Phil Broderick

The Institute of Financial Professionals Australia do not believe that a factor-based approach which leads to an effective tax rate of 90% is the correct way to deal with a general expense breach. Head of Superannuation & Financial Services, Natasha Panagis, said other changes should be made to the law to deal with non-arm’s length dealings.

“Although the proposed legislative changes to the non-arm’s length expense (NALE) rules are an improvement to the initial proposal to tax NALE at a rate of 225% (ie, a five times multiple), we continue to oppose the concept of a multiple,” Ms Panagis says.

“Under this proposal, small funds will still have the obligation to prove that all their expenses are at market rates or pay extra tax. As a result, SMSF trustees will be required to obtain benchmark evidence to prove that the amounts to be charged, or that the amount paid to another party, is at arm’s length/market rates to minimise the risk of the non-arm’s length income (NALI) provisions applying.

“Identifying whether an expense is NALE may not be a straightforward task as benchmark evidence can be difficult to obtain as expenses/costs can be subjective and can vary widely between providers. In addition, it will be often difficult to determine whether activities are undertaken in a trustee/director role for which no charge is required and other activities which must be charged (and supported by benchmark material). This means the proposed method will likely mean an increase in costs for smaller funds, both from an administration and auditing perspective.”

Ms Panagis notes that the superannuation system already has sufficient regulatory tools to deal with non-arm’s length dealings.

“Existing regulatory powers such as treating the non-arm’s length dealings as contributions (as per Taxation Ruling TR 2010/1), using the current tax penalty regime on top of a proportionate NALI tax assessment, abiding by the sole purpose test and the arm’s length dealings rules (sections 62 and 109 of the SIS Act), and relying on the ATO to use its power to issue SIS Act penalties, rectification orders, disqualification of the SMSF trustees and/or making the SMSF non-compliant, are just a few existing solutions to deal with NALE.”

Ms Panagis says exempting large APRA-regulated funds for both general expenses and specific expenses but subjecting SMSFs and small-APRA regulated funds (SAFs) for both general and specific expenses of the fund is also unjust.

“The proposal as it stands will result in an unlevel playing field between APRA-regulated funds and smaller funds and does not promote tax neutrality/equality across the superannuation sector.”

Board Member and Chair of the Superannuation Technical and Policy Committee, Phil Broderick, says there must be consistency between general and specific expenses and NALI/NALE should be proportionate.

“Rather than using a two times multiple for general expenses and the “existing” NALI treatment apply for specific expenses, it is our view that general and specific expenses be treated the same. In particular, we believe the NALI tax rate of 45% should only apply to the amount of underpayment/non-payment of the expense,” Mr Broderick says.

“It is also our strong view that NALI and NALE should be made proportionate – that is, only the additional income (over and above an arm’s length income) or the underpayment of expenses (ie, below the arm’s length expense) should be subject to the NALI tax rate of 45% (plus penalties, as applicable)”.

Mr Broderick says the proposed legislation is overly complex and the proposed amendments will make the NALI/NALE rules even more difficult to interpret: “We believe the NALE rules should be abolished rather than amended. However, if the proposed changes are retained, we suggest that the rewrite be redrafted in a simpler style.”

Mr Broderick notes the association is disappointed that the consultation paper has failed to address a number of critical points that have been raised by the industry over almost five years of lobbying.

“Issues such as specific expenses were not addressed, the lack of clarity between duties undertaken in a trustee capacity versus an individual capacity remains unsolved, the interaction with other tax provisions is unclear, particularly the capital gains tax regime and the contributions rules, and the NALI provisions provide no opportunity for trustees to rectify any unintended errors,” Mr Broderick says.

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Phil Broderick

A hot topic for SMSF trustees during the COVID-19 crises is whether SMSF trustees that hold land can offer rent relief to their tenants, in particular to related tenants, without breaching the superannuation laws.

Rent relief by SMSF trustee landlords can potentially cause issues for SMSF trustees. That could include breaches of the sole purpose test (section 62 of the Superannuation Industry (Supervision) Act 1993 (SIS Act)), the prohibition against providing financial accommodation (section 65 of the SIS Act), the prohibition against dealing on a non-arm’s length basis (section 109 of the SIS Act) and the in-house asset rules (Part 8 of the SIS Act). Rent relief is unlikely to breach the non-arm’s length income rules (NALI) on the basis that the SMSF will not receive more income than it should.

For unrelated tenants, offering rent relief is unlikely to breach the superannuation laws as any rent relief will be either negotiated by arm’s length parties or compelled under various State based legislative regimes.

For related tenants (of business real property), the position is not so clear cut. In “normal times”, an arm’s length landlord would be expected to enforce the terms of the lease and any deviation from the lease terms, or altering the terms of the lease in favour of the related tenant, could breach the superannuation laws.  In simple terms, this is because such actions would be a non-arm’s length dealing.

However, during the COVID-19 crises there is arguably no “normal” and, therefore, arm’s length dealings could incorporate discounting rent, deferring rent or both.  This is particularly so for tenants who can avail themselves of the statutory rent relief measures.

So, where does this leave SMSF landlords who want to offer rent relief to their related party tenants? Well, the Australian Taxation Office (ATO ), in its Q&A website material, has confirmed that their “compliance approach for the 2019–20 and 2020–21 financial years is that we will not take action if an SMSF gives a tenant – even one who is also a related party – a temporary rent reduction, waiver or deferral because of the financial effects of COVID-19 during this period.” This applies to both land held by SMSFs and regulation 13.22C unit trusts.  The ATO website material is silent as to what relief can be offered and whether it can be offered to all tenants (even those not suffering a downturn).

This raises the question as to what relief can be offered. In the author’s view, the following should be considered in relation to rent relief granted to related tenants:

• match the rent relief to that which is offered under the various statutory COVID-19 measures (this approach is best practice);
• SMSF landlords could structure their relief against benchmarking materials (e.g. from estate agents) of what relief is being granted in the rental market by arm’s length parties for similar properties; or
• Determine their own terms for the relief (although this carries the greatest risk of being found to be a non-arm’s length dealing).

It is also important, if a SMSF landlord offers rent relief, that the relief be formally documented (e.g. through a deed of variation of the lease or an exchange of letters). It is also recommended that the reasons for offering the rent relief be recorded (e.g. in the formal documents or a trustee resolution).

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