SMSF trustees must be mindful of the new non-arm’s-length income (NALI) rules when assessing fund strategies so as not to pay maximum levels of taxation, a sector expert has warned.
In May, the federal government introduced a bill into Parliament dictating income derived from circumstances where undervalued expenses are involved will be treated as NALI and taxed at the highest marginal tax rate, regardless of whether the costs in question are capital in nature.
According to I Love SMSF chief executive Grant Abbott, this change means the taxation of capital gains inside an SMSF could be significantly more severe if trustees did not take the new rules into account.
Abbott pointed out the new bill is particularly dangerous for SMSFs that have used a related-party limited recourse borrowing arrangement (LRBA) at a slightly less than market value interest rate to purchase a property, which would render the strategy a NALI transaction.
“The bill scares me greatly as it states non-arm’s-length interest in borrowing to buy an asset will result in any eventual capital gain on disposal of the rental property being treated as non-arm’s-length income,” he said.
To illustrate the full impact of the bill, he cited a potential situation where a property originally valued at $3 million was acquired via a related-party LRBA where a below market interest rate was applied by an SMSF and was now worth $10 million.
“It now means $7 million in capital gains will be classified as non-arm’s-length income and taxed at 47 per cent,” he noted.
“The bill actually goes further in its explanatory memorandum that explains if you get a share or any investment at a discount, and it doesn’t have to be from a related party, it can be from a non-related party because, for example, you’re a loyalty program member or the like, effectively that will be treated as NALI.
“So anything you do these days, always check the NALI implications.”''