Common industry practice leaves SMSFs in potential NALI territory
The ATO’s stance on whether non-arm’s length income will apply to asset acquisitions from the past that comprise part cash and part in-specie contribution is still uncertain.
Speaking at a recent Tax Institute conference, Heffron SMSF Solutions director Leigh Mansell said one of the things that have emerged from LCR 2021/2 is that where an SMSF acquires something for less than market value, they’ve essentially got non-arm’s length income and they’ve tainted the asset.
“Any income, including realised capital gains, when you sell it is going to be non-arm’s length income taxed at 45 per cent. Even if your fund is in pension phase, you don’t get the 0 per cent tax rate; you will get hit for tax at 45 per cent,” explained Ms Mansell.
In the case of an asset purchased partly for consideration and partly by way of an in-specie contribution, the ATO has stated in LCR 2021/2 that the difference between the consideration paid by the fund and the market value of the asset purchased under a contract cannot represent the value of an in-specie contribution made by the seller, she explained.
“This is because there is no other asset being transferred to the fund that can be regarded as being an in-specie contribution. The difference between the consideration paid and the market value is not an asset, and as such, it cannot be an in-specie contribution made to the fund,” she said.
“Rather, as the fund will pay less than the market value of the asset, the non-arm’s length expenditure provisions will apply to the purchase, and all income derived from that asset will be NALI.”
Ms Mansell gave an example of an SMSF client, Inga, who personally owns a commercial property with a market value of $1 million that is leased to an unrelated party from which that party runs their business.
“Inga and the trustee of her SMSF exchange a sales contract for the SMSF to acquire the entire property for $1 million (market value). The SMSF pays Inga $0.67 million in cash for the purchase of the property,” she explained.
In the past, the common practice, she said, was to treat the difference between the consideration paid by the fund, $0.67 million, and the market value of the asset purchased, $1 million, as an in-specie non-concessional contribution for Inga.
The ATO ruling 2021/2 states that there is no in-specie non-concessional contribution in this case, said Ms Mansell.
“This is because there is a single sales contract for the acquisition of the entire property for $1 million. That is, there is only one asset being acquired – the entire property,” she said.
The ATO ruling does outline, however, that if the sale was done differently so that the contract relates to the 67 per cent acquisition of that property for $670,000 and then there’s a different contract in relation to a non-concessional contribution for 33 per cent of that property, then that would actually be OK, she explained.
“You’d have an acquisition for $670,000, which is the market value in relation to that 67 per cent acquisition and then you’d have a contribution representing the 33 per cent,” she said.
Ms Mansell said this means the way the contracts are constructed will be very important moving forward.
“If you’ve got a client buying something now, make sure that they explain to their lawyer that there needs to be either two contracts, one for the acquisition and one for the contribution, or if it’s in the same contract, then they need to cover off on the contribution in the wording so that’s clear that part of it is a contribution,” she cautioned.
Given it has been a fairly standard practice for SMSFs to undertake a part acquisition/part in-specie contribution combo via a sales contract or a single transfer document, there is a real risk of NALE or NALI for many SMSFs, she warned.
She noted that the ATO had drafted some amendments to its contributions ruling, TR 2010/1, to reflect the changes stemming from the NALE/NALI ruling.
“So, they’ve made some amendments to that, but they’re not final yet. It’s due to be finalised [in] mid-2022. Hopefully, we’re going to see some more guidance for clients that have already done this,” she said.
“At this stage, the ATO have not given any indication whether they will apply a ‘no-compliance activity’ approach for transactions that have occurred prior to the release of LCR 2021/5.”
Miranda Brownlee is the deputy editor of SMSF Adviser, which is the leading source of news, strategy and educational content for professionals working in the SMSF sector.
Since joining the team in 2014, Miranda has been responsible for breaking some of the biggest superannuation stories in Australia, and has reported extensively on technical strategy and legislative updates.
Miranda also has broad business and financial services reporting experience, having written for titles including Investor Daily, ifa and Accountants Daily.