Key NALE areas that need to be resolved ahead of ATO ruling
Continued issues surrounding non-arm’s length expenses (NALE) have been complicated by the ATO’s changes in positioning, with a technical specialist weighing in on several key areas that will need to be resolved.
The issues surrounding NALE first began in October 2019 when Parliament passed changes to the Tax Act to ensure that a super fund’s expenses are taken into account in determining if all or part of a fund’s income is to be taxed as non-arm’s length income (NALI).
Along with the law change, the ATO released a draft ruling (LCR 2019/D3) outlining the ATO’s stance on how the new rules for non-arm’s length expenses (NALE) should be interpreted.
Heffron head of SMSF technical and education services Lyn Formica said it was at that moment when “the proverbial hit the fan”.
“While we understand the law change was initially targeted at nil/low-interest related-party LRBAs, the actual wording of the new law means the net is cast much wider than that,” she said in a blog.
“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.”
It is also noted that, specifically for income derived in 2018–19 and later years, the 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.
Ms Formica said in defining 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,” Ms Formica said.
“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.”
Ms Formica said, like every other SMSF practitioner, she hopes these examples will be expanded to provide more clarity when the ruling is finalised later this year. The expected completion date is 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,” she said.
In regard to expenditure of a general nature, Ms Formica explained this would have a nexus with all of a fund’s income (for example, accounting fees), so no action is needed (i.e. 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 like 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,” she said.
“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.”
Issues around ‘staff discounts’
Commonly, rather than the trustee providing services to the fund, the services are provided by another entity and at a discounted or nil rate. Prime examples are an accounting, advice or property management firm of which the trustee is an employee.
Ms Formica said 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, the 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 that they are not able to influence the discounts provided to them,” she said.
“But again, we hope the final ruling will further clarify what the ATO considers normal commercial practice in this area.”