Public advice and guidance compendium

It is not considered that the legislation was drafted with the intention that general expenses have a sufficient and necessary nexus to all of the income of the fund. Rather, the legislation provides a basis for expenses that have a sufficient and relevant nexus to assets and income of the fund where an inappropriate advantage has been arranged.

The wording of section 295-550 refers to 'an amount' of ordinary or statutory income is non-arm's length income (NALI). Further, the Commissioner's approach is not supported by the Explanatory Memorandum (EM) to the Treasury Laws Amendment (2018 Superannuation Measures No. 1) Bill 2019 or common law.

The EM states:

2.16 The legislation requires the identification of a specific amount of ordinary or statutory income that is non-arm's length income. This ensures that the consequences of an amount of income being non-arm's length income are restricted to that amount of income and any related deductions.

While paragraph 2.16 refers to 'amount', this should be read, in context, as 'an amount in respect of specific income or a category of income'.

The EM, while referencing section 8-1 of the Income Tax Assessment Act 1997^[1] also makes clear that a specific amount of income needs to be identified when calculating a super entity's non-arm's length component. The ATO's interpretation appears to be far broader.

If relying on a nexus due to section 8-1, this nexus is not sufficient and necessary for the NALI provisions which require that the expense must have been incurred 'in' gaining or producing the relevant income. That is, the expenditure must be incurred in the course of producing such income and cannot be an expense that is incurred at a point in time either too early or too late to be related to the production of income of the super entity.

If the Commissioner maintains the legislative interpretation, then consideration of certain expenses such as section 25-5 and expenses on establishment or winding up should be clarified.

We also consider the views to be consistent with statements in the EM. Paragraph 2.38 of the EM draws parallels between the requisite nexus with respect to paragraphs 295-550(1)(b) and (c) and (5)(b) and (c), and the application of section 8-1.

The final Ruling contains additional guidance to assist trustees to comply with the NALI provisions. This includes a number of examples of general expenditure that could be deductible under section 8-1, including interactions with other specific deduction rules (such as 25-5).

However, in recognition of the impact of the interpretative position on general expenses, the Appendix in the final Ruling sets out our compliance approach to considering whether general expenses are on 'arm's length' terms.

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the parties deal on non-arm's length terms, and

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the fund incurs a loss, outgoing or expenditure (or none) that is less than the amount the fund might have been expected to incur had the parties dealt at arm's length.

This significant impact will result in income of the fund being NALI where the market value of the relevant loss, outgoing or expenditure is relatively small compared to the relevant income. This disproportionate outcome is not consistent with the policy intent of the amendments. This is an issue for self-managed superannuation funds (SMSF) and APRA-regulated funds.

Actions required to be taken to avoid this disproportionate outcome (for example, substantiating values) may themselves be regarded as excessive and a compliance burden.

Some practical solution should be considered to provide certainty, such as a de minimus amount, materiality level, safe harbour or guidance on arrangements the ATO views as 'high' and 'low' risk. This would significantly reduce the compliance burden on trustees, advisers and auditors.

To further assist taxpayers, the Appendix in the final Ruling sets out our compliance approach in relation to general fund expenses, according to whether the fund is an SMSF or an APRA-regulated fund. In the circumstances specified in the Appendix, we will not allocate compliance resources from 1 July 2022 to determine whether those general fund expenses are in fact on arm's length terms.

This compliance approach does not impact the approach set out in Practical Compliance Guideline PCG 2020/5 Applying the non-arm's length income provisions to 'non arm's length expenditure' - ATO compliance approach for complying superannuation entities.

Additional guidance should be provided as to how Taxation Ruling TR 2010/1 Income tax: superannuation contributions interacts with the NALI provisions.

For example, the Commissioner should clarify that the same under-valued expense would not be subject to both the NALI and contributions provisions.

Transactions deemed to constitute a contribution should not be subject to NALI.

However, we have issued for consultation a draft update to Taxation Ruling TR 2010/1 with the Commissioner's preliminary views on the interaction between the NALI and contribution provisions. The draft update includes a proposed compliance approach for the 2018-19 and later income years. Under this approach, compliance resources would not be allocated to determine whether a contribution is made in certain circumstances when income is characterised as NALI.

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act in their personal capacity

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act in their capacity as a trustee of a superannuation fund, and

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act in both capacities at the same time.

A trustee (or director of a corporate trustee)^[2] must determine when they are acting in the capacity of trustee of the fund or in some other legal capacity. Paragraphs 40 to 48 of the final Ruling includes updates to provide further guidance to assist trustees.

Further guidance could include:

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defining what are typically considered to be trustee services, compared to those services that generally would not be provided by a trustee of a super fund. The list of trustee services could be distinguished between APRA funds and SMSFs. For example, accounting, bookkeeping, broad financial advice, governance services, minor repairs, overseeing investments and representing the fund

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providing further examples of a trustee acquiring services from related parties at less than standard commercial prices

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examples of other trades could be provided including a plumber, electrician or landscaper.

What terms of the trust deed require consideration? If this requires objective consideration, please provide an example.

There are inconsistencies between the factors listed in paragraph 39 of the draft Ruling and sections 17A and 17B of the SISA.

The draft Ruling infers that if a fee is charged, you are likely to be operating in a non-trustee capacity.

The position should be that if no charge is made for a service, there is strong presumption that a person is acting as trustee, unless there is evidence to the contrary.

Would this give rise to issues concerning the application of the sole purpose test in section 62 of the SISA?

NALI should not apply (or only apply in excessive instances) where the trustee enters into a non-arm's length dealing with a separate legal entity that is, for example:

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related to the trustee of the fund

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any other associate of the trustee of the fund

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the employer of the trustee of the fund, or

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a friend of the trustee of the fund.

For example, a husband and wife as trustees of their SMSF obtain assistance from their adult child (a qualified accountant) to prepare the fund's annual financial accounts. NALI should not apply in this case.

The NALI provisions will apply where, as a result of a scheme the parties to which were not dealing with each other at arm's length with respect to the scheme, a trustee of a superannuation fund, incurs NALE.

The Appendix in the final Ruling sets out our compliance approach to considering whether general expenses are on 'arm's length' terms.

NALI should not apply where a discount is available to all employees, office holders, etc, and those people are not able to influence the discounts provided to them or where the discount is excessive.

Further examples are required to explain the application of the discount policy.

See also Example 8 of the final Ruling.

Work to build relationships for future business should be excluded with respect to the application of the NALE provisions.

Paragraph 42 of the draft Ruling should make clear that a cost-recovery approach to fees charged to a large superannuation fund by a related entity (whether the related entity be wholly owned or controlled) is in all cases considered to be commercially justifiable, on the basis of maximising returns within the fund for its members, and is therefore consistent with arm's length dealings.

Capital gains tax (CGT) discounts should also be applied in the examples. Greater clarification around the application of the market value substitution rules is required.

Paragraphs 81 and 82 of the final Ruling address the application of the market value substitution rules in determining the amount of NALI. Addressing all instances of the application of the CGT provisions and NALI is outside the scope of this Ruling.

Is there a sufficient nexus for the application of the NALI provisions when an asset is acquired for less than market value? In referring to Examples 1 and 3 of the draft Ruling, if the ATO wishes to apply NALI to net capital gains it should urgently revise its approach to contributions as outlined in TR 2010/1.

Is there a sufficient nexus when the asset is acquired for market value but financed using a limited recourse borrowing arrangement (LRBA) that was not on arm's length terms? In this instance, any capital gain on the asset should not be subject to NALI.

The ATO needs to outline how it will apportion the application of NALI to part of a capital gain.

Disagree with the outcome in Example 4 of the draft Ruling that the income and capital gain is NALI.

Section 295-550 does not provide for a mechanism to apportion income.

Example 7 should also address the implications of the fund selling the property at a later date and using the services of the trustee's real estate agency business to facilitate the sale. That is, would any capital gain from the sale be considered NALI?

Example 2 of the final Ruling has been updated to clarify that income of the fund in a later income year will not be NALI where the arrangement is changed such that expenditure incurred by the SMSF is now on arm's length terms.

Example 11 of the final Ruling outlines the application of the NALI provisions to any future capital gain in the circumstances of that example.

For example, where a qualified accountant, financial advisor or lawyer provides services to their SMSF should they charge the business rate or should they charge a rate of $40 for an unqualified person?

The Appendix in the final Ruling provides further guidance on evidentiary expectations, including the allocation of our compliance resources from 1 July 2022 in considering whether expenses of a general nature are on arm's length terms.

The draft Ruling does not provide any examples where an SMSF trustee is assisting with managing the activities of a unit trust that owns real estate. We query whether these would be treated in a similar manner to the situation where the trustee provides internal or trustee type services directly to a SMSF.

Trustees may seek certainty on their specific circumstances through the private ruling process

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COVID-19

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LRBA

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Practical Compliance Guideline PCG 2016/5 Income tax - arm's length terms for Limited Recourse Borrowing Arrangements established by self managed superannuation funds, and

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similar administrative concessions where NALI is not strictly applied.

For example, if an SMSF structures an LRBA in accordance with PCG 2016/5, that should generally not give rise to NALI unless there is some other reason why NALI should be applied.

For example, a low or nil interest loan should be viewed as a valuable asset and be able to be recognised as a contribution.

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Taxation Determination TD 2016/16 Income tax: will the ordinary or statutory income of a self-managed superannuation fund be non-arm's length income under subsection 295-550(1) of the Income Tax Assessment Act 1997 (ITAA 1997) when the parties to a scheme have entered into a limited recourse borrowing arrangement on terms which are not at arm's length?, and

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PCG 2016/5.

Given that the provision of a guarantee may give rise to a NALI or NALE risk, we request that this important and uncertain topic be dealt with in the final Ruling. We refer you to one of the latest ATO examples, for instance, Example 3 of SMSF Regulator's Bulletin SMSFRB 2020/1 Self-managed superannuation funds and property development.

Also, updates for employee share plans are required. The ATO website material refers to the following:

For example, when shares acquired under an ESS are transferred to an SMSF at less than market value, the acquisition results in a super contribution because the capital of the fund increases and the purpose of the acquisition is to benefit a member, or members, of the fund.

Trustees may seek certainty on their specific circumstances through the private ruling process.

Trustees may seek certainty on their specific circumstances through the private ruling process.

It is noted that individuals may utilise existing review rights where we issue an amended assessment.