A massive worry for certain trustees

NALE SMSF trustees

Non-arm’s-length expenses (NALE) is looming as an area of concern for SMSF trustees waiting to see if the ATO will address its far-reaching implications.

Four letters are making the wider SMSF community, and particularly trustees, very nervous at the moment, and they are NALE. It’s an acronym that stands for non-arm’s-length expenses and relates to new rules brought in to determine the tax, or tax penalty, that is to be paid on certain assets of a fund.

It stems from an amendment to the legislation governing non-arm’s-length income (NALI) contained in the Income Tax Assessment Act 1936.

In a nutshell, if an SMSF is deemed to have received services for which it did not pay a market rate fee, then any associated income or capital gain derived that can be connected to that service will be treated as NALI and will have the top marginal tax rate, currently 47 per cent, applied to it.

On the surface a lot of trustees might look at this and think it won’t really affect them, but there are others who might be sweating a little more profusely upon the mention of those four letters.

If we begin looking at the outer layer of the onion, individuals who are perhaps real estate agents or the like might be a little concerned. The new rules dictate that if these trustees had acquired a property in their SMSF and along the way may have used their professional skills and resources to achieve the best outcome without charging the fund an arm’s-length fee, any income or capital gain stemming from that property asset will be treated as NALI and taxed at the top marginal rate.

That’s obviously not such a good result, but on a positive note if the fund only owns one property, then the tax hit is somewhat quarantined.

The key is a concept the legislation refers to as nexus, that is, being able to establish a direct link between the discounted service and the income-generating asset in question.

This concept of nexus means the new provisions take on a new dimension if you are, say, an accountant or have been fortunate enough to have sourced accounting and administrative services for your SMSF at less than standard market rates.

This is not an uncommon situation and could end up being completely catastrophic for these trustees. As the accounting and administrative functions of an SMSF are pervasive of the fund, the nexus here extends to all assets of the fund.

That means all of the income of the fund could potentially be considered NALI and the SMSF would be taxed at the top marginal tax rate.

I’m pretty sure the government did not intend this scenario to eventuate, but nevertheless it is a distinct possibility.

Of course, let’s not forget the potential for this amendment to increase the administrative burden for SMSF trustees even if a more practical solution to NALE is found.

Granted I’m crystal-balling here, but imagine if the legislation is further fine-tuned allowing an asset to be considered to have generated NALI for only a short period of its life because the original indiscretion was corrected. You would then have to account for an item that would be considered a NALI asset for one period and then a normal asset for another.

As you can see, this appears to be a poorly thought out legislative amendment and no doubt discussion arising from it will continue to dominate SMSF discussions for a while to come.


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