The Federal Government has introduced into Parliament, the Treasury Laws Amendment (Support for Small Business and Charities and Other Measures) Bill 2023 (on 13 September 2023), which amends the non-arm’s length income (NALI) rules within s.295-550 of the ITAA 1997 to deal with non-arm’s length expenditure (NALE) that relate to general expenses of a fund.
This position is effectively that announced in the 2023/24 Federal Budget. For general expenses, the amount of income that is taxed as non-arm’s length income is twice the difference between the amount of the expense that might have been expected to be incurred had the parties been dealing at arm’s length, and the amount the entity did incur.
Where the entity did not incur any expense, the amount of income that is taxed as non-arm’s length income (NALI) is twice the amount that might have been expected to be incurred had the parties been dealing at arm’s length.
Different super funds, different rules
The general expense provisions will not apply to large APRA funds, only SMSFs and small APRA-regulated funds (funds with 6 or less members). The total amount of an SMSF or SAF’s non-arm’s length component is capped at an entity’s taxable income for the year not including any assessable contributions or any deductions against assessable contributions. These amendments apply from 1 July 2018.
For specific expenses the previous NALE treatment continues to apply.
One notable change for the draft consultation is that there was previous a distinction between expenses of a revenue or capital nature that alluded to expenses of a capital nature resulting in the entirety of the funds income being taxed a NALI, this has been changed ensuring that all expenses of a general nature result in the two times factor.
The result of all this is that it sets an upper limit on the amount of fund income taxable as NALI due to a general expenses breach. The maximum amount of fund income taxable at the highest marginal rate is to now be 2 times the level of the general expenditure breach (or 90%, being 2 x 45%).
Calculating the shortfall
The non-arm’s length expense (shortfall) is calculated as the difference between:
- the amount that would have been charged as an arm’s length expense; and
- the amount that was actually charged to the fund.
The following examples have been provided within the explanatory memorandum:
Example 7.1: SMSF using an accounting service
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.
Example 7.2: SMSF using legal services (lower fund income)
Min is a trustee of an SMSF. The members of the SMSF are Min and Min’s spouse Tony. Min is a lawyer and through her law firm, Min Lawyers, provides general legal services, worth $10,000 to their SMSF which the SMSF acquires for $5,000. These services were provided in circumstances such they were provided in a capacity other than as a trustee and meet the other requirements of section 17B of the SIS Act.
Min offers the same services she provides to the SMSF to the general public and the market value of these services is readily apparent from the fee schedule available on Min’s website.
The acquisition of legal services by the SMSF constitutes a scheme between Min and their SMSF in which the parties were not dealing with each other at arm’s length, and the expense was incurred at a value less than what the SMSF would have been expected to have incurred as an expense had the parties been dealing at arm’s length, so the non-arm’s length expense provisions apply. The legal 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(8).
The total income of the SMSF in 2023-24 is $23,000 in rent from a rental property to which $10,000 in eligible deductions for maintenance apply. No assessable contributions were made in that income year.
The taxable income is calculated as $23,000 in rent income minus $10,000 in deductions minus $5,000 charged for legal services, equalling $8,000.
As a general expense of $5,000 was incurred, which would have been $10,000 if the parties had been dealing at arm’s length, the amount of non-arm’s length income is twice the amount of the difference between what was incurred and what would have been expected to have been incurred had the parties been dealing at arm’s length, which is $10,000.
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 $23,000 in rental income minus the $15,000 in deductions, giving $8,000. This cap is lower than the non-arm’s length component arrived at above, so the non-arm’s length component becomes $8,000 instead of $10,000, as previously calculated.
This leaves a low-tax component of $0. The low tax component is any remaining taxable income after calculating the non-arm’s length component.
Cessation of ATO’s guidance relief
It is important to note that the current PCG 2020/5 ceased as of 30 June 2023, meaning that any existing non-commercial arrangements in place need to comply with commercial terms – see LCR 2021/2 for more details. Importantly the ruling says the following with regards to discounted fees (paragraph 51):
A complying superannuation fund might enter arrangements that result in it receiving discounted prices. Such arrangements will still be on arm’s length terms where they are consistent with normal commercial practices, such as an individual acting in their capacity as trustee (or a director of a corporate trustee) being entitled to a discount under a discount policy where the same discounts are provided to all employees, partners, shareholders or office holders
Further the ruling states (at paragraph 92):
From 1 July 2023, where the ATO applies any compliance resources for such general fund expenses, they will only be directed toward ascertaining whether the parties have made a reasonable attempt to determine an arm’s length expenditure amount for services provided to the fund, other than services provided by an individual either acting in the capacity as trustee of the SMSF or as a director of a body corporate that is a trustee of the fund.
Summary
These new laws will finally put to bed the long and drawn out process of finalising a position on the non-arm’s length income laws in section 295-550. Whilst it might not have been the desired outcome that the SMSF industry wanted, it provides a framework that gives clarity on how the laws will apply where a non-commercial arrangement exists for expenses of a general nature in the fund.
Now more than ever it becomes important to know which hat you’re wearing when it comes to different services being provided within a SMSF!
