SMSF Alert: ATO Confirms aggressive NALI and NALE stance – Make sure you know when you have your Trustee Hat on
In late July, in an extremely significant development, the ATO released Law Companion Ruling LCR 2021/2. This ruling upholds the ATO’s recent expansive interpretation of the Non-Arm’s Length Income (“NALI”) and Non-Arm’s Length Expenses (“NALE”) provisions of the ITAA 97.
Previously, industry had viewed the ATO’s position as something of an ambit claim, and had hoped that the ATO would step back. With some minor caveats, those hopes have been dashed.
NALI includes NALE
In 2018, the treatment of NALI under the ITAA 97 was amended to include NALE. The principle informing this change was that a self-managed superannuation fund’s income should be treated as NALI where a less-than-commercial expense is incurred in the pursuit of that income and there is a sufficient nexus between the income received and the expense.
The ATO’s initial response to these amendments was set out in LCR 2019/D3. Significantly, this draft ruling suggested that a general non-commercial expense – for example, accounting services provided for free – might have a sufficient connection to all of the statutory and ordinary income of a fund. A $100 discount on accounting fees might therefore lead to a 45% tax rate for an entire SMSF.
Non-Commercial General Expenses can ruin everything
Sadly, this interpretation still holds in the finalised ruling. LCR 2021/2 confirms that non-arm’s length expenses (the ATO cites the example of an accountant hiring her own firm to provide accounting services for free) can taint the whole of a fund’s ordinary and statutory income.
Similarly, a non-arm’s length expense incurred during the acquisition of an asset will taint all receipts generated by that asset, including any capital gain. It should be noted, of course, that there is a great deal of nuance and complexity in the application of these principles.
Most SMSF trustees acquire services and assets from parties with whom they have no connection. However, professionals from a wide assortment of industries, ranging from financial service providers through to builders, have been known to provide services to their own super funds. Potentially, they must now be alert to whether all losses, outgoings and expenditures have been incurred on an arm’s length basis and, in particular, whether they are able to provide documentary evidence benchmarking those expenditures.
What hat were you wearing when you lodged that return?
The issue of providing services to one’s own SMSF is somewhat fraught, and feeds into section 17A of the SIS Act. Section 17A states that trustees are not allowed to be paid remuneration when acting as trustees, however the same individuals may be paid remuneration when they are not acting as trustees. A good rule of thumb was that any activity that required a licence – such as a builder’s licence – was unlikely to be in a trustee capacity.
While LCR 2021/2 confirms an accountant providing basic bookkeeping services might be acting in their trustee capacity (and therefore, may choose not to charge a fee), any activity that requires a licence or insurance is much more likely to have been performed in that individual’s personal or professional capacity. Consider an accountant lodging a tax return – if you use your tax agent number, are you still just acting as an SMSF trustee?
Don’t forget the unit trust
Although LCR 2021/2 is not particularly expansive on this point, SMSF trustees should also allow that the NALE principles can apply both to acquisitions of units in a unit trust, and potentially to the provision of services to that unit trust. An unrelated or a 13.22C unit trust could become a pitfall if a trustee provides professional services to that trust.
There is some comfort, however
Everyone should be forewarned – the ATO will apply compliance resources to this issue from July 2022. The ATO wants to see that parties have “made a reasonable attempt to determine an arm’s length expenditure amount for services provided to the fund.” It is important to note that the NALI provisions are based in the ITAA 97, meaning there is none of the usual protections for voluntary disclosure as there are for breaches of the SIS Act. Presumably, then, documentary evidence demonstrating the trustee’s “reasonable attempt” to benchmark their services against market rates will be priceless.
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