What has Treasury proposed?
Treasury’s proposed amendments are only intended to apply to general expenses which have a sufficient nexus to all ordinary and statutory income derived by an SMSF or a small APRA fund (SAF). The proposed amendments to the non-arm’s length income (NALI) provisions are as follows:
- SMSFs and SAFs would be subject to a factor-based approach which would set an upper limit on the amount of fund income taxable as NALI due to a general expenses breach. The maximum amount of fund income taxable at the highest marginal rate would be 5 times the level of the general expenditure breach, calculated as the difference between the amount that would have been charged as an arm’s length expense and the amount that was actually charged to the fund. Where the product of 5 times the breach is greater than all fund income, all fund income will be taxed at the highest marginal rate.
- Large APRA-regulated funds would be exempt from the NALI provisions for general expenses.
If implemented, how are the proposed amendments intended to apply?
The consultation paper provides the following examples:
- In Example 1A, an SMSF trustee uses his brother’s accountancy services, which would usually cost $5,000 if provided under an arm’s length arrangement. As his brother charges the SMSF $0 for these services, under the proposed change, the following would be tainted as NALI:
- Given there is a lower than arm’s length expense of $5,000, this is multiplied by 5 resulting in a $25,000 amount of deemed NALI which is taxed at 45% with $11,250 of tax payable.
- The SMSF’s income (after relevant expenses) for FY2023-24 is $100,000 which would usually give rise to a 15% tax rate (without any NALI/E).
- Another example (Example 1B) is given where the SMSF’s income (after relevant expenses) for FY2023-24 is only $20,000.
- Under the proposed change, the trustee would pay 45% tax on all of the fund’s income, as 5 times the NALE breach (ie, $25,000) is greater than the fund’s total income ($20,000). That is, $20,000 x 45% = $9,000 of tax payable on the deemed amount of NALI.
Note that NALI is not a breach in the sense that an auditor contravention report needs to be issued. If NALI is invoked a 45% tax rate applies to the non-arm’s length component of the income and only the low tax component obtains concessional tax treatment of 15% or nil, if the fund is in pension or retirement phase.
How does the proposal compare with the current NALE position?
Under the current legislation, a lower than arm’s length expense, even a $100 discount, would result in a tax of 45% on a fund’s entire ordinary and statutory income (including a large APRA fund). Given NALI applies to statutory income, this would also tax any concessional contributions at 45%. The ATO in LCR 2021/2 state:
… the Commissioner is alive to concerns that a finding that general fund expenses are non-arm’s length is likely to have a very significant tax impact on the complying superannuation fund, even where the relevant expenses are immaterial.
However, the ATO is currently not applying compliance resources to general expenses giving rise to NALE
Broadly, the ATO’s current administrative practice in PCG 2020/5 is not to apply its compliance resources towards general expense NALE leading up to 30 June 2023. However, from 1 July 2023 reasonable benchmark evidence will need to be shown for related party services.
Lower specific expenses still exposed to NALI
The consultation paper confirms that for all funds (including large APRA funds), where a NALE is related to a specific asset, the current NALI rules continue to apply.
Naturally, SMSF trustees and advisers need to be mindful that, on closer examination, some general expenses may be challenged as not being general in nature but relating to specific asset acquisitions such as typical adviser fees where, for example, specific investments are involved.
Some further observations
While the Treasury proposal is welcome, the Joint Professional Bodies (JPB) have submitted to Treasury that the NALI provisions (s 295-550 of the Income Tax Assessment Act 1997 (Cth)) need a total overhaul given there are a range of other shortcomings, including no flexibility to rectify honest and inadvertent errors.
Given it’s taken over 4.5 years to obtain a consultation paper from the NALE changes that have applied since 1 July 2018, an extension to the ATO’s PCG 2020/5 administrative relief to 30 June 2024 will likely be required.
It is important to note that the above proposal is a potential change and the closing date for submissions is 21 February 2023. The law will not be changed until legislative changes are implemented.
Conclusions
SMSF trustees and advisers should be mindful of the current NALE/I rules and ensure they seek appropriate advice wherever there is any doubt. Given the change in ATO practice that applies from 1 July 2023, SMSF trustees should be making sure that they are making necessary adjustments to minimise any NALE/I risk when the current ATO ‘amnesty’ on general expense NALE ceases (unless the ATO extend this deadline).
Ongoing management is needed in relation to specific expenses that lead to NALI.
Daniel Butler, director, DBA Lawyers
