High-risk factors for NALI flagged

While the tax consequences of having non-arm’s length income (NALI) applied can be significant, Mr Day pointed out that the majority of SMSFs are unlikely to be impacted by the issues raised in LCR 2021/2.

Mr Day outlined a traffic light system for identifying which clients are at greatest risk of non-arm’s length income and where SMSF professionals need to focus their attention.

“A lot of funds are going to be fine and won’t need to worry about it too much. Those are the funds that just buy listed shares, managed funds and cash and all contributions are in cash rather than in-specie contributions. These funds only engage third-party service providers,” said Mr Day.

“This probably explains around 80 to 90 per cent of SMSFs out there. They’re not entering into any sort of transaction with a related party. So therefore, the risk of non-arm’s length expenses coming into play is not there.”

Where SMSF clients might start to move up the risk profile, said Mr Day, is where the fund contains physical assets that are leased to related parties such as business real property, he warned.

“[With those types of assets] I need to start worrying about the rent,” he explained.

Where there are related-party acquisitions involving in-specie contributions, this also increases the risk, as it will be critical to examine how those transactions were done and whether the documentation has been done correctly, he cautioned.

If the fund is only using third-party service providers, however, this helps to minimise the risk, so the client would still be considered medium risk or “amber”, said Mr Day.

SMSF trustees enter the red light or high-risk category where they engage related-party service providers, he warned. 

This means SMSF professionals who do work for their own fund are at a much higher risk, he said. 

“If you’re an accountant or tax agent or whatever and you have your own SMSF and you do work for that fund, then watch out. Get this wrong and all of your income in that year is now non-arm’s length income,” he cautioned.

Assets such as related-party companies and trust investments would also place the client in the high-risk category. 

“You can have in house assets up to the 5 per cent, but then you’ve got to worry about what you paid for those units or shares. Is everything going on within that company, also an arm’s length terms? Is there a discretionary trust mixed up in here somewhere?” he explained.

“If you’ve got a limited recourse borrowing arrangement, you also need to make sure that’s on arm’s length terms.”

Mr Day also reminded SMSF professionals that the compliance relief provided by the ATO in PCG 2020/5 would cease on 30 June. 

In response to concerns raised about the ATO’s approach to general fund expenses in the draft version of LCR 2021/2, the ATO announced in PCG 2020/5 that it would not allocate any compliance resources to determine whether the income of a super fund is NALI where the fund incurred NALE of a general nature that has a sufficient nexus to all ordinary and/or statutory income derived by the fund from 1 July 2018 to 30 June 2022.