Legislative overview

We find it useful to outline the relevant provisions before discussing them.

General NALE where there is a lower expense

Section 295-550(8) deals with a lower than arm’s length loss, outgoing or expenditure (expense); which provides:

(8) If:

(a) a complying superannuation entity is:

(i) a regulated superannuation fund with no more than 6 members; or

(ii) a self managed superannuation fund; and

(b) as a result of a scheme the parties to which were not dealing with each other at arm’s length in relation to the scheme:

(i) in gaining or producing the ordinary income and statutory income of the entity (but not in gaining or producing income in relation to any particular asset or assets of the entity), the entity incurs a loss, outgoing or expenditure of an amount; and

(ii) the amount is less than the amount of a loss, outgoing or expenditure that the entity might have been expected to incur if those parties had been dealing with each other at arm’s length in relation to the scheme;

An amount of the entity’s ordinary income and statutory income equal to twice the difference between the amount that the entity did incur and the amount that the entity might have been expected to incur is non-arm’s length income of the entity.

In summary, s 295-550(8) applies to an SMSF if:

· there is a scheme (and almost anything constitutes a scheme);

· the parties were not dealing with each other at arm’s length; and

· the fund incurs an Expense that is less than an arm’s length amount.

Where s 295-550(8) applies, an amount equal to twice the difference between the expense actually incurred and the arm’s length amount is included in the fund’s assessable income.

For example, if the fund obtained accounting services from an accounting firm at a $1,000 discount compared to the arm’s length fee, then $2,000 (being equal to twice the difference, ie, 2 x $1,000) is included in the fund’s assessable income.

We assume here that the accounting firm has no staff discount policy, as an employer might be able to confer a discount to a staff member’s SMSF where the discount is in line with a proper staff discount policy that has been appropriately benchmarked. The ATO also consider that any discount provided must not be one where the relevant staff member cannot exert influence in relation to that discount policy. There is a separate article ‘SMSF Staff Discount Policy –– do you have one?’ under the related articles heading at the end of this article.

Note that s 295-550(8) does not apply if there is no expense incurred such as where the service is provided free of charge and there is no consideration. This is where s 295-550(9) applies and the key difference between subsection (8) and (9) is that subsection (9) applies where the fund does not incur any expense.

General NALE where there is a nil expense

Section 295-550(9) provides:

(9) If:

(a) a complying superannuation entity is of a kind referred to in paragraph (8)(a) (about certain small entities); and

(b) as a result of a scheme the parties to which were not dealing with each other at arm’s length in relation to the scheme, in gaining or producing the ordinary income and statutory income of the entity (but not in gaining or producing income in relation to any particular asset or assets of the entity), the entity does not incur a loss, outgoing or expenditure that the entity might have been expected to incur if those parties had been dealing with each other at arm’s length in relation to the scheme

An amount of the entity’s ordinary income and statutory income equal to twice the amount that the entity might have been expected to incur is non-arm’s length income of the entity.

ATO position – LCR 2021/2DC

The ATO’s revised draft for the consultation (DC) ruling, namely, LCR 2021/2DC, was released on 27 November 2024 to outline the ATO’s draft views of ss 295-550(8) and (9). Submissions on the draft ruling closed on 24 January 2025 and the final ruling is expected to be released mid to late 2025.

Note that the NALI changes have effect from 1 July 2018 and the LCR 2021/2 which was initially released in 2021 and is still not finalised, largely due to a change of legislation in mid-2024. We refer you to our Part 1 article that discusses the major developments for the NALI provisions to get to where they are today regarding general NALE provisions.

We extract paragraphs 18 to 20 from LCR 2021/2DC to provide the ATO’s views on how the general NALE provisions apply:

18. In some instances, the non-arm’s length expenditure will have a sufficient nexus to all of the ordinary income, statutory income, or both, derived by the fund rather than to any particular asset or assets of the fund. A general expense is a loss, outgoing or expenditure of an amount that is incurred (including nil expenditure) in gaining or producing income of the fund but not in relation to any particular asset or assets of the fund…

19. In some instances, the non-arm's length expenditure will have a sufficient nexus to all of the ordinary income, statutory income, or both, derived by the fund rather than to any particular asset or assets of the fund. A general expense is a loss, outgoing or expenditure of an amount that is incurred (including nil expenditure) in gaining or producing income of the fund but not in relation to any particular asset or assets of the fund. For example, a fund may incur expenditure that does not specifically relate to a particular asset or assets owned or acquired by the fund but still has a sufficient nexus more generally to the income derived by the fund to be deductible under section 8-1, such as:

· actuarial costs – except those incurred in complying with, or managing, the fund's income tax affairs and obligations (for example, Subdivision 295-F) which are ordinarily deductible under section 25-5

• accountancy fees – except those incurred in complying with, or managing, the fund's income tax affairs and obligations (for example, Subdivision 295-F) which are ordinarily deductible under section 25-5

• audit fees

• costs of complying with a 'regulatory provision' as defined in section 38A of the Superannuation Industry (Supervision) Act 1993 (SISA) (unless the cost is a capital expense)

• trustee fees and premiums under an indemnity insurance policy

• costs in connection with the calculation and payment of benefits to members (but not the cost of the benefit itself); for example, interest on money borrowed to secure temporary finance for payment of benefits and medical costs in assessing invalidity benefit claims

• investment adviser fees and costs in providing pre-retirement services to members, and

• other administrative costs incurred in managing the fund.

20. Where the fund incurs non-arm’s length general expenditure of the nature outlined in paragraph 19 of this Ruling, the amount of income that is NALI is calculated using the ‘twice the difference’ approach as follows:

· where an amount of non-arm’s length general expense is incurred – the amount that might have been expected to be incurred if the parties had been dealing at arm’s length, minus the amount actually incurred, with the resulting number multiplied by 2, or

· where no amount of non-arm’s length general expense is incurred – twice the amount that might have been expected to be incurred if the parties had been dealing at arm’s length.

Broadly speaking, before the legislative changes in mid-2024 introducing ss 295-550(8) and (9), the ATO's view was that a lower general expense would taint a fund’s entire ordinary and statutory income (including concessional contributions and net capital gains). Thus, the general NALE provisions were designed to provide some relief for SMSFs by limiting exposure to a 45 per cent tax to a two-times multiplier for a general expense (rather than exposing 100 per cent of the fund’s assessable income to a 45 per cent tax).

You will note that both ss 295-550(8) and (9) include the following wording:

… (but not in gaining or producing income in relation to any particular asset or assets of the entity) …

This is because the general NALE two times multiplier only applies where the expense is a general expense of a fund rather than a specific expense that relates to a particular asset. Paragraph 30 of LCR 2021/2DC provides:

30. The non-arm's length expenditure incurred by the fund in acquiring the property is a specific expense. A consequence of the non-arm's length expenditure provisions applying to the purchase of either all or a part of the asset is that all of the income derived from that asset will be NALI, including any capital gains from the disposal of the asset.

The changes in mid-2024 did not contain any relief in relation to a lower specific expense that relates to a particular asset and the ordinary NALI provisions, eg, ss 295-550(1) apply. We have extracted s 295-550(1) below which can be briefly summarised as follows:

• Paragraph (a) of s 295-550(1) applies where the income is more than an arm’s length amount;

• Paragraph (b) of s 295-550(1) applies where the Expense is less than an arm’s length amount;

• Paragraph (c) of s 295-550(1) applies where the fund does not incur an Expense and the parties are not dealing at arm’s length.

Extract of s 295-550(1):

(1) An amount of * ordinary income or * statutory income is non-arm's length income of a * complying superannuation entity if, as a result of a * scheme the parties to which were not dealing with each other at * arm's length in relation to the scheme, one or more of the following applies:

(a) the amount of the income is more than the amount that the entity might have been expected to derive if those parties had been dealing with each other at arm's length in relation to the scheme;

(b) if the entity is of a kind referred to in paragraph (8)(a) (about certain small entities):

(i) in gaining or producing the income, the entity incurs a loss, outgoing or expenditure of an amount that is less than the amount of a loss, outgoing or expenditure that the entity might have been expected to incur if those parties had been dealing with each other at arm's length in relation to the scheme; and

(ii) subsection (8) does not apply to the loss, outgoing or expenditure;

(c) if the entity is of a kind referred to in paragraph (8)(a) (about certain small entities):

(i) in gaining or producing the income, the entity does not incur a loss, outgoing or expenditure that the entity might have been expected to incur if those parties had been dealing with each other at arm's length in relation to the scheme; and

(ii) subsection (9) does not apply to the loss, outgoing or expenditure that the entity might have been expected to incur.

This subsection does not apply to an amount to which subsection (2) applies or an amount * derived by the entity in the capacity of beneficiary of a trust.

Note that advisers need to be careful with how they record the work they do and what is reflected in invoices. For example, the preparation of financial statements and tax returns each financial year is a general expense. However, where advice is provided in relation to a particular asset or assets, then this is a specific expense which does not benefit from the two-times multiplier cap.

For example, an SMSF may have a broad range of shares and investments in the fund and a lower investment management fee by the related financial planning firm would result in tainting all of the income from those investments with a 45 per cent tax rate. This is so despite there being a broad range of investments in a fund due to the investment management fee being related to particular assets. Again, we assume there is no staff discount policy in place as indicated in LCR 2021/2DC.

Conclusions

The introduction of the general NALE provisions provides welcome relief with NALI exposure for lower or nil general expenses incurred by an SMSF or small APRA fund.

As you will note by reviewing this and the related articles on NALI below, the NALI provisions are complex and can easily be invoked. Indeed, there is no minimum threshold that applies (e.g., while technically a $1.00 greater income or lower expense might invoke NALI, we would not expect the ATO to worry about a trifling amount).

The current draft ruling LCR 2021/2DC provides limited guidance and leaves considerable uncertainty for SMSF trustees. We hope this ruling will soon be finalised, and more supplementary web guidance material will be provided to guide taxpayers.

In short, there are still many contentious and uncertain areas when dealing with general NALE and NALI. The application of the capital gains tax provisions and their interaction with NALI need urgent reform, and are particularly contentious and will be featured in our next article.