The ATO has released its final ruling on non-arm’s-length expenditure (NALE) inside an SMSF and has retained its position expenditure categorised manner can have a sufficient nexus to all of the ordinary and/or statutory income derived by the fund.
The regulator released Law Companion Ruling (LCR) 2021/2 this week, which states in section 19 “a fund may incur expenditure that does not specifically relate to a particular amount being derived by the fund but still has a sufficient nexus more generally to all income derived by the fund”.
The LCR also stated NALE incurred to acquire an asset would also have a sufficient nexus to income derived by the fund and this would include any capital gains realised on disposal of the asset, even where a trustee has refinanced any borrowings and shifted them to an arm’s-length basis.
This position was altered in the case where a super fund incurs NALE of a recurrent nature, that was not related to the acquisition of an asset, in one income year, but does not incur that cost in a later year, with section 21 of the LCR stating the nexus to the ordinary or statutory income would only apply during the relevant income year.
In response to the release of the final ruling, the SMSF Association has called on the government and Treasury to review the NALE rules, claiming they could have unintended punitive consequences.
Association deputy chief executive and director of policy and education Peter Burgess, speaking during the industry body’s Technical Summit, said: “The industry has lost the battle to convince the ATO that a general expense cannot have a direct link to income of a fund.
“Whether we agree with that view or not, the consequences of having all the income taxed as non-arm’s-length income (NALI) because the fund did not receive a general expense at arm’s-length terms is very severe and disproportionate. The only way to address this issue is to push for a law change.”
Burgess acknowledged the final ruling provided greater clarity around when an expense would be considered non-arm’s length and provided more examples of what constitutes acting in a trust capacity or individual capacity.
“If an SMSF incurs an expense on arm’s-length terms for all the services it receives, then these NALE rules would have no application. There is one exception and that is where the trustee is providing services and they are doing that in their capacity as a trustee,” he said.
“This is important for clients providing services to their own fund to know whether they are performing that service in their capacity as a trustee or an individual.”
He pointed out the ruling will allow SMSF members to provide services to their fund using their own business skills and experience without having to charge the fund for that service.
“For example, a financial planner who has an SMSF can use their skills and knowledge in formulating an investment strategy for their fund and this service can be provided to their fund without charge,” he said.
“Even if they use their business assets in a minor or infrequent way, it will still not be classified as a service they need to charge their SMSF for.
“But the ruling does draw the line at services that can only be provided if the SMSF member holds a particular licence or qualification, or the service is covered by an insurance policy relating to their business.
“In these instances, the SMSF member is required to charge their fund an arm’s-length fee for the service provided or risk some or all of the fund’s income being taxed as NALI.”''