Status update on the non-arm’s length expense legislation as Senate approves

The non-arm’s length expense (NALE) legislation was approved by the Senate on 27 March 2024.

The draft legislation (ie, the Treasury Laws Amendment (Support for Small Business and Charities and Other Measures) Bill 2023 (Bill)) that includes a limit on general NALE for SMSFs, now awaits approval from the House of Representatives. Parliament resumes on 14 May 2024 and the earliest date for the NALE changes to take effect will now be 1 July 2024 assuming the Bill is passed by that date.

The Bill will, when it becomes law, reduce the tax impact where a lower or nil general expense is incurred by an SMSF by imposing an upper cap (discussed below) on the amount that is taxed as non-arm’s length income (NALI) under s 295-550(1)(b) and (c) of the Income Tax Assessment Act 1997 (Cth) (ITAA 1997).

This cap is in the form of a two times (ie, 2 x) multiplier of the amount of the lower general expense for an SMSF or a small APRA fund. The example below outlines how this cap will apply.

Example applying a 2 x multiplier

Take an SMSF trustee that uses their brother’s accounting firm’s services, which would usually cost $8,000 under an arm’s length relationship, and is not charged any fee. This scenario is considered NALE as the parties were not dealing at arm’s length. Therefore, the tax payable would be calculated as follows:

• 2 x $8,000 = $16,000 NALE
• $16,000 x 45% = $7,200 tax payable by the fund.

Note that where the product of 2 x the NALE is greater than the fund’s actual taxable income, an “upper cap” will be the SMSF’s taxable income for the FY (not including any assessable contributions or any deductions against those assessable contributions).

Referring to the example above, the amount under a 2 x multiplier is $16,000. However, if the fund’s actual taxable income is only $6,000, the upper cap would result in total NALE being $6,000 for that financial year.

While the amendments are an improvement on the current law (where general lower expenses are said to be connected to all ordinary and statutory income including concessional contributions), the SMSF Association and a number of other professional bodies believe the 2019 NALE amendments should have been repealed for all funds and not just for the large APRA regulated funds. Moreover, numerous professional associations representing both large and small funds as well as a range of professional associations requested changes to ensure NALI was more proportionate and fairer, however, these requests were ignored.

Specific expenses

In particular, there is no relief for SMSFs for specific expenses which will be subject to the usual NALI rules in s 295-550. A specific expense will be any other expense other than a general expense. A specific expense is one that relates to ‘gaining or producing income in relation to any particular asset or assets of the fund’.

Specific expenses can result in tainting an asset for life as outlined in the Sam and Trang examples discussed below.

Example 7.4 of the explanatory memorandum to the Bill highlights an SMSF utilising the services of a related party. The example relevantly states:

[Sam is a related party of an SMSF, whose assets include a rental property.]

… Sam is a licensed builder and blocks time out of their work calendar to conduct renovations on the rental property worth $3,000 for which they charge nothing.

The renovations were an expense incurred in deriving income from a particular asset, the asset being the rental property. The renovations are a specific [NALE] …

Example 9 in LCR 2021/2 involved Trang, a plumber, who renovated the kitchen and bathroom to her SMSF’s second rental property exposed the net rental income and future capital gain of the property to NALI.

Since Trang and Sam’s services are non-arm’s length, the relevant asset is tainted for the period it is held by the fund and is subject to a 45% tax rate.

What advisers should be doing

Advisers should be on top of the NALI/E legislation and how it impacts their clients. Moreover, advisers offering staff discounts, should have an SMSF Staff Discount Policy in place. DBA Lawyers offers advice, training and an SMSF Staff Discount Policy service.

Related articles:

• NALE changes introduced as Bill on 13 September 2023
• Firms providing discounted SMSF services to staff need an appropriate discount policy ASAP
• SMSF Staff Discount Policy
• New SMSF case demonstrates how not to have non-arm’s length income
• Non-arm’s length income – A history and overview

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This article is for general information only and should not be relied upon without first seeking advice from an appropriately qualified professional. The above does not constitute financial product advice. Financial product advice can only be obtained from a licenced financial adviser under the Corporations Act 2001 (Cth).

For more information regarding how DBA Lawyers can assist in your SMSF practice, visit www.dbalawyers.com.au.

By Daniel Butler ([email protected]), director and Fraser Stead, lawyer.

DBA LAWYERS

2 April 2024