The ATO has taken an aggressive approach on non-arm’s length income (NALI) for a number of years now, both in its public documents and via its audit teams. This has culminated in an approach that puts a high expectation on SMSF’s in relation to proving arrangements are on an arm’s length basis – in particular, in relation to benchmarking such arrangements.

This approach is simple enough in relation to certain things that have readily available benchmarking material – for example the market value of real estate or rent. However, for other transactions it can be very difficult to find benchmarks – for example, many commercial arrangements are unique in their own way. What has been lost in this ATO approach is the more common sense approach of whether an arrangement is just generally a commercial one or not.

The recent Administrative Appeals Tribunal (AAT) decision of BPFN and Commissioner of Taxation (Taxation) [2023] AATA 2330 has struck a blow to the ATO’s strict approach to NALI and taken a more general commercial approach to NALI.

Here, the SMSF invested in a related unit trust (JJUT). JJUT then lent funds to a related company (ABC). ABC in turn lent funds to a related discretionary trust (DEF). DEF then lent the funds to unrelated third parties.

It was accepted that the loans from DEF to the third parties were negotiated at arm’s length terms. The loan terms for the loan from JJUT to ABC and ABC to DEF provided that the interest rate was equal to the interest rate payable by the third parties to DEF. That is, there was no interest mark up or margin received by either ABC or DEF under the arrangement and the interest payable by the third parties was effectively passed through to the SMSF. The third parties also paid DEF certain fees which appear to have been retained by DEF.

The taxpayers argued, with support of two expert witnesses who were lawyers with experience in private lending, that it was typical to have on-lending arrangements on such terms and that the interposed entities (DEF and ABC) could be used to share the risk and that the rewards here for those intermediaries were within the reasonable bounds acceptable within the commercial market.

The ATO argued, with support from an accountant expert witness, that the lack of margin on the interest rate paid to ABC and JJUT was not at arm’s length. Likewise, it argued that ABC’s fees were “unsustainably low”.  The ATO’s expert gave evidence that mortgage managers or brokers would not enter into arrangements with such terms. Ultimately, the AAT did not accept this as evidence as what occurs in relation to a private lending arrangement.

Rather, the AAT accepted the taxpayer’s arguments, and evidence, that “the scheme established under the private lending facility did not differ from that which might be expected to have operated between independent parties dealing independently with one another in the private lending market at the time”. As such the AAT found that NALI was not triggered.

This is an important, and sensible, decision in relation to the application of the NALI rules and supports the position that arrangements can be commercial (ie an arm’s length dealing) even in the absence of benchmarking and the strict evidence position pushed by the ATO.

To discuss this further or for more information please contact:

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

Terence Wong
Senior Associate
T +61 3 9611 0112 l M +61 0458 846 022
E twong@sladen.com.au

Jan Harnischmacher
Lawyer
T +61 3 9611 0158
E jharnischmacher@sladen.com.au