Author: Emma Partenza, Manager, TAG Financial Services
The Federal Government recently released draft legislation amending the non-arm’s length income rules, specifically in relation to the general expenses of a fund. As the Senate Committee has now approved the legislation in its draft form, the expectation is this will soon become law.
To recap, a non-arms length expense is an expense that was not incurred by the fund, or it was incurred at less than what it should have been incurred (as they should if they were dealing with parties on an arm’s length basis).
What is the proposed change?
Where a fund incurs a general expenditure breach, income that is taxable as non-arm’s length income will be capped at the fund’s taxable income for the financial year (excluding contributions assessable to the fund).
For a general expenditure breach, the maximum amount of fund income that is taxable as NALI is 2 times the level of the general expenditure breach (up to the fund’s taxable income).
It is important to note there is no longer a distinction between general expenses of a revenue nature vs capital nature. General capital expenditure will not incur the two times adjustment to the expense. It is proposed it will no longer apply.
Non-arm’s length income is taxed at 45%.
Act in the proper capacity – Trustee capacity vs Individual capacity
For individuals undertaking work in respect to their SMSF in their trustee capacity, as part of their ongoing trustee duties and responsibilities, the SIS Act provides trustees cannot receive any remuneration for any duties or services performed by them. Trustees must maintain assets.
However, where the individual performs work for the fund in their individual capacity (i.e. as an accountant, real estate agent, tradesperson – where they are licensed professionally) a fee should be charged to the fund, where they are not acting in their capacity as trustee. Generally, this type of work is undertaken by the individual for which they are appropriately qualified. Arm’s length expenditure must be incurred by the fund for such services to avoid the application of NALI provisions.
When do the proposals commence?
The commencement date has been amended from 1 July 2023, back to 1 July 2018. This Bill is yet to become law.
Example – accounting services provided
Michelle is the sole trustee and member of the Retire Wealthy Superannuation Fund. She is an accountant and provides general accounting services worth $3,000 to her SMSF (using her business software). Michelle does not charge a fee for the accounting services she undertakes for her fund.
During 2023-24 Michelle’s fund receives the following income:
The 2024 taxable income of Retire Wealthy is $42,500.
Calculating the deemed general expense:
Michelle has indicated the value of accounting services she provides to the fund annually is $3,000. Using the two-factor approach, the general expense is doubled, $3,000 x 2 = $6,000.
$6,000 is assessed as NALI unless the general expense should have been capped, based on the fund’s taxable income. As assessable contributions are not included in the calculation of taxable income for these purposes, the fund’s 2024 taxable income is therefore $15,000.
This results in the full $6,000 non-arms length expense being taxed at 45% in Michelle’s SMSF for the 2024 financial year, amounting to $2,700 in additional NALI tax.
To be capped, the general expense multiplied by a factor of 2 would have to be greater than $15,000 in this example. Should net rental income have been say, $5,000, the non-arm’s length expense for Michelle’s fund would be capped at $5,000, which is the fund’s taxable income, excluding assessable contributions.
What Now?
While there is now a more palatable cap, the NALE provisions still represent a penalty if breached. It is important to understand the capacity in which you are acting and determine appropriate fees where required.
For those in business, ensure your business policy is updated and clearly reflects a commercial arrangement that is clear and can be implemented.
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Disclaimer: The information contained is general in nature. Professional advice should be sought before acting on any aspect on this page. Financial planning services provided by TAG Financial Advisors Pty Ltd (ABN 77 154 205 017 AFSL 415632), a wholly owned subsidiary of TAG Financial Services Pty Ltd (ABN 67 075 374 686). Copyright 2023. Please do not reproduce without the expressed written consent of the author.