NALI and NALE FAQ | Accurium

FAQ

This FAQ addresses questions from the webinar 'New rules for NALI and NALE' presented on 26 June 2020 and Mark Ellem's response to each of those questions.

This is an example of expenditure of a general nature and consequently it is subject to PCG 2020/5. As noted by PCG 2020/5, the ATO will not allocate compliance resources to determine whether the NALI provisions apply to a complying superannuation fund for the 2018-19, 2019-20 and 2020-21 income years, where the fund incurred NALE (as described in paragraphs 9 to 12 of LCR 2019/D3) of a general nature that has a sufficient nexus to all ordinary and/or statutory income derived by the fund in those respective income years (for example, NALE on accounting services).

Applying PCG 2020/5, there would not be a requirement for the SMSF to be charged for these services provided during the 2018-19, 2019-20 and 2020-21 income years. Once LCR 2019/D3 is finalised, this scenario would be reviewed and considered in light of the final version of the ruling.

However, based on the draft ruling as issued, as the SMSF is utilising the software and licenses (tax agent number) of the member's employer and no fee is being charged for those two items, there would be the risk that the arrangement would be caught by the broadened NALI rules. Consideration could be given to the accounting firm (that employs the SMSF member) charging an arm's length fee for the use of the software and the provision of tax agent services.

It is noted that in the draft LCR paragraph 42 states that a 'fund might enter into arrangements that result in it receiving discounted prices. Such arrangements will still be on arm's length terms where they are consistent with normal commercial practices'. The question is whether this would apply where an employer provides discounted or even free SMSF compliance services to all staff or provides the use of software and tax agent services for staff to attend to their own SMSF compliance requirements – is this consistent with normal commercial practices? Hopefully the finalised version of the Law Companion Ruling (LCR) will provide a clear and practical solution.

This depends on which capacity you are providing the services. If provided in your capacity as trustee, then this is regarded as an internal service and the broadened NALI rules will not apply (refer example 6, paragraph 43 of LCR 2019/D3). However, if you provide the service in your individual capacity, indicated by consideration of the factors outlined in paragraph 39 of LCR 2019/D3, then the broadened NALI rules will apply if a less than arm's length price is charged for the service.

I would not expect this situation to result in there being NALE causing the distribution from the unit trust to the SMSF being treated as NALI. The painting has been done by the tenant, who is also trustee of the unit trust and trustee of the SMSF (assume same individuals involved, but the trustee of the SMSF and non-geared unit trust is not the same). Referring to paragraph 39 of LCR 2019/D3, there are not factors that would indicate the service is being carried out in a personal capacity.

This will depend on the prior year NALI/NALE issues. Paragraph 17 of LCR 2019/D3 states that 'Non-arm's length expenditure incurred to acquire an asset (including associated financing costs) will have a sufficient nexus to all ordinary or statutory income derived by the complying superannuation fund in respect of that asset. This includes any capital gain derived on the disposal of the asset'.

This is illustrated in example 1 from the draft ruling where the SMSF acquires a commercial property from a member for less than market value. As the expenditure incurred, being the acquisition of the property, is less than market value, this would result in the rental income (ordinary income) for all following income years and any subsequent capital gain (statutory income) being treated as NALI. Example 3 from the draft ruling is a similar example involving the SMSF acquiring listed shares from a member for less than market value.

In both examples there would also be a SIS Act issue, specifically section 66, as in the case of the property acquired from the member, albeit business real property, was not acquired at market value. Consequently, the exception to the prohibition on acquiring assets from a member or related party would not apply.

A similar outcome would arise where other expenditure (in relation to the property) was provided on non arm's length terms. Example 4 of the draft ruling shows that despite the property being acquired from the member at market value and leased on commercial terms, the rental income (ordinary income) and capital gain (statutory income) can still be caught by the broadened NALI rules as the expenditure associated with the limited recourse borrowing arrangements (LRBA), the structure used to acquire and hold the property, is on terms that are not commercial.

This could also be the outcome in the example of an SMSF acquiring a property, from a unrelated party and leased to an unrelated party, but where the member operates a Real Estate business, which provides real estate management services to the SMSF on terms that are not commercial. The expenditure directly associated with the holding of the property would have sufficient nexus to the ordinary (rental income) and statutory (capital gain) income from that property and would be caught by the broadened NALI rules. However, refer to a later question where it is discussed how in this situation, provided the real estate services are charged on commercial terms, NALI should no longer apply.

Consequently, when considering NALI the focus is not limited to the income generated by the fund investment and whether such income is commercial. Consideration must also be given to expenditure, both of a revenue and capital nature, that has been incurred in relation to that asset and whether such expenditure constitutes NALE. If it does, then the ordinary and statutory income from that particular asset can be deemed as non arm's length income, notwithstanding such income, in isolation, is commercial.

Where the relevant expenditure is of a general nature, that is, there is no nexus to a specific source of fund investment income, the approach would be to wait until the finalisation of the draft ruling. Hopefully, the final version of the ruling will provide a practical solution to the issue of NALE that's of a general nature and the punitive tax outcome.

For fund expenditure, including where there is no expenditure incurred, that has a nexus to specific fund income and it falls within the ambient of the NALE rules, it must be first determined if the service is provided by a trustee of the SMSF (or director of the corporate trustee). If this is the case, it must then be determined if the service is provided in their capacity as trustee or in their individual capacity. If the former, the NALI rules do not apply, but if the later, the NALI rules do apply.

The draft ruling provides at paragraph 39 factors that indicate that the individual is performing their activities in their individual capacity and not in their capacity as trustee. Where such factors indicate that the individual is performing the activities in their individual capacity, an arm's length price should be paid by the SMSF to the trustee/director to avoid the application of the NALI rules. Relevant evidence of an arm's length price would be required to substantiate that the price paid is commercial.

However, where the SMSF pays an individual for performing activities and that individual is a trustee/director of the SMSF, such payment must be in accordance with section 17B of the SIS Act. This section states that the prohibition on remunerating a trustee/director for any duties or services performed does not apply if:

a) the trustee performs the duties or services other than in the capacity of trustee;
b) the trustee is appropriately qualified, and holds all necessary licences, to perform the duties or services;
c) the trustee performs the duties or services in the ordinary course of a business, carried on by the trustee, of performing similar duties or services for the public; and
d) the remuneration is no more favourable to the trustee than that which it is reasonable to expect would apply if the trustee were dealing with the relevant other party at arm's length in the same circumstances.

All the above must apply for compliance with section 17B. If section 17B cannot be complied with, but the NALI rules under the Tax Act still apply, consideration should be given to having the services provided by someone that is not a trustee/director of the SMSF or another entity.

Where the services are provided by a party who is not a trustee/director, for example an entity that is a related party of the fund, to avoid application of the NALI rules, an arm’s length price needs to be paid by the SMSF for the services provided or activities performed. Again, relevant evidence would be required to substantiate that the price paid by the SMSF is commercial.

Section 17B of the SIS Act would not be relevant in this scenario as the services provided or activities performed are not by a trustee/director.

Assuming the trustee is not a lawyer who used the resources of their legal firm to prepare the document, then the preparation of the document has been performed by the individual in their capacity as trustee and consequently should not be considered as NALE.

As noted in an answer to a similar question above, paragraph 42 of LCR 2019/D3 states that a 'fund might enter into arrangements that result in it receiving discounted prices. Such arrangements will still be on arm's length terms where they are consistent with normal commercial practices'.

Again, the question is whether this would apply where an employer provides discounted SMSF compliance services to staff and family, including, for example the use of software and tax agent services for staff to attend to their own SMSF compliance requirements - is this consistent with normal commercial practices? Hopefully the finalised version of the LCR will provide a clear and practical solution.

PCG 2020/5 does indeed state that the ATO will not allocate compliance resources to determine whether the NALI provisions apply to a complying superannuation fund for the 2018-19, 2019-20 and 2020-21 income years, where the fund incurred NALE (as described in paragraphs 9 to 12 of LCR 2019/D3) of a general nature that has a sufficient nexus to all ordinary and/or statutory income derived by the fund in those respective income years. For example, NALE on accounting services.

Is this a safe harbour? No. However, given the issues surrounding the application of the NALE rules to expenditure of a general nature it would be surprising for the ATO to apply the broadened rules to this type of expenditure (or lack of expenditure) prior to the 2021-22 income year and prior to the finalisation of the draft LCR. The ATO has previously commented, when the draft ruling was expected to be finalised in May 2020, that the final version of the ruling needed to be released in time for SMSF trustees to put in place appropriate arrangements prior to the PCG (2019/D6) expiring on 30 June 2020 (extended to 30 June 2021 under the final PCG - 2020/5). This implies that their compliance focus would be after the expiration of the PCG and the issue of the final version of the draft LCR.

Assuming that the expenditure paid by the trustees, on behalf of the SMSF, relates to a service or product provided by an arm's length party for a commercial price, then the NALI/NALE provisions would not apply. However, the SMSF may have a compliance issue with respect to the general prohibition on a fund borrowing, under SIS Act section 67. The ATO provides guidance in SMSF 2009/2 "the meaning of 'borrow money' or 'maintain an existing borrowing of money'; for the purposes of section 67 of the Superannuation Industry (Supervision) Act 1993".

The ruling states at paragraph 16 that an arrangement under which expenses are paid on behalf of the SMSF trustee by an agent or any other person where reimbursement is immediately sought from and made by the SMSF is not considered a borrowing and consequently not a breach of the general borrowing restriction under SIS Act section 67. However, if the expense is not immediately reimbursed, then the relevant amount may constitute either a borrowing, which would be a breach or a member contribution (refer TR 2010/1). In the latter case, the contribution could not be accepted by the trustee and consequently would be required to be refunded to the member in accordance with SIS regulation 7.04(4).

Based on the draft ruling, this would be treated as NALE with a nexus to all of the fund's income. Consequently, all the fund's ordinary and statutory income is at risk of being treated as NALI. However, as the NALE is of a general nature, the ATO's approach in PCG 2020/5 should be considered as well as reference to the final version of the LCR, once issued.

The service performed by the trustee, who is an accountant, to repair the leaky tap in a rental property owned by the SMSF would be provided in their capacity as trustee and consequently not be regarded as NALE. If the individual is not in the business of providing rental property repairs/plumbing services, then none of the factors outlined in paragraph 39 of the draft ruling would apply.

However, where the individual also provides accounting services to their SMSF and utilises the equipment, licenses etc of their accounting practice, this would indicate that these services are being performed in a capacity other than as trustee and consequently where an arm's length fee is not paid, would be considered non arm's length expenditure. As such expenditure was of a general nature, it would have a nexus to all the ordinary and statutory income of the SMSF.

One of the issues raised is how to substantiate that the price paid is commercial. The Explanatory Memorandum to the Bill that introduced the amendments to the NALI provisions acknowledged that it may be difficult to determine an exact price that is 'non arm's length' for these purposes. In any event, further guidance on how to substantiate the price charged is arm's length would be welcomed in the final version of the LCR.

This would not be considered a NALI/NALE issue as the SMSF would not be deriving any more income than it might expect had the parties been dealing at arm's length and a rental bond is not expenditure that an SMSF would be expected to incur - it's expenditure of the related party tenant.

Reference should be made to the lease agreement to ascertain if a rental bond is required to be paid. Failure to adhere to the terms of the lease, which puts the SMSF in a worse position than if it had been dealing with an unrelated party would be a SIS Act section 109 issue.

Yes, it can apply. Whilst the relevant amendments to the NALI provisions have effect from 1 July 2018, that is, to ordinary and statutory income derived by the superannuation fund from that date, the scheme or arrangement that gives rise to the application of the new provisions may have been entered into before 1 July 2018 (refer paragraph 1 of LCR 2019/D3).

Applying PCG 2020/5, which runs until 30 June 2021, any services provided, or activities performed that involves expenditure that is of a general nature, e.g. accounting fees, after this date needs to be on an arm's length basis. That is, it is the date that the service is provided, or service performed that is relevant not the income year to which it relates. Further, reference should be made to the final version of LCR 2019/D3 for any further guidance it may provide in relation to the application of the broadened NALI provisions to such expenditure.

With the removal of commission, it may result in the premiums being lower. The insurance premiums, being the relevant expenditure, would be considered specific to the insurance policy and not expenditure that is of a general nature. Consequently, only the ordinary and statutory income from the insurance policy would potentially be caught by the broadened NALI rules. However, income from an insurance policy is taxed under the capital gains tax provisions and is specifically exempt from the capital gain rules under section 118-300 Tax Act 1997. Consequently, even if the NALI provisions apply, there is no ordinary or statutory income to be treated as NALI.

Alternatively, if the commission would be considered a 'fee'; for the insurance advice, then such expenditure (or lack of such expenditure) would also be regarded as specific to the asset of insurance. However, where a view is taken that such expenditure is of a general nature, PCG 2020/5 would apply until 30 June 2021 and we would await further guidance from the finalisation of LCR 2019/D3.

Again, the capacity in which the service or activity is being performed needs to be determined. Does the individual, who is a director of the corporate trustee provide such services via a business and the manner of the services provided includes factors as outlined in paragraph 39 of LCR 2019/D3, that is, in a capacity other than as trustee?

If none of the factors outlined in paragraph 39 of LCR 2019/D3 apply and the SMSF software subscription is in the name of the SMSF, but paid for by the director/member, then the non-reimbursement of the expenditure is a either a SIS compliance borrowing issue or may be treated as a contribution, as discussed in a response to question 9.

It would appear that the individuals are providing the service in their capacity as trustees, as they do not operate a business that provides kitchen renovation services. Consequently, the NALI/NALE provisions should not apply. However, consideration would need to be given to TR 2010/1 as to whether there has been a contribution made to the fund due to the renovations done by the members for no labour costs. Whether there is a contribution would be in part determined by whether the nil cost labour increased the capital of the fund, that is, increased the value of the relevant fund asset.

A commercial fee would need to be charged by Leonie's employer to her SMSF for the services provided. This would include the use of the software and the provision of tax agent services. It could be argued that such a commercial fee would not include Leonie's time on the basis that she attended to the relevant work in her own time (for example from home) and was not remunerated for such time.
As such expenditure is of a general nature, PCG 2020/5 would apply and consideration should also be given to the final version of LCR 2019/D3.

Yes, they could. Section 295-550(5) applies to other income derived by the superannuation fund as a beneficiary through holding a fixed entitlement, being treated as NALI where one or more of the following applies:

a) the amount of the income is more than the amount that the entity might have been expected to derive if those parties had been dealing with each other at arm's length in relation to the scheme;
b) in acquiring the entitlement or in gaining or producing the income, the entity incurs a loss, outgoing or expenditure of an amount that is less than the amount of a loss, outgoing or expenditure that the entity might have been expected to incur if those parties had been dealing with each other at arm's length in relation to the scheme;
c) in acquiring the entitlement or in gaining or producing the income, the entity does not incur a loss, outgoing or expenditure that the entity might have been expected to incur if those parties had been dealing with each other at arm's length in relation to the scheme.

Essentially, the broadening of the application of the NALI provisions from 1 July 2018 apply to income derived and expenditure incurred (or lack of expenditure incurred) either directly by a superannuation fund or via a unit trust. For example, if the unit trust incurred expenditure that was less than would be expected had the parties to the transaction been dealing with each other on an arm's length basis, which results in the amount of income the superannuation fund receives as a beneficiary being higher, then the distribution from the unit trust would be treated as NALI.

The NALI provisions need to be applied to each year of income. From the examples in the draft LCR there are situations where an asset of the fund will be forever tainted from a NALI perspective. For example, where the asset was acquired for less than market value or via a LRBA that was not on commercial terms or complied with the relevant safe harbour provisions. In the example of the asset being acquired from a related party at less than market value, the NALE, being the amount paid for the acquisition of the asset, will have sufficient nexus to all future ordinary and statutory income derived by the asset.

However, the NALI provisions may only apply for the income year that the fund has non arm's length expenditure. For example, the fund acquires a property at market value, leases to an unrelated tenant on commercial terms, however, the members run a real estate business and provide real estate management services to their fund, at no cost, utilising their real estate business resources. The rental income from the property would be NALI for the income years that a non-commercial price was paid for the real estate services. Once a commercial fee is paid, the NALI provisions would no longer apply as:

1. their fund would not be deriving income greater than what would be expected on an arm's length basis; and:
2. the fund has no NALE, either on a revenue or capital basis that has a nexus to the property asset.

This would also be the case for NALE of a general nature. Once rectified, there is no longer NALE and consequently the NALI provisions would not apply (assuming the NALE of a general nature was the only NALI/NALE related issue).

No. The fund would still be considered to have NALE as there is a scheme (the accounting services being provided) to which the two parties (the SMSF and the accounting firm) are not dealing on an arm's length basis. The fund should be charged a commercial fee for the services provided by the accounting firm that employs Mikasa. Alternatively, Mikasa does the work herself without using any resources of her employer - refer example 6 in LCR 2019/D3.

This was the example of Harold, where his SMSF acquired business real property from himself at market value, but then leased it to his business at more than a commercial rental rate. The rental income would be treated as NALI, as the fund is deriving an amount greater than what would be expected if the parties were dealing with each other on an arm's length basis. However, any subsequent capital gain should not be treated as NALI as the amount of capital gain would be expected to be no greater than what would be expected if the parties were dealing at arm's length (this would not be the case if the property was sold to a related party at more than market value).

However, let's say that Harold also ran a real estate business and provided rental management services to his SMSF at no cost, using the resources of his real estate business. Harold's fund would have NALE which would mean that the ordinary and statutory income of the fund for income years it has the non-arm';s length real estate management expenditure would be treated as NALI. Consequently, in the year that Harold's SMSF sells the property there must be no NALE, so that the resulting capital gain is not treated as NALI.

Note, had Harold's SMSF acquired the property for less than market value, that is the capital expenditure to acquire the property was less than what would be paid had the parties been dealing on an arm's length basis, the property would be forever tainted from a NALI perspective and all current and future year ordinary and statutory income would be assessed as NALI.

PCG 2020/5 applies to all superannuation funds, not just SMSFs and not just SMSFs that have accountants as members. Further, the NALI rules also apply to all superannuation funds, not just SMSFs.

The PCG provides a transitional compliance approach where a superannuation entity incurs non-arm's length expenditure of a general nature that has a sufficient nexus to all ordinary and/or statutory income derived by that entity in the respective income year.

No, provided the services are provided by the individual in their capacity as trustee or director of the corporate trustee. This would be regarded as an internal service and not caught by the NALE rules.

The service would not be provided in their capacity as trustee (and consequently the NALE rules would apply), where such services meet the factors outlined in paragraph 39 of LCR 2019/D3. For example, if the individuals operated a financial advisory business, with the relevant licenses and provided the service using the resources of their business.

Further, trustees can only charge for services where the requirements of SIS Act section 17B are complied with.

The information on this article is provided by Mark Ellem ABN 69 989 271 960 and Accurium Pty Limited ABN 13 009 492 219 (Accurium). It is factual information only and is not intended to be financial product advice, legal advice or tax advice, and should not be relied upon as such. The information is general in nature and may omit detail that could be significant to your particular circumstances.  The information is provided in good faith and derived from sources believed to be accurate and current at the date of publication. While all care has been taken to ensure the information is correct at the time of publishing, superannuation and tax legislation can change from time to time and Mark Ellem ABN 69 989 271 960 and Accurium is not liable for any loss arising from reliance on this information, including reliance on information that is no longer current. We recommend that you seek appropriate professional advice before making any financial decisions. Links to third-party websites are inserted for your convenience, but do not constitute endorsement of material on those sites.

Disclaimer

This information is provided by Accurium Pty Limited ABN 13 009 492 219 (Accurium). It is factual information only and is not intended to be financial product advice, legal advice or tax advice, and should not be relied upon as such. The information is general in nature and may omit detail that could be significant to your particular circumstances. The information is provided in good faith and derived from sources believed to be accurate and current at the date of publication. While all care has been taken to ensure the information is correct at the time of publishing, superannuation and tax legislation can change from time to time and Accurium is not liable for any loss arising from reliance on this information, including reliance on information that is no longer current. We recommend that you seek appropriate professional advice before making any financial decisions.