Are invoices an SMSF or personal expense and will NALE or a contribution arise?

Moreover, some invoices need to be split between the SMSF and another party if only part of the invoice relates to the SMSF.

This article discusses these issues in view of the impact of recent legislative changes and Australian Taxation Office (ATO) materials. In particular, we examine the proposed non-arm’s length expense (NALE) draft legislative changes and the ATO’s Law Companion Ruling (LCR) 2021/2 view on NALE. The ATO’s latest view differs from its traditional view that an expense paid on behalf of an SMSF is a contribution, as per Taxation Ruling (TR) 2010/1 [11].

Given the NALE changes and the serious consequences and penalties that can be imposed on SMSF trustees for minor transgressions, we recommend that greater consideration be given before paying an invoice that might involve an SMSF.

Payment by another party on behalf of an SMSF

As noted above, the ATO has traditionally treated an expense paid on behalf of a fund as a contribution in TR 2010/1. However, the ATO’s Law Companion Ruling (LCR) 2021/2, issued in relation to the NALE changes that commenced from 1 July 2018, displaced this ATO view that an expense payment on behalf of a fund is a contribution. LCR 2021/2 provides that the payment of an expense on behalf of a fund is NALE.

Further, the ATO consider a lower general expense, such as an accounting fee or an investment adviser’s fee, paid by a related party has a sufficient nexus with all the fund’s ordinary and statutory income invoking NALE, therefore tainting 100 per cent of the fund’s income as non-arm’s length income (NALI) at a 45 per cent tax rate.

However, where a general expense is paid by another party on behalf of an SMSF and that general expense is not a capital expense, it is proposed that the NALE consequences will be capped at a two times multiplier of the lower than arm’s-length expense (ie, only 2 x the lower expense would be taxed at 45 per cent). This change is expected to apply from 1 July 2023. (Under current NALI/E legislation, 100% of the fund’s ordinary and statutory income would be taxed at 45 per cent).

Unfortunately, if the payment relates to a specific expense or a specific asset, the ATO view is that all of the fund’s ordinary and statutory income derived from that income source or asset (including any net capital gain on disposal) is tainted as NALI and taxed at a 45 per cent tax rate.

Unfortunately, there is no discretion in the NALI/E provisions for the ATO to forgive honest and inadvertent mistakes. The NALI legislation does not accept that to “err”, or to make errors, is human.

Payment by SMSF on behalf of another party

On the flip side, the payment of an expense by an SMSF on behalf of another party may give rise to serious consequences. This is because an SMSF paying an expense for someone else suggests:

• The SMSF is not dealing at arm’s length (Superannuation Industry (Supervision) Act 1993 (Cth), (SISA), s 109).
• The SMSF is providing a loan or financial assistance to a member or relative (SISA s 65). A loan or financial assistance can be covered by s 65 even if that loan or financial assistance is provided indirectly via one or more other persons or entities.
• The SMSF trustee must comply with the sole purpose test (SISA 62). Namely, the trustee must ensure that the SMSF is maintained solely for providing retirement benefits. A payment by a fund for a member, related party or third party naturally raises queries under the sole purpose test.

Some practical examples:

Pension documents

Typically, an SMSF trustee would pay for the provision of pension documents for a member who seeks to commence a transition to retirement income stream (TRIS) or an account-based pension. However, if the services provided by the adviser relates to the member’s personal financial planning needs, the invoice may need to be split between the fund and the member. Otherwise a SISA contravention may raise. Conversely, if the member paid for some of the fund’s expense, then NALE might be invoked.

Binding death benefit nominations (BDBN)

The costs of someone obtaining advice regarding a BDBN and how to integrate a BDBN with their personal estate planning also gives rise to similar issues, as discussed above in relation to pensions. A split between the fund and the member may therefore be appropriate to avoid a contravention and NALE.

The cost of a corporate trustee’s ASIC fee

The Australian Securities and Investments Commission (ASIC) annual review fee for a company that acts as both an SMSF trustee and in another capacity also raises similar issues. In many cases, a person or entity may pay the entire annual ASIC fee where a corporate trustee also acts in another capacity (in addition to acting as the SMSF trustee). (Click here for this article.)

Who pays for what?

In short, SMSF trustees, advisers and auditors need to spend more time deciding whether an expense should be paid by an SMSF, a member or related party or whether it should be split between the fund and another party.

These risks still arise even if the expense is only of a small or trifling amount, as serious consequences may arise if there is a contravention or NALE. There is no ‘de minimis’ threshold before NALI/E is invoked, eg, a $1.00 discount will invoke NALE.

SMSF auditors are undertaking more detailed reviews of SMSF activities especially where a related party is involved and there is an increased likelihood of more auditor contravention reports and qualified audit reports being issued. SMSF auditors are also required to report contraventions under s 129 of SISA (and even potential contraventions that may happen in the future).

Penalties and other potential consequences

If there is a contravention of SISA, the administrative penalties can result in significant penalties being imposed on trustees. Many of these penalties involve a $18,780 penalty per individual trustee (ie, 60 penalty units x $313). In contrast, the directors of a corporate trustee are jointly and severally liable for one penalty per strict liability offence. Further, these penalties cannot be paid or reimbursed from fund assets. A remission in whole or part can be sought.

In addition to these penalties, other adverse consequences may follow and, in certain cases, these may include a trustee being disqualified, a notice of non-compliance being issued to the fund and a range of other penalties and rectification and education directions.

Can a mistakes be rectified?

Some mistaken payments can be rectified and the best thing to do is to obtain advice on what is the best option to ‘make good’. Advice should be obtained as soon as practicable as timely action minimises risk. In particular, the ATO’s SMSF ruling (SMSFR) 2009/2 at [16] suggests that a payment made on behalf of a fund must be reimbursed ‘immediately’ for this to not constitute a borrowing. There is no context on how quick ‘immediately’ means in this ruling. However, the longer that time ticks bye, the worse things look.

There is no discretion in the NALI/E provisions for honest and inadvertent mistakes. However, timely rectification generally minimises risk.

Conclusions

Careful ongoing management is needed to the ensure the proper payment and allocation of SMSF expenses. If there is any error, seek expert advice as soon as practicable and take timely corrective action. Naturally, DBA Lawyers would be pleased to assist.

Related articles:

• Is an ASIC fee paid by a member for an SMSF corporate trustee a contribution or NALE?
• Penalties on SMSF trustees to increase substantially, so definitely time to change to a corporate trustee
• NALI Advice
• SMSFs and voluntary disclosure to the ATO

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This article is for general information only and should not be relied upon without first seeking advice from an appropriately qualified professional. The above does not constitute financial product advice. Financial product advice can only be obtained from a licensed financial adviser under the Corporations Act 2001 (Cth).

Note: DBA Lawyers presents monthly online SMSF training. For more details or to register, visit www.dbanetwork.com.au or call 03 9092 9400.

For more information regarding how DBA Lawyers can assist in your SMSF practice, visit www.dbalawyers.com.au.