NALI updates now in force: What the changes to NALI mean for your SMSF

Non-arm’s length income (NALI) rules are back in the spotlight as new changes clarify the treatment of non arm’s length expenses (NALE) for SMSFs.

The Treasury Laws Amendment (Support for Small Business and Charities and Other Measures) Act 2024 (Act), came into effect on 1 July 2024 and apply retrospectively from 1 July 2018.

The Act amends the application of the NALE rules, seeking to improve their operation and remove ambiguity in relation to the treatment of such expenses.

This article provides an overview of the changes and highlights the risks SMSF trustees need to be aware of in light of the amended NALI and NALE rules.

The previous rules relating to NALI

Australian taxation law splits the taxable income of complying SMSFs into two components: a low tax component, and a NALI component. A concessional rate of 15% applies to the low tax component, while the NALI component is taxed at the highest marginal rate (being 45%).

An SMSF’s total non-arm’s length component of its taxable income must not exceed the SMSF’s assessable income, minus deductions, and excluding assessable contributions and deductions.

Under the current rules, an amount of ordinary income or statutory income is considered NALI if:

• There is a scheme: it derives income (including capital gains) from a scheme, the parties to which were not dealing with each other at arm's length. This first component of the definition – that the income be derived from a scheme – is particularly broad and will capture a range of transactions and formal and or informal arrangements; and
  
  
• The fund derives more income: the amount of income derived is more than the amount that the SMSF might have been expected to derive if those parties had been dealing with each other at arm's length; or
  
  
• The fund incurs a loss: in gaining or producing the income, the SMSF incurs a loss, outgoing or expenditure (including nil expense) that is less than what the SMSF might have been expected to incur if the parties were dealing on an arm's-length basis.

So what is changing?

The changes introduced under the Act, which became effective on 1 July 2024 and apply retrospectively from 1 July 2018:

• limit the amount of NALI arising from a non-arm's length general expense for small superannuation funds to twice the difference between the actual expense and the expected market rate of the expense;
  
  
• exempt large APRA regulated funds, including exempt public sector superannuation funds, PSTs and ADFs from the NALE provisions for both general and specific expenses of the fund, and confirm that the remaining NALI rules continue to apply; and
  
  
• exempt the application of the NALE provisions, as amended by the Act, for expenditure that occurred prior to the 2018–19 income year.

These changes were introduced following concerns raised by industry stakeholders in respect of the original NALE provisions contained in the Treasury Laws Amendment (2018 Superannuation Measures No. 1) Act 2019. Under the previous regime, relatively minor breaches of the NALE such as discounted compliance services from related entities, resulting in the fund’s income being taxed at the top marginal rate.

While the specific expense NALE rules continue to operate without change, for small SMSFs, general expense NALE will only be taxed at the highest marginal rate on two times the difference between the expense the SMSF paid and the expense the SMSF should have paid, if it were dealing at arm’s length.

Consequences of breaching the NALI rules

If a trustee fails to comply with the NALI rules, all income including net capital gains and assessable contributions of the SMSF, will be categorised as NALI and will be taxed at the highest marginal rate, as opposed to the concessional superannuation rate. This rate applies even if a SMSF is in pension mode and would otherwise pay no tax on pension earnings.

Considerations for SMSF trustees

These amendments serve as a reminder to all SMSF trustees to ensure their fund is transacting on an arm’s length basis. To establish which category of expense a loss, outgoing or expense falls into, it will be necessary to examine whether or not the expense is incurred in relation to a particular asset or assets of the fund. Services such as actuarial, audit, accounting, adviser and trustee fees are specified by Treasury as failing within general expenses.

More information from Maddocks

For more information, contact Maddocks on (03) 9288 0555 and ask to speak to a member of the Commercial team.

You can read earlier ClearLaw articles on a range of topics, including the following related articles:

• ATO Takes Expansive Approach To NALI And CGT In New Determination
• SMSFs and related party borrowings: ATO waves a red flag on non-arm's length arrangements
• SMSFs borrowings: Government reject LRBA ban

Order related document packages

• Superannuation Trust (SMSF)
• Update to SMSF
• SMSF set up + register Corporate Trustee
• Change SMSF Trustee (Cleardocs deed)Change SMSF Trustee (death of a trustee)