As previously discussed here, the definition of non-arm’s length income (NALI) under the Income Tax Assessment Act 1997 was amended in mid-2018 to include non-arm’s length expenses or NALE. NALE includes not just an expenditure, but also a loss or outgoing that is lower than an arm’s length amount, and also includes where there is a nil amount (ie, no expenditure).

Following the NALE amendments, the ATO issued Draft Law Companion Ruling 2019/D3 (LCR 2019/D3) indicating how the ATO intended to interpret and apply the NALE provisions. There are some concerning aspects to LCR 2019/D3, including the ATO view that ‘in some instances, the non-arm’s length expenditure will have a sufficient nexus to all of the ordinary and/or statutory income derived by the fund.’ That is, potentially all the SMSF’s income and gains for the particular year would be characterised as NALI (and taxed at 45%).

As LCR 2019/D3 remains a draft ruling, the ATO issued Practical Compliance Guideline PCG 2020/5 (PCG 2020/5) which confirms the ATO’s transitional compliance approach to the NALI/NALE provisions. Under PCG 2020/5, the ATO will not allocate compliance resources to determine whether the NALI provisions apply to a fund for the 2018-19, 2019-20 and 2020-21 income years where the fund incurred NALE of a general nature that has a sufficient nexus to all ordinary and/or statutory income derived by the fund in those respective income years (for example, NALE on accounting services provided to an SMSF for free or for an under market value fee).

Given the level of interest in this issue, and the concern voiced by many in the SMSF industry over the ‘general expenses NALE’, the ATO is now seeking independent, specialist advice from the public advice and guidance panel before finalising LCR 2019/D3. As this will further delay the finalisation of LCR 2019/D3, the ATO will be extending the transitional compliance approach in PCG 2020/5 by another 12 months (ie, to the end of the 2022 financial year).

Importantly, the transitional compliance approach does not apply in other circumstances where the fund incurs NALE that directly relates to income from a particular asset. That is, it only applies where the fund incurs NALE of a general nature.

To discuss or for further information please contact:

Phil Broderick
Principal
M +61 419 512 801 | T +61 3 9611 0163
E: pbroderick@sladen.com.au

Philippa Briglia
Senior Associate
T +61 3 9611 0173
E pbriglia@sladen.com.au