Introduced into the House of Representatives on 13 September 2023.
As you know, the non-arm's length income (NALI) rules were extended in 2018 to prevent superannuation trustees artificially increasing the balance of the fund, and accessing preferential tax treatment on the higher amount, by failing to recognise expenses incurred by the fund provided by a related party at a reduced rate. For example, your brother is a qualified accountant and does your SMSF’s accounting work for free (that he would normally charge $5k for).
Currently, where general expenses incurred by the fund are below market rates, any income derived by the fund could be deemed to be non-arm’s length income and taxed at the top marginal tax rate.
The tax treatment of expenses that are incurred on a non-arm's length basis will depend on whether you are dealing with a general or specific expense:
General expense - an expense that is not related to gaining or producing income from a particular asset of the fund.
Specific expense – an expense that relates to a specific asset of the fund. For example, a property.
Under the new rules, general non-arm’s length expenses will result in a maximum of twice the difference between the amount that would have been expected at arm’s length and the amount actually incurred being treated as NALI, with no deductions applying against that amount. The total amount taxed at the highest marginal rate is then capped to no more than the income of the fund minus deductions, excluding assessable contributions and deductions against them.
General expenses most commonly include:
Administrative costs in managing the fund
Costs of complying with the regulatory obligations of the fund
Investment adviser fees, where those fees relate generally to the operation of the fund and not to a specific investment or a particular pool of investments
The existing treatment will continue to apply. The amount of income that will be taxed as NALI will be the amount of income derived from the 'scheme' in which the parties were not dealing at arm’s length.
Specific expenses (related to gaining or producing income) could include:
Maintenance expenses for a rental property
Investment advice fees for a particular pool of investments
A limited recourse borrowing arrangement for the purchase of a specific asset
The purchase of an asset such as a rental property or shares
An expense incurred in relation to gaining or producing income as a beneficiary of a trust through holding or acquiring a fixed entitlement to the income of a trust will always be a specific expense.
What’s a scheme?
NALI applies where the ATO considers that a scheme exists.
Let’s look at what’s not a scheme first. It’s not a scheme where it is an internal arrangement between the fund and the trustee. For example, if the trustee performs a bookkeeping function for the fund as part of the trustee's obligations to maintain the fund (the trustee cannot charge for these services under 17B of the SIS Act).
A scheme does exist where the:
Trustee is not acting as a trustee but is instead providing services that are procured as a third-party; and
Amount charged for their services is less than what would have been charged if the parties were dealing at arm’s length.
Note also that the trustee cannot charge more than what would have been charged if the parties had been dealing at arm’s length under section 17B of the SIS Act.
So, what does all of that mean in practice?
Let’s dissect that with example 7.1 from the explanatory memorandum.
Al is the director of Purple Co. Purple Co is the corporate trustee of an SMSF of which Al is the sole member. Al, through his accounting firm Al Accountants, provides general accounting services to his SMSF in circumstances such that these services are provided in a capacity other than as a trustee and meet the other requirements of section 17B of the SIS Act. Although Al’s accounting firm charges his clients $3,000 for these types of services, his SMSF acquires the services free of charge.
The acquisition of accounting services by the SMSF constitutes a scheme between Al and their SMSF in which the parties were not dealing with each other at arm’s length. No expense was incurred when the SMSF would have been expected to have incurred an expense in respect of acquiring the accounting services had the parties been dealing at arm’s length, so the non-arm’s length expense provisions apply. The accounting services were general in nature and did not relate to any particular asset or assets so are a general expense that is a non-arm’s length expense captured under subsection 295-550(9).
The total income of the SMSF in 2023-24 is $20,000 in rent from a rental property to which $5,000 in eligible deductions for maintenance apply, resulting in a taxable income in 2023-24 of $15,000. No assessable contributions were made in that income year.
As no expense was incurred towards the general accounting services, the amount of non-arm’s length income under subparagraph 295-545(2A)(a)(ii) is twice the amount that might have been expected to have been incurred, or twice the $3,000 value of the services, which is $6,000.
Applying the cap on the total non-arm’s length component, the cap amount is the total of income other than assessable contributions, minus deductions other than deductions against assessable contributions. In this case, the cap is the $20,000 in rental income minus the $5,000 in deductions against that rental income, giving $15,000. As the cap on the total non-arm’s length component is higher than the non-arm’s length component arrived at above, the non-arm’s length component remains at $6,000 to be taxed at the highest marginal rate. This leaves a low-tax component of $9,000. The low tax component is any remaining taxable income after calculating the non-arm’s length component.
The example set’s out that the accounting services provided to Al’s SMSF for free are caught by the NALI rules to the amount of $6,000 (twice the value of the services - 2 x $3,000). As the $6,000 is less than the SMSF’s cap of $15,000 (in this case total income minus deductions), tax will apply to the whole of the NALI component.
Non arm’s length accounting services provided by Al Accountants
Non arm’s length component (2 x difference)
Total income of the SMSF in 2023-24
(less) Deductions available to the SMSF
Remaining low tax component
If however, the SMSF’s cap had been $5,000, the NALI component would be capped to $5,000.
The amendments will apply to expenses incurred or expected to be incurred from 1 July 2018.