SMSF NALE ruling finalised – ATO gives some good news, some not so good

Meg Heffron

A key ATO ruling (LCR 2021/2) was released yesterday to update the original draft from 2019. It deals with the vexed issue of when transactions between a superannuation fund and another party potentially create non arm’s length expenses (NALE).

NALE exists when expenses incurred by a SMSF are too low – they are less than the amount that would be been incurred if the parties had been dealing with each other on an arm’s length basis.

Meg Heffron, Managing Director of Heffron and leading SMSF expert explains that NALE is bad because where it exists, the fund also has NALI (non arm’s length income).

“In other words, if a fund’s costs are artificially low, some or all of its income is taxed at the top marginal tax rate of 45% rather than the normal superannuation rates of 15% or nil%” said Heffron.

“The ATO has consulted widely and has ended up in a place that won’t please a lot of us on every front.” Like the original draft, the final ruling divides potential NALE into two buckets:

• Costs that relate specifically to an individual asset – in which case all future income in relation to that asset is tainted forever and will be NALI (including capital gains), and
• Costs which don’t relate to an individual asset (let’s call them general expenses) and are therefore deemed to relate to all income of the fund – in which case NALE means ALL fund income is NALI.

For SMSFs in particular, when it comes to trustees doing work for their own fund, the final ruling also draws a distinction between:

• Work done in the person’s individual capacity – which might create a NALE problem if the fund isn’t charged arm’s length rates, vs
• Work done in their trustee capacity – where it’s generally OK not to charge for the work, since being a trustee naturally involves (unpaid) work and sometimes that work will leverage particular skills the trustee happens to have. In fact, the super law prohibits trustees being remunerated for the work they do as trustee.

Heffron explains that the final ruling includes a sensible compromise that where a general cost is recurring, having a NALE problem in one year won’t taint the relevant income forever. General costs will only give rise to NALI in the years in which they are charged on a non arm’s length basis.

“In practical terms, this means that undercharging accounting fees in one year (a general expense that causes all fund income to be NALI) will only impact that year” says Heffron.

Note that the ruling explicitly distinguishes between this type of “once off NALE” and a similar problem where the expense relates to the purchase of an asset. Unfortunately, there is a permanent problem for NALE under these circumstances. The ruling even provides an explicit example where an LRBA is entered into on non arm’s length terms. Even refinancing and moving to arm’s length terms doesn’t help – all income and capital gains, now and forever, will be NALI.

“That’s rough. It means there is actually no solution for LRBAs that aren’t set up on a solid market basis” says Heffron.

A second piece of good news is that the very tough stance originally taken on (most commonly) accountants doing work for their own SMSFs using company equipment has been softened to include some important new language: “However, minor, infrequent or irregular use of equipment or assets will not, of itself, indicate the individual is acting in their individual capacity. For example, in the absence of any other factor indicating otherwise, minor, infrequent or irregular use of a business computer at the office by an individual would not, of itself, indicate the individual is acting in their individual capacity” LCR 2021/2.

Heffron says there are still plenty of questions to answer in regard to this subject.

“The importance of relying on a licence or insurance – it would seem that (for example) it’s fine for a qualified accountant to do their SMSF’s bookwork on their work computer and using their expertise gained via their work. But if they also lodged their tax return under their firm’s corporate tax agency, that is likely to create a problem,” says Heffron.

“A similar issue would appear to arise for financial advisers. An example provided in the ruling (Example 7, Levi) makes it clear that it’s fine for Levi to place investments for his SMSF (even using his work computer). But we’re unclear as to how far that stretches. If Levi’s SMSF is invested via the same platform as all Levi’s other clients, can he manage it under the same dealer code?”

“And finally, the ruling does acknowledge the commercial reality of things like staff discounts. It provides examples about situations where (say) accounting fees for work on SMSFs of the staff who work at the firm can be discounted without automatically creating NALE. A key feature of the examples provided, however, is that the trustee / member is not in a position to influence the discount. How far does this go? Could we be in the bizarre situation where I can offer all Heffron staff a discount on their SMSF work but can’t receive one myself because I can influence the decision? It’s not clear.”

Meg Heffron explains that there is still much to decipher and consider from this ruling.

“It’s a good start but as always, we need more examples that are closer to real life. We have specific time devoted to this important topic in our forthcoming Super Intensive Day as we predict there are many nuances that will need to be nutted out before SMSF practitioners and advisers feel they have this under control. “