The ATO final ruling on NALI and NALE

The world of SMSFs has some very clear rules and regulations, which often carry with them different acronyms and technical “jargon”. Two of these such terms are NALI and NALE.

What is NALI and NALE?

NALI – is non-arm’s length income. This occurs when the SMSF receives income that is not on commercial terms, such as paying twice the market rent for leasing an SMSF property.

NALE – is non-arm’s length expense. This occurs when the SMSF receives lower expenses than commercial terms. An example of this would be nil interest charged on a related party LRBA loan.

Non-Arm’s length income rules clarified?

In August 2021, the ATO released Law Companion Ruling LCR 2021/2 Non-arm’s length income – expenditure incurred under a non-arm’s length arrangement, which clarifies our interpretation of amendments to NALI rules relating to non-arm’s length expenditure (NALE).

The ruling provides guidance with examples on the application of the amendments. It also confirms the Commissioner’s view that non-arm’s length expenditure incurred by a trustee of a superannuation fund that is of a general nature (such as fees for accounting services) can have a sufficient relationship to all the income of a superannuation fund. The result is that all the fund’s income is assessed at the top marginal tax rate as NALI.

While maintaining the interpretative position, LCR 2021/2 also sets out the ATO’s practical compliance approach when considering whether general expenses are ‘arms’ length’. The approach depends on the type of fund and is outlined in the Appendix to LCR 2021/2.

How will this impact me?

Any income derived by an SMSF that is NALI or as a result of NALE will be taxed at the top marginal tax rate (45%), rather than the concessional rates (15%) that apply to most income in an SMSF.

Sufficient nexus between NALE and income or maybe not?

The ATO states there must be sufficient nexus between the NALE and the relevant ordinary or statutory income. NALE incurred to acquire an asset will have sufficient nexus to all statutory and ordinary income derived from that asset. In a very concerning view, the ATO stated that with respect to general expenses of the fund, there is sufficient nexus to all ordinary and statutory income of the fund.

Here are a few examples on how SMSFs are impacted:

Example 1 The fund owns a rental property, and the related party real estate agent does not charge the fund any fees for managing the property. In this case, all rental income of the fund will be NALI and taxed at the highest marginal tax rate.

Example 2 The fund purchases a business real property at a $200,000 discount to the market value. All rental income will be considered NALI, and all future capital gains will also be considered NALI. This would still be the case if the discount was only $1,000.

Example 3 The fund buys a property using a related party LRBA. The interest rate is less than the benchmark rate. All rental income will be considered NALI, and all future capital gains will also be considered NALI. This will still be the case if the loan is refinanced and now on arm’s length terms. According to the ATO, the LRBA needs to be perfect from the start.

Example 4 The fund does not incur any accounting fees as the trustee owns an accounting practice and chooses not to charge his fund for lodging the accounts. The ATO’s view is that this expense has a nexus to all income of the fund including capital gains. So, if the fund sold an investment it held for over 10 years in the same year no accounting fees were charged all the capital gains would be taxed at the highest marginal tax rate. Examples of general expenses that might trigger this include accounting, audit, actuarial and investment advice fees.

Example 5 The fund trustee prepares the accounts of the fund not using any equipment or software from the accounting practice they work in. The ATO is satisfied the trustee is operating in their trustee capacity and no NALE is incurred.

Example 6 The fund receives staff discount for accounting fees as they work at an accounting firm. The ATO is satisfied if all staff are eligible for the discount, and no NALE has occurred.

When do I need to comply?

To assist SMSFs with transitioning to these new rules, the ATO has previously advised it will not allocate compliance resources to determine whether the NALE changes will apply to SMSFs for the 2019, 2020 and 2021 financial years where the SMSF incurs expenditure of a general nature. For NALI or NALE that is not general in nature, SMSFs have been complying with NALI for some years and NALE applied from 1/7/2018.

From 1 July 2022, where the ATO applies any compliance resources for such general fund expenses, they will only be directed toward ascertaining whether the parties have made a reasonable attempt to determine an arm's length expenditure amount for services provided to the fund, other than services provided by an individual either acting in the capacity as trustee of the SMSF or as a director of a body corporate that is a trustee of the fund.

Provided this is the case, the ATO will not allocate compliance resources to determine whether those expenses are in fact arm's length expenses.

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