After industry pushback against the disproportionate application of the non-arm’s length income (NALI) and non-arm’s length expenses (NALE) rules, Treasury has a released a discussion paper to modify the application of the NALI/NALE rules.
Under the proposal, there will be a upper cap on the application of NALE to general expenses applicable to self managed superannuation funds (SMSFs), being equal to NALI tax of 45% on 5 times the amount that the expense charged is less than its arm’s length costs. That is an effective tax rate of 225%! If taxing all of the income of the fund at the rate of 45% would result in a lower amount of tax, then that tax amount will be payable by the SMSF.
While this is a lower tax rate than is generally applicable under the ATO view is better than nothing, it is hoped that Treasury will revise its view to simply tax the NALE at 45%. For example, the effective rate of 225% compares unfavourably to other anti avoidance measures including Part IVA, the diverted profits tax (40%) and intentional disregard penalties (75%). It’s even greater than one of the highest tax penalties being Part 7 penalties under the super guarantee system (200%).
The paper also proposes that general expense NALE will no longer apply to large public offer superannuation funds.
Under the discussion paper, the application of NALE to expenses that relate to specific expenses would continue to apply in accordance with the ATO’s view (as set out in LCR 2021/2).
Below are some examples of the proposed regime that are set out in the discussion paper:
Example 1A: SMSF using an accountancy service
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, this is a non-arm’s length arrangement.
The SMSF’s income (after relevant expenses) in the 2023-24 financial year is $100,000. The applicable rate of tax on this income would have otherwise been 15 per cent.
Under the current NALI rules, there is a sufficient nexus between the accounting services expense and all income of the SMSF. The SMSF’s total income in the financial year would be taxed at the highest marginal tax rate of 45 per cent. The SMSF would pay $45,000 in tax in 2023-24, resulting in $55,000 in after-tax income.
Under the potential amendments, the income ‘tainted’ as NALI would be limited by the market value of the accounting service, since no fee was charged to the SMSF. The amount of income would be calculated by applying a factor of 5 on the difference between the market value of the accounting service and the actual fee charged the fund. The trustee would pay tax at a rate of 45 per cent on $25,000 of fund income, and at a rate of 15 per cent on the remaining $75,000 of income.
The SMSF would pay $22,500 in tax in 2023-24 and have after tax income of $77,500. In comparison, if the fund had incurred an expense for the accountancy services as per its usual cost of $5,000, the SMSF would pay $14,250 in tax (i.e., 15 per cent of $95,000) and have after tax income of $80,750.
Example 1B: SMSF using an accountancy service (lower fund income)
As in Example 1A, the SMSF trustee uses his brother’s accounting services that would usually cost $5,000, but the brother charges $0. The SMSF’s income (after relevant expenses) in the 2023-24 financial year is $20,000.
Under the potential amendments, the trustee would pay tax at a rate of 45 per cent on all the income of the fund, as 5 times the NALE breach is greater than the total income of the SMSF. The SMSF would pay $9,000 in tax for the 2023-24 financial year (i.e., 45 per cent of $20,000), as would occur under the current NALI provisions.
Phil Broderick
Principal
M +61 419 512 801 | T +61 3 9611 0163
E: pbroderick@sladen.com.au
Jan Harnischmacher
Lawyer
T +61 3 9611 0158
E jharnischmacher@sladen.com.au
