In 2019, the government passed amendments to s 295-550 of the Income Tax Assessment Act 1997 (Cth) (ITAA 1997) to reduce the ambiguity surrounding the effect of non-arm’s length expenditure for SMSFs.
The amendments made it clear that all fund activities must be undertaken on commercial terms and assets purchased at market value and that each situation needs to be assessed in terms of whether NALI applies to the income of a particular asset or to all the income of the fund.
Speaking to SMSF Adviser, BDO partner – private wealth Mark Wilkinson said there are still some issues surrounding these rules, particularly as it took such a long time for the legislation to be passed.
“It lapsed before the last election and was then reintroduced and passed, but the effective start date goes back to 1 July 2018,” Mr Wilkinson said.
“From an audit perspective, there is quite a degree of exposure for auditors, in that they really need to examine the costs or the non-incurring of costs associated with transactions to a much larger degree than they’ve probably done in the past.”
One of the areas where non-arm’s length issues tend to be missed, he warned, is where the fund is invested in underlying entities such as trusts and companies.
“While these may be permitted investments, the cleaning, for example, might be carried out by a member and a charge is not put through, or there’s another type of or non-arm’s length transaction that might have occurred,” he explained.
“This is certainly an ongoing audit challenge because it directly impacts the rate of tax that’s payable by the fund in that instance.”
Mr Wilkinson said the legislation is very clear that if expenses are not incurred or incurred at a lesser extent than they should be in a non-arm’s length arrangement, then they need to be aware of the consequences of that.
“The risk is that all of the income is being taxed as ordinary income when it should actually be taxed at this higher non-arm’s length rate, or special income tax rate and therefore as a result of that, the process that they’ve gone through is inaccurate,” he said.
While there is currently transitional relief in place where the expense is a general expense and doesn’t have a direct nexus to a particular investment in the fund, Mr Wilkinson said accounting firms will need to start thinking about an appropriate pricing mechanism for partner funds completed internally at the firm.
“They’ll have to go through the process of working out an appropriate pricing mechanism for those, to make sure that they don’t fall foul of the NALI provisions in that instance,” he stated.
Great comments, Mark.