SMSF NALE | ATO Non Arms Length Expenses

27 Jul 2021
Meg Heffron

Meg Heffron

Managing Director

A key ATO ruling (LCR 2021/2) was released today to update the original draft from 2019. It deals with the vexed issue of when transactions between a self managed superannuation fund and another party potentially create non arm’s length expenses (NALE).  

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NALE exists when expenses incurred by a SMSF are too low – they are less than the amount that would be been incurred if the parties had been dealing with each other on an arm’s length basis. 

NALE is bad because where it exists, the fund also has NALI (non arm’s length income). In other words, if a fund’s costs are artificially low, some or all of its income is taxed at the top marginal tax rate of 45% rather than the normal superannuation rates of 15% or nil%. 

For a stroll down memory lane, re-read our previous blog on this topic when the original draft ruling was released. The big question on everyone’s lips is - were all the issues emerging from the first draft put to bed in a sensible way in the final version? 

Hmm. Some yes, some no. 

(To be fair – much like I would not want to be a state premier or our prime minister right now, dealing with lockdowns, vaccines and pandemics in general, I would NOT want to be the ATO trying to land in the right place on this ruling. They have consulted widely and have ended up in a place that won’t please a lot of us on every front.  Personally I think a great result here was an impossible task.) 

Like the original draft, the final ruling divides potential NALE into two buckets: 

  • Costs that relate specifically to an individual asset – in which case all future income in relation to that asset is tainted forever and will be NALI (including capital gains), and
  • Costs which don’t relate to an individual asset (let’s call them general expenses) and are therefore deemed to relate to all income of the fund – in which case NALE means ALL fund income is NALI.  

For SMSFs in particular, when it comes to trustees doing work for their own fund, the final ruling also draws a distinction between: 

  • Work done in the person’s individual capacity – which might create a NALE problem if the fund isn’t charged arm’s length rates, vs
  • Work done in their trustee capacity – where it’s generally OK not to charge for the work, since being a trustee naturally involves (unpaid) work and sometimes that work will leverage particular skills the trustee happens to have. In fact, the super law prohibits trustees being remunerated for the work they do as trustee. 

So what’s the good news?

The final ruling includes a very sensible compromise that where a general cost is recurring, having a NALE problem in one year won’t taint the relevant income forever. General costs will only give rise to NALI in the years in which they are charged on a non arm’s length basis. 

In practical terms, this means that undercharging accounting fees in one year (a general expense that causes all fund income to be NALI) will only impact that year. 

That’s a very sensible change and extremely good news. It means that getting it wrong once can be very bad but not terminal. 

Note that the ruling explicitly distinguishes between this type of “once off NALE” and a similar problem where the expense relates to the purchase of an asset. Unfortunately, there is a permanent problem for NALE under these circumstances. The ruling even provides an explicit example where an LRBA is entered into on non arm’s length terms. Even refinancing and moving to arm’s length terms doesn’t help – all income and capital gains, now and forever, will be NALI. 

That’s rough. It means there is actually no solution for LRBAs that aren’t set up on a solid market basis. 

A second piece of good news is that the very tough stance originally taken on (most commonly) accountants doing work for their own SMSFs using company equipment has been softened to include some important new language : “However, minor, infrequent or irregular use of equipment or assets will not, of itself, indicate the individual is acting in their individual capacity. For example, in the absence of any other factor indicating otherwise, minor, infrequent or irregular use of a business computer at the office by an individual would not, of itself, indicate the individual is acting in their individual capacity.” 

To my mind, there are still plenty of questions to answer here, though. There are still strong themes: 

  • The importance of relying on a licence or insurance – it would seem that (for example) it’s fine for a qualified accountant to do their SMSF’s bookwork on their work computer and using their expertise gained via their work. But if they also lodged their tax return under their firm’s corporate tax agency, that is likely to create a problem,
  • A similar issue would appear to arise for financial advisers. An example provided in the ruling (Example 7, Levi) makes it clear that it’s fine for Levi to place investments for his SMSF (even using his work computer). But we’re unclear as to how far that stretches. If Levi’s SMSF is invested via the same platform as all Levi’s other clients, can he manage it under the same dealer code? 

And finally, the ruling does acknowledge the commercial reality of things like staff discounts. It provides examples about situations where (say) accounting fees for work on SMSFs of the staff who work at the firm can be discounted without automatically creating NALE. A key feature of the examples provided, however, is that the trustee / member is not in a position to influence the discount.  How far does this go? Could we be in the bizarre situation where I can offer all Heffron staff a discount on their SMSF work but can’t receive one myself because I can influence the decision? It’s not clear.

There’s still much to decipher and consider from this ruling. It’s a good start but as always, we need more examples that are closer to real life.  To stay informed on changes to rules and legislation subscribe to our Super Companion. It's our go-to online resource and knowledge centre – we use it internally to support our staff as they navigate SMSF accounting and compliance for our clients. It's so good that we've opened it up for all – find out more and sign up here.   

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