David Busoli, principal of SMSF Alliance, asked where no related party charge has been raised for a provided service, there is an issue but, if one has, who is to say what constitutes market value?
“The ATO is not going to investigate situations where firstly, a reasonable attempt has been made to apply an arm’s length amount or whether a broad staff discount has been applied,” he said.
“Additionally, the ATO is not likely to investigate if the trustee has provided the service in their capacity as trustee only. More importantly, this is not a SIS compliance area so is not something the auditors are required to check.”
The new NALI rules, which have been the subject of debate and consideration for several years now, limit the amount of NALI arising from a non-arm’s length transaction to twice the difference between the actual expense and the expected market rate of the expense. Large APRA funds are excluded.
“Simply put, if a related party accountant charged their SMSF accounting fees of $1,000 when they should have charged $2,000, then the amount of NALI would be 2 x ($2,000 – $1,000) = $2,000. A tax of 45 per cent would then be levied and equal to $900. This is not a particularly onerous treatment,” Busoli said.
“The far more serious application of NALI is the permanent tainting of an asset, generally real estate, where the net income and eventual taxable capital gain is hit with 45 per cent tax. Incredibly, this provision was not even considered.”
Busoli said three examples from LCR 2021/2 indicate the unreasonableness of this rule.
The first considers Russell, whose SMSF purchases $900,000 of listed shares from a related entity for $500,000. He doesn’t take measures to have the difference treated as a non-concessional contribution.
All future dividends and eventual net capital gain will be NALI and taxed at 45 per cent.
“Interestingly, if Russell was trying to limit his CGT on the sale of the shares to his fund he would have failed as the market substitution rules will revalue the transaction, for CGT purposes, to $900,000,” Busoli said.
“In keeping with this principle, the cost base shown by the SMSF, for eventual CGT purposes, would also be $900,000.”
The second scenario from the ATO involves Kellie, who lends her SMSF 100 per cent of the $2 million required for the fund to purchase a property, from an unrelated party, using a related party limited recourse borrowing. The interest rate is 1.5 per cent paid annually over 25 years. The property is rented to an unrelated party at commercial rates.
“Because the terms of the loan are not allowable under the safe harbour provisions, the net rent, and subsequent taxable capital gain on sale of the property, will be NALI and subject to 45 per cent tax,” Busoli said.
“This is a permanent position. Even refinancing the loan through a bank won’t help.”
He said despite the passing of the NALI legislation, the regulator is reticent to consider changes because it “doesn’t believe the provision has ever been applied to this type of scenario”.
“To ensure your client doesn’t become the first instance, be sure to stress the importance of dealing at arm’s length and, if related party limited recourse borrowings are involved, to do everything by the book.”
