancies for the 2020 and 2021 financial years is welcome, fund administrators must keep a few basic rules in the forefront of their minds or risk a reluctant collision with their SMSF auditor.

Action now will determine the audit ramifications later.

Review the existing lease. Ensure that any COVID-19 amendments comply with the Mandatory Code where business turnover is reduced by 30%, or reflect the golden rules of arm’s length dealing where the reduction is less. Preserve a paper trail, outlining the grounds for a rent reduction and the trustee’s acceptance of the revised terms. And remember – once the amended arrangement is in place, it must be complied with as though the parties were arm’s length.

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