William Fettes, senior associate at DBA Lawyers, noted in a recent webinar that the issue of non-arm’s length gains being assessable only after specific reduction steps are applied had largely “slipped under the radar” in the recent legislative changes to non-arm’s length income (NALI). However, a newly finalised tax determination offers crucial guidance on how NALI interacts with CGT provisions.
“Tax Determination TD 2024/5 was finalised on 17 July 2024 and outlines how the CGT provisions interact with NALI, and from my reading, it broadly favours the taxpayer,” he said.
“Although s295-550 talks about ordinary income or statutory income being NALI, capital gains are generally only assessable as part of a net capital gain calculated under s102-5 of the ITAA 1997.
“Therefore, a question arises about whether it is only assessable net capital gain that is brought to tax as NALI after the reduction in relation to a tainted, non-arm’s length capital gain.”
Additionally, he noted, “you need to also consider what the market value substitution rules are in this context”.
“If you use the method statement for working out a net capital gain, does that mean a capital loss, and maybe combined with a general CGT discount, for example, reduce your tax liability? I think the answer is yes,” he said.
Fettes said there are four key takeaways from the TD that can help clarify the issue. The first is that the assessable net capital gain has primacy for NALI purposes.
“TD 2024/5 confirms the Commissioner’s view that a NALI assessment in respect of a tainted capital gain is limited to the fund’s assessable net capital gain,” he said.
“That is, despite s295-550(1) referring to ‘an amount of ordinary or statutory income’ that is NALI, paragraph [9] confirms the ATO view that in determining ‘the amount’ of statutory income that is NALI, the amount of NALI cannot exceed the superannuation fund’s net capital gain as calculated under subsection 102-5(1) for the relevant income year.”
He added that in circumstances where the non-arm’s length capital gain made by the superannuation fund would otherwise exceed the superannuation fund’s net capital gain, the amount of NALI equals the superannuation fund’s net capital gain.
The second key takeaway is related to market value substitution rules and suggests that where a CGT asset is acquired below market value, as a result of non-arm’s length dealings, the market value substitution rule in s112-20 of the ITAA 1997 will typically apply in relation to the asset’s cost base.
“Similarly, where a CGT asset is disposed for below market value capital proceeds such as a result of non-arm’s length dealings, the market value substitution rule in s116-30 of the ITAA 1997 will typically apply in relation to the capital proceeds,” Fettes said.
“However, the market value substitution rule in s116-30(2) does not apply where the capital proceeds from the CGT event exceed the market value and assuming that those capital proceeds were statutory income, the proceeds would be NALI.”
The third key takeaway concerns how capital losses can reduce NALI and states that capital losses can reduce NALI arising from tainted capital gains.
In paragraph 15, the TD states that “where a superannuation fund’s net capital gain for the income year is nil due to the application of capital losses and previously unapplied net capital losses at steps one and two of the method statement in subsection 102-5(1), respectively, the superannuation fund will have no amount of NALI referable to the non-arm’s length capital gain”.
Finally, the TD considers the treatment of tainted and non-tainted gains and gives several examples showing SMSFs deriving capital gains that are both arm’s length and tainted.
“The tax outcome is broadly a matter of working through the method statement in s102-5 of the ITAA 1997,” Fettes said.
