NALI - Transitional compliance approach for SMSF non-arm's length expenditure extended

In PCG 2020/5, the ATO has determined that its approach to the FY18-19, FY19-20 and FY20-21 tax years will be extended to include FY21-22.

This means that if a fund incurred certain general non-arm's length expenditure - that has a sufficient nexus to the fund's ordinary and/or statutory income in those income years - then the ATO will not expend its resources to determine whether the NALI provisions apply. This article outlines how non-arm's length expenditure is treated as NALI and the transitional compliance approach.

Background

Generally, an SMSF could incur non-arm's length income (NALI) (which is therefore income that is taxed at the highest marginal tax rate) if there is a scheme between parties which are not dealing with each other at arm's length and one of the following occurs:

• The SMSF derives more income than what might have been expected to have been derived if the parties were dealing with each other at arm's length: or
• The SMSF derives income as a beneficiary of a trust through holding a fixed entitlement to the income of the trust and the amount of income is more than what might have been expected to be derived if the parties were dealing with each other at arm's length.

More recently, the operation of the NALI provision has been extended to include circumstances where the fund incurs a loss, outgoing or expenditure which is smaller than what would be expected if the parties were otherwise dealing at arm's length as set out below (NAL Expenditure).

Non-arm's length expenditure

The treatment of NAL Expenditure as NALI was introduced after changes to section 295-550 of the Income Tax Act 1997 (ITAA97) were made by the Treasury Laws Amendment (2018 Superannuation Measures No. 1) Act 2019.

An SMSF could incur NALI if there is a scheme between parties which are not dealing with each other at arm's length and one of the following occurs:

• if the SMSF incurs a loss, outgoing or expenditure of an amount in gaining or producing income and the amount of the loss, outgoing or expenditure is less than the amount that the fund might have been expected to incur had those parties been dealing with each other at arm's length in relation to the scheme¹;
• if the SMSF does not incur a loss, outgoing or expenditure that the fund might otherwise have been expected to incur if those parties where dealing with each other at arm's length : or

• the SMSF derived income as a beneficiary of a trust through holding a fixed entitlement to the income of the trust and:

  • the amount of income is more than the amount the SMSF might have been expected to derive if the parties were dealing with each other at arm's length: or
  • the SMSF incurs a loss, outgoing or expenditure of an amount that is less than the amount of a loss, outgoing or expenditure that the SMSF might have been expected to incur of the parties were dealing with each other at arm's length²; or
  • in acquiring the entitlement or in gaining or producing the income, the SMSF does not incur a loss, outgoing or expenditure that the SMSF might have been expected to incur if the parties were dealing with each other at arm's length³.

ATO transitional compliance approach extended

The ATO has announced that it will not allocate its compliance resources to determine whether the NALI provisions apply to a complying super fund for the FY18-19, FY19-20, FY20-21 and FY21-22 years where the fund has incurred NAL Expenditure of a general nature that has a sufficient nexus to all ordinary and/or statutory income derived by the fund in those respective income years (for example, non-arm's length expenditure on accounting services).

The most recent announcement of the ATO agreed to extend its transitional compliance approach to the 2021-22 income year. Therefore, this approach will only apply to expenditure incurred on or before 30 June 2022.

The transitional compliance approach does not apply to NAL Expenditure which is expenditure incurred directly related to the fund deriving a particular ordinary or statutory income.

In order to determine whether there is a 'sufficient nexus' between the NAL Expenditure and all ordinary and/or statutory income derived by the fund, the NAL Expenditure must be incurred 'in gaining or producing the relevant income (or acquiring the relevant entitlement)'. Further the NAL Expenditure does not have to be deductible under section 8-1 of the ITAA97 for it to fall under the NAL Expenditure provisions⁴. For example, NAL Expenditure incurred to acquire an asset (including associated financing costs) will have a sufficient nexus to all ordinary or statutory income derived by the SMSF in respect of that asset.

A detailed set of examples can be found in the ATO's Law Companion Ruling 2019/D3.

More information from Maddocks

For more information, contact Maddocks on (03) 9258 3555 and ask to speak to a member of the Commercial team.

More Cleardocs information on related topics

You can read earlier ClearLaw articles on a range of topics, such as:

• Superannuation Contributions - A Guide
• Superannuation Contributions and Income Tax - for Self-Managed Superannuation Funds
• Understanding - Contributions, Contributions Caps and Reserves

Order related document packages

• SMSF Minutes and Resolutions Package
• SMSF Pension Commutation
• SMSF Pension Pack
• Superannuation Trust (SMSF)
• Update to SMSF