Drawing a clear line in NALE, NALI impacts on property
While the ATO has made an extension relief on defining its compliance approach around NALI, advisers will need to be very mindful of the breadth of the provisional impacts on SMSF property and its associated expense elements moving forward.
The well-known criticism of the draft Law Companion Ruling 2019/D3 is the breadth of the ATO’s view in relation to the “nexus” required between the scheme and the loss, outgoing or expense that can constitute non-arm’s length income (NALI) under s 295-550 of the Income Tax Assessment Act 1997 (Cth) (ITAA 1997).
Recently, the ATO had delayed the commencement of the Law Companion Ruling concerning the super fund non-arm’s length income until 30 June 2022, making an extension relief on the ATO’s transitional compliance approach in PCG 2020/5.
DBA Lawyers director Daniel Butler had stated that while the draft LCR is still to be finalised, it appears the initial intent of the exposure draft legislation has taken on a far broader application, given the ATO’s views in relation to how a general expense can taint all income (ordinary and statutory).
SuperGuardian education manager Tim Miller said that all the talk at the moment around LCR 2019/D3, its associated practical compliance guidelines and the ATO’s vision of extending the relief period, is the issues around the application in the nexus between the expenses and its associated impacts on what constitutes NALI.
“One of the key issues associated with this that we all need to be acutely aware of is that extension and the conjecture around what it all means, the consideration around the concept where the lack of an expense or discounting fees as such will be applicable to all income where there is a nexus to all income of the superannuation fund,” Mr Miller said at the Tax Institute Superannuation Intensive Series.
“That to me is the catalyst of all of this extension by the ATO in this non-arm’s length expense area.
“What is very clear through those practical compliance guidelines that extends the time frame out before taking any compliance action, is where it is absolutely easy to identify that an expense relates to an investment, then if that expense is non-arm’s length, as in if no expense is paid or if the expenses is discounted and it has a pure or direct link to a specific investment, then any income associated with that investment will be NALI.”
Mr Miller said that is a significant issue for SMSFs that invest in property and particularly SMSFs that invest in business property where it is leased to a related party, because it means the whole concept around what is a contribution under TR 2010/1 regarding the acquisition of assets from related party ruling and the whole Section 17B and trustee remuneration to ceases in its effect.
“This whole idea that we can offset a fund expense with a fund contribution that is in effect unless it’s contracted into the arrangement has gone out the window under this LCR and new NALE requirements,” he said.
“Clearly, if a fund is underpaying property-based expenses, not just interest on LRBAs but any property-based expense, then arguably all income or rental income and then all CGT attached to that asset will be subject to NALI provisions.
“SMSFs are now in a position where if a trustee performs a service in their individual capacity, the NALI provisions will apply where remuneration is paid by the fund on non-arm’s length terms, and if the SMSF has individuals rather than a corporate trustee, it will also breach Section 17B.
“This applies whether the fund underpays and where no remuneration is provided. Ultimately, this creates a subset of property problems for SMSFs given the link between trustee remuneration, the acquisition of assets from related party rules and the definition of a contribution.
“It’s easy to say that’s a long bow to draw, but it’s also easy to read that’s exactly what the provisions will provide for, and so one of those things to be mindful of is that all our expenses moving forward in the property space really need to be undertaken on a commercial term.”
Furthermore, one of the key issues of the ruling is that the NALE provisions are not intended to apply where a trustee provides services to their SMSF in their capacity as trustee, according to Mr Miller.
“Functions performed in an individual capacity are more likely to come under greater scrutiny, but the line between trustee and individual can be blurred. This is where property-related expenses can become problematic,” he said.
“For example, what about the farmer who fixes the fence and uses his own farming equipment to fix the fence and doesn’t charge for that, is that a minor issue or is that a major issue?
“Now that’s just one particular issue, but how about the maintenance of the property? Who pays for it, how it’s paid for, what are the terms of the lease — all of those things become relevant in the life cycle and property transactions.
“There needs to be clarity in the transaction and recognition of the work done and materials purchased, but there is a line that now seems blurred with NALE. These historical rulings really do create a dilemma when we contemplate the NALE provisions and how they apply.
“Unfortunately, it’s not just expenses related to the provision of services such as accounting and building and construction that create issues.”