Parts 1–4 of this series of articles on NALI are available from the related articles heading at the end of this article.

For a recent webinar outlining some general changes to the Ruling, click here.

All references to legislation are to the ITAA 1997 unless otherwise stated.

General overview: specific and general expenses

The Ruling broadly explains the differences between a general non-arm’s length expense (General NALE) under s 295-550(8) and (9) and a specific non-arm’s length expense (Specific NALE) under s 295-550(1)(b) and (c).

Specific NALE

Paragraphs 10–11 of the Ruling provide the following in respect of Specific NALE:

10. An amount of ordinary or statutory income will be NALI of a small complying superannuation fund where:

· there is a scheme in which the parties to the scheme were not dealing with each other at arm’s length

· in gaining or producing the income of the fund in relation to any particular asset or assets of the fund, the fund incurs a loss, outgoing or expenditure of an amount, and

· the amount of the loss, outgoing or expenditure is less than the amount that the fund might have been expected to incur had those parties been dealing with each other at arm’s length in relation to the scheme.

11. An amount of ordinary or statutory income will also be NALI of a small complying superannuation fund where:

· there is a scheme in which the parties to the scheme were not dealing with each other at arm’s length, and

· in gaining or producing income in relation to any particular asset or assets of the fund, the fund does not incur a loss, outgoing or expenditure that the fund might have been expected to incur if those parties had been dealing with each other at arm’s length in relation to the scheme.

[Bolding added]

General NALE

In respect of General NALE, paragraphs 11A–11B of the Ruling provide:

11A. An amount of ordinary or statutory income will be NALI of a small complying superannuation fund where:

· there is a scheme in which the parties to the scheme were not dealing with each other at arm’s length

· in gaining or producing the income of the fund (but not in gaining or producing the income in relation to any particular asset or assets of the fund) the fund incurs a loss, outgoing or expenditure of an amount, and

· the amount of the loss, outgoing or expenditure is less than the amount that the fund might have been expected to incur had those parties been dealing with each other at arm’s length in relation to the scheme.

11B. An amount of ordinary or statutory income will also be NALI of a small complying superannuation fund where:

· there is a scheme in which the parties to the scheme were not dealing with each other at arm’s length, and

· in gaining or producing the income (but not in gaining or producing the income in relation to any particular asset or assets of the fund) the fund does not incur a loss, outgoing or expenditure that the fund might have been expected to incur if those parties had been dealing with each other at arm’s length in relation to the scheme.

Identifying Specific or General NALE

In considering whether the expense relates to a particular asset or assets of the Fund, paragraph 17 of the Ruling states:

17. In identifying whether the small complying superannuation fund has incurred NALI, there must be a sufficient nexus between the [NALE] and the relevant ordinary or statutory income. That is, the expenditure must have been incurred ‘in’ gaining or producing the relevant income (or acquiring the relevant entitlement). Further, to determine whether the income is in relation to any particular asset or assets of the fund, there must also be a sufficient nexus between the [NALE] and ordinary or statutory income derived in respect of that asset or assets including the disposal of that asset.

We summarise the following notable takeaways from the ATO’s views in paragraphs 17A–21 of the Ruling in respect of Specific NALE and General NALE:

· NALE does not have to be deductible under s 8-1 for the NALE provisions to apply (see paragraph 17A).

· NALE incurred to acquire an asset (including associated financing costs) will be Specific NALE and will have a sufficient nexus to all ordinary or statutory income (including any capital gain on disposal) derived by an SMSF in respect of that particular asset (see paragraph 18).

· In some instances, the NALE will have a sufficient nexus to all of the ordinary income, statutory income, or both, rather than to any particular asset or assets of the fund (ie, General NALE) (see paragraph 19 which also provides examples of General NALE).

· Where the fund incurs General NALE, the amount of income that is NALI is calculated using the ‘twice the difference’ approach (see paragraph 20) — for further information on the ‘twice the difference’ approach, refer to our article here.

· Where General NALE is actually incurred, the amount of NALI using the ‘twice the difference’ approach is not reduced by the amount actually incurred when calculating the non-arm’s length component (NALC) under s 295-545 (see paragraph 20A).

· Where NALE is incurred by an SMSF that does not relate to the acquisition of any particular asset that only has a nexus with the fund deriving ordinary or statutory income during a particular income year, and the SMSF subsequently ceases to incur that NALE in a later income year, income derived in the later income year is not NALI provided the SMSF ceases to incur NALE (see paragraph 21).

Changes to Examples

The welcome relief for SMSFs in relation to the new General NALE provisions is demonstrated by the changes to Example 2 of the Ruling, which concerns a trustee of an SMSF, Mikasa, obtaining non-arm’s length accounting services for nil expenditure. Notably, the prior version of the Ruling provided that such NALE resulted in all of the fund’s income for a particular income year being NALI:

25. …The NALE (being the nil amount incurred for the services) has a sufficient nexus with all of the ordinary and statutory income derived by the SMSF for the 2020–21 income year. As such, all of the SMSF’s income for the 2020–21 income year is NALI.

However, the updated Ruling now confirms that this General NALE will be subject to the ‘twice the difference’ (ie, 2x multiplier) approach:

25. …The [NALE] (being the nil amount incurred for the services) has a sufficient nexus with all of the ordinary and statutory income derived by the SMSF for the 2020–21 income year. The [NALE] incurred by the SMSF in acquiring the accounting services (nil amount) is a general expense. As such, for the 2020–21 income year, the amount of NALI as a result of the general expense will be twice the difference between the amount of the expense that might have been expected to be incurred had the parties been dealing at arm’s length and the amount the entity incurred…

Other relevant examples in the Ruling that contain NALE (eg, including examples 1–4, 9, 11 and 12) provide additional clarification as to whether the relevant expenditure is specific or general.

SMSF staff discount policies

Paragraph 51 of the Ruling has been updated in relation to arrangements for staff discount policies (note the bolded text below indicates the new additions to paragraph 51):

51. A small complying superannuation fund might enter into arrangements that result in it receiving discounted prices. Such arrangements will still be on arm’s length terms where they are consistent with normal commercial practices, such as an individual acting in their capacity as trustee (or a director of a corporate trustee) being entitled to a discount under a discount policy where the same discount is provided to all employees, partners, shareholders or office holders. Where this is not the case, or where the trustee (or director of a corporate trustee) of the fund is able to influence the discount policy, this may indicate that the discount policy is not consistent with normal commercial practices.

Unfortunately, no further guidance has been provided in relation to what ‘influence the discount policy’ means. Further, there is no context as to what kind of influence would result in NALI, eg, material or sufficient influence. However, we note that:

· influence of a discount policy by a trustee/director; and

· different discounts being provided to all employees, partners, shareholders or office holders;

‘may’ indicate the policy is not consistent with normal commercial practices, and potentially may not be at arm’s length.

This provides some extra comfort to firms where SMSF trustees/directors may have some influence over the firm’s discount policy; the prior ATO position suggested any influence would result in NALI.

Firms offering discounts to staff (including employees, directors, partners, office holders and shareholders) should ensure that they have a discount policy in place that is demonstrably consistent with normal commercial practice. Naturally, DBA Lawyers would be pleased to assist. For further information on our SMSF staff discount policy see here.

Resolving the tension between trustee remuneration and NALI

The starting question here is – can the trustee/director be paid remuneration?

Broadly, an SMSF trustee/director is precluded from being remunerated by an SMSF for duties or services performed on behalf of the fund under s 17A of the Superannuation Industry (Supervision) Act 1993 (Cth) (SISA).

However, an SMSF trustee/director may be remunerated in accordance with s 17B of the SISA, where a trustee/director performs non-trustee services in a capacity other than as an SMSF trustee/director. Remuneration can be paid by an SMSF for non-trustee type services provided the four criteria in s 17B are complied with. Broadly, these criteria are that the trustee/director:

· performs the duties or services other than in the capacity of trustee/director;

· is appropriately qualified, and holds all necessary licences, to perform the duties or services;

· performs the duties or services in the ordinary course of a business, carried on by the trustee/director, of performing similar duties or services for the public; and

· receives remuneration that is no more favourable than would be expected if the parties were dealing at arm's length in the same circumstances.

Naturally, this created a tension between s 17B and the NALI provisions where a trustee/director performed duties for their SMSF in an individual capacity (ie, not as a trustee/director) but did not otherwise satisfy the requirements in s 17B to charge the SMSF for their services.

Amendments to the Ruling

However, the Ruling has been amended to confirm that where the requirements of s 17B are not met, the NALI provisions will not apply if the trustee/director does not charge the SMSF for their services. Specifically, paragraph 42 of the Ruling states:

42. Given the statutory restrictions that prevent a trustee or director of a corporate trustee from receiving remuneration, paragraphs 295-550(1)(b) and (c) or subsections 295-550(8) and (9) will not be enlivened due to the trustee or director not charging for the services performed in relation to the fund. Therefore, the [NALE] provision will not apply where:

· a trustee acting in that capacity, provides services to the fund for no remuneration, or

· a trustee acting in a capacity other than as trustee, provides services to the fund for no remuneration where the requirements in section 17B of the SISA are not met.

Where the trustee/director does satisfy the requirements to charge the SMSF under s 17B, the NALI provisions might still apply where a lower or nil expenditure is incurred. Specifically, paragraph 43 of the Ruling states:

43. However, the fund does incur NALE under either paragraph 295-550(1)(b) or (c) or subsection 295-550(8) or (9) when the trustee or director of a corporate trustee operates in another capacity and they can receive remuneration for their service under section 17B of the SISA, but either:

· does not receive any remuneration for those services, or

· receives remuneration that is less than what parties dealing with each other at arm’s length might have been expected to receive.

Trustee or individual capacity?

Naturally, it is still necessary for the purposes of the NALI provisions and s 17B to determine whether an individual is performing duties and services in an individual or trustee capacity, and whether any remuneration can or should be obtained from an SMSF.

Unfortunately, the considerations outlined in paragraphs 44–48 of the Ruling regarding whether a person is performing duties in a trustee or individual capacity remain largely unchanged from the prior version of the Ruling. However, a new but not very generous example, Example 7A, has been added to provide minor clarification on this issue:

57A. Mina is a trustee of her SMSF of which she is the sole member. She is a chartered accountant and she operates Once Accounting Services as a sole trader. Whilst at the office, Mina receives a phone call on her office phone from her SMSF auditor during her business hours. The call is related to supporting documentation for an investment made by her SMSF required by the SMSF auditor to complete the audit process. After the phone call, Mina sends a follow-up email to the SMSF auditor using her business computer providing the relevant supporting documentation.

57B. Mina performs these activities as trustee of her SMSF and does not charge her SMSF. Although Mina undertakes the activities at her business premises where she operates her accounting business, the use of the business supplied computer and the office telephone is minor and incidental in nature, and would not, of itself, indicate that Mina is acting in any capacity other than as trustee for her SMSF. Accordingly, the [NALE] provisions will not apply.

Conclusions

The updated Ruling provides some further clarity for SMSF trustees, advisers, and auditors in navigating the NALI and NALE provisions. However, considerable grey areas and ambiguity remains, particularly in relation to determining whether a person is performing duties for an SMSF in an individual or trustee capacity. Where relevant, expert advice should be obtained so that the NALI provisions are not enlivened.