The ATO is targeting Non-Arm’s Length Income (NALI) and Non-Arm’s Length Expenses (NALE) for Super Funds.
If SMSF transactions are assessed to be either NALI or NALE then there is a significant financial impact for the SMSF.
As SMSF trustees it’s important to know what might trigger the NALI/NALE rules, to prevent adverse tax implications.
What is NALI?
NALI refers to income derived by an SMSF where the parties involved in a transaction were not dealing with each other at arm's length. This could result in a tax rate of up to 45% being applied that income.
NALI Tests:
Income from Non-Arm’s Length Transactions: If an SMSF derives income through a scheme where dealings are not at arm’s length and the income is greater than it would be otherwise, this income is considered NALI.
Private Company Dividends: If an SMSF receives dividends from a private company under non-arm’s length conditions, this income may be taxed as NALI.
Trust Income: Income derived by an SMSF from trusts, other than fixed entitlements, can be subject to NALI rules.
Example: Mark Waters involves his SMSF in a property development, intending to benefit from lower tax rates. The distribution of profits, however, exceeded the SMSF's entitlement, making it subject to NALI – that is, potentially taxed at up to 45%.
What is NALE?
NALE rules apply when an SMSF incurs losses, outgoings, or expenditure below commercial rates or not at all. Such transactions also lead to income being taxed at the highest marginal rate under NALI rules.
NALE Tests:
Property Management Expenses: If an SMSF does not incur commercial property management fees from a related party, the rental income generated will be NALI.
Property Purchase Below Market Value: If real estate is bought from a related party below market value, any income or capital gains from this property will be subject to NALI.
Related Party Loans: Loans to an SMSF that are not at arm’s length terms result in all income generated by the acquired property being taxed as NALI.
General Expenses Under NALE: Expenses such as actuarial costs, accounting fees, audit fees, investment adviser fees, and other administrative costs incurred in managing the SMSF must be at market rates (this includes accountants with their own SMSF!). Otherwise, the SMSF's income could be classified as NALI.
Practical Implications: For SMSF trustees, it's crucial to ensure all transactions, especially with related parties, are on commercial terms. Proper documentation and proof that transactions are at market rates are essential to avoid NALI/NALE implications. This includes ensuring borrowing arrangements, service fees, and income distributions align with arm’s length principles.
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