Historically, the income of a fund has been taxed as non-arm’s length income (NALI) (ie at 45% instead of the concessional rate usually applied to super fund income) if:
- the parties to the arrangement are not dealing at arm’s length, and
- the amount of income earned by the fund from the arrangement is more than would be expected in an arm’s length situation.
So where does expenses come into it?
The issue of a fund’s expenses first raised its head in October 2019 when Parliament passed changes to the Tax Act to ensure that a super fund’s expenses are also taken into account in determining if all or part of a fund’s income is to be taxed as NALI. Specifically, for income derived in 2018/19 and later years, income of a fund will also be NALI if:
- the parties to the arrangement are not dealing arm’s length, and
- in gaining or producing the fund’s income, the fund incurs expenses and the amount of those expenses is less than would be expected in an arm’s length situation.
To coincide with the law change, the ATO released a draft ruling (LCR 2019/D3) explaining how they believed the new rules for non-arm’s length expenses (NALE) should be interpreted. And that’s when the proverbial hit the fan. Whilst we understand the law change was initially targeted at nil/low interest related party LRBAs, the actually wording of the new law means the net is cast much wider than that. Suddenly trustees providing services to their own SMSF at little or no cost were under the spotlight. In the worst cases, the fact that some relatively minor fund expenses were not at arm’s length could mean some or even all of the fund’s income was classified as NALI.
Fast forward 18 months and where are we at?
Services provided by SMSF trustees
Where trustees provide services to their own SMSF, the ATO makes a distinction between:
- services provided by the trustee in their capacity as trustee (in which case there are no NALE issues), and
- services provided by the trustee in their capacity as an individual (in which case the NALE rules are relevant).
The problem is in determining which “hat” a trustee is wearing when they provide services to their fund. To date, the examples provided by the ATO have tended to steer towards a trustee wearing their “individual hat” with the potential for NALE issues if:
- the trustee is qualified and licensed to provide the particular service to the public,
- the trustee uses their business or professional assets or equipment in providing the service, or
- the services are covered by an insurance policy relating to the business/profession.
Like every other SMSF practitioner, we hope these examples will be expanded to provide more clarity when the ruling is finalised later this year (the expected completion date is now June 2021). We would also like the ATO to take a less hard line approach in determining whether a trustee is wearing their “trustee hat” or their “individual hat” so that fewer situations create NALE issues for the fund, particularly if the trustee’s use of their business assets or equipment is relatively minor.
In the meantime, for expenditure of a general nature that has a nexus with all of a fund’s income (eg accounting fees), no action is needed (ie trustees do not need to charge fees to the fund) until at least 30 June 2021 (based on the transitional compliance relief offered in PCG 2020/5).
However, for expenditure relating to particular fund assets (eg repairs and maintenance on fund owned property), there is no compliance relief. If the trustee provided those services to the fund in their individual capacity, then to avoid a NALE issue arm’s length fees need to be charged. Some trustees will be caught in a catch-22 here because the super law prohibits trustees from receiving remuneration from the fund unless:
- they are appropriately qualified and licensed (if necessary) to perform the services, and
- the services are performed as part of a business through which these services are offered to the public.
Again it is hoped that this dilemma will be resolved when the ATO’s ruling is finalised.
Sometimes rather than the trustee providing services to the fund, the services are provided by another entity (eg an accounting, advice or property management firm of which the trustee is an employee) and at a discounted or nil rate.
The draft ruling indicates that these sorts of “staff discounts” will not be caught as NALE provided they are “consistent with normal commercial practice”. In our view, normal commercial practice would encompass arrangements where:
- the same discounts are provided to all employees/shareholders/officeholders, or employees/shareholders/officeholders of a particular class, and
- the employee/shareholder/officeholder was not able to influence the discounts provided to them.
But again, we hope the final ruling will further clarify what the ATO considers normal commercial practice in this area.
Expenses of entities in which the fund invests
One area we often see overlooked in discussions around NALE is where a company or trust in which the fund invests engages a non-arm’s length party to provide services to the entity. As with services provided to the fund itself, it is important to ensure an arm’s length rate is charged to the entity for those services. In fact, this was the case before the October 2019 law change. If the expenses of the entity are artificially low, the income of the entity will be “too high” and the distributions/dividends which flow to the fund will be caught as NALI.
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