Right now, it feels like a perfect storm is brewing for small businesses and their cash flow. The increase in the cost of fuel and its availability will be impacting businesses, whilst persistent inflation will likely keep interest rates higher for longer. Couple this with the introduction of payday super from 1 July, and you can see why cash flow might start to come under pressure.
For SMSFs with related-party tenants (typically where the fund leases business real property to a related entity), cash flow pressure may start to show up as delayed or missed rent. And whilst pausing rent with the intention of “catching up later” may feel practical in the moment, it’s important the fund and the related-party tenant continue to deal with each other on an arm’s length basis.
A good starting point is to follow the lease terms for late payment of rent. For example, it’s common for tenants to be notified in writing of unpaid rent, immediate payment requested and for interest to be charged.
If the related-party tenant continues to struggle to pay rent on time, the fund trustee must assess whether it is appropriate to retain the tenant. Usually, an arm’s length tenant that is struggling to make rent would approach the landlord and seek to negotiate a temporary reduction in rent.
Where there is a related party tenant, the fund trustee can only agree to a temporary reduction in rent if they can demonstrate that they are acting on an arm’s length basis. For example, could the trustee obtain written confirmation from a local real estate agent that all businesses in the precinct are struggling to pay rent & that they would be unlikely to secure another tenant who would agree to the current lease terms.
If it’s only a particular business or industry that is struggling and alternative tenants are available to lease the property, the fund trustee will breach the sole purpose test and will be providing financial assistance if they “prop up” the related party business with a rent reduction or deferral and allow the tenant to continue to use the property.
If a related party tenant decides to sub-lease part of the property to help with cash flow, it’s important to ensure the property continues to qualify as business real property. The use of the property by both the related party tenant and the sub-lessee is relevant in determining whether the “business use” test is met.
If the entire property is used only for business purposes, business real property status can be retained regardless of the tenant. However, any non-business use, such as residential use (even if it’s by an unrelated party), would cause the property to cease to qualify as business real property and become an in-house of the fund.
Cash flow stress for businesses can make putting off paying rent to the SMSF feel like the easiest option, but SMSF trustees need to ensure they keep related party leases on an arm’s length basis. If cashflow pressures persist, it is worth getting advice early rather than simply allowing rent to go unpaid.
Key takeaways
If you need further support with SMSFs and related-party tenants, our Technical Support Desk are available to answer your questions here.