Non-Arm’s Length Expenditure And SMSFs: Compliance
The ATO has recently released a guideline which provides a transitional compliance approach for complying super funds including SMSFs concerning the application of provisions in relation to certain non-arm's length expenditure (or where expenditure is not incurred) in gaining or producing ordinary or statutory income.
Section 295-550 of the ITAA 1997 sets out rules as to when a complying super fund will derive non-arm's length income (NALI). Under the amendments to s 295-550, income is included in a superannuation fund's non-arm's length component and taxed at 45% if there is a related-party scheme and:
non-arm's length expenses are incurred in gaining or producing that income;
the fund holds a fixed entitlement to the income of a trust, derives income as a beneficiary of that trust and incurs non-arm's length expenditure in acquiring that entitlement or in deriving that income; or
no expenses are incurred but the fund might be expected to have been incurred expenses if the transaction were on arm's length terms.
A draft law companion ruling on non-arm's length income had been previously issued and was subsequently withdrawn. From the consultation feedback on the draft law companion ruling, the ATO's preliminary view on the issue was that certain non-arm's length expenditure incurred by a complying super fund may have a sufficient nexus to all ordinary and/or statutory income derived by the fund for that income to be NALI (eg fees for accounting services).
According to the ATO, this can be contrasted to non-arm's length expenditure that has a more direct nexus to particular ordinary or statutory income derived by the fund (eg expenditure relating to the acquisition of an income-producing asset).
A simple example to illustrate the complexity above would be where a trustee of an SMSF, who is also a partner in an accounting firm, contracts the accounting firm to provide services to the fund and the firm does not charge the fund for those services. For the purposes of s 295-550, the scheme involves the SMSF acquiring the accounting services under a non-arm's length arrangement. The non-arm's length expenditure (nil amount incurred for the services) has a sufficient nexus with all of the ordinary and statutory income derived by the SMSF in the relevant year the accounting services were performed. As such all the of the SMSF's income for the relevant year is NALI and potentially taxed at 45%.
However, the ATO notes that as the above view was not explicitly stated in the initial draft law companion ruling which was subsequently withdrawn. Therefore, it is understandable that trustees of complying super funds may not have realised that amendments will apply to non-arm's length expenditure of a general nature that has a sufficient nexus to all ordinary and/or statutory income derived by the fund in an income year.
In addition, according to the ATO, the amendments were also slated to apply to the 2018-19 and later income years, which may result in all income derived by a fund during the 2018-19 and 2019-20 income years being classified as NALI where it has incurred non-arm's length expenditure of a general nature.
As such, pending the finalisation of the draft law companion ruling, the ATO will not allocate compliance resources to determine whether the NALI provisions apply to a complying super fund for the 2018-19, 2019-20 and 2020-21 income years where the fund has incurred non-arm's length expenditure 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.
Does your SMSF have NALI?
Even though the ATO will not devote compliance resources to this issue for the near future, it is still important to get it right. Getting it wrong may mean that your SMSF could take a big tax hit, in turn lowering the amount you have available for your retirement. If you're not sure about NALI, contact us today, we're here to help.