The New World of NALI

But first….what you need to know

The content of this presentation has been prepared to provide you with general information only. It is not intended to take the place of professional advice and you should not take action on specific issues in reliance on this information. In preparing this information, we did not take into account the investment objectives, financial situation or particular needs of any particular person. Before making an investment decision, you need to consider (with or without the assistance of an adviser) whether this information is appropriate to your needs, objectives and circumstances. You should obtain a copy of the relevant Product Disclosure Statement (PDS) before making a decision to invest in any financial product.

Any advice in this presentation is provided by SMSF Administration Solutions Pty Ltd, ACN 097 695 988, AFSL No. 291195 which is part of the AMP group of companies.

Today’s Agenda

• NALI – A brief review

• What the legislation says

• Direct expenditure

• General expenditure

• Investments via trusts

• What’s to come?

A bit of history

• Purpose explained in EM to SLAB (No. 2) 1999:

• “….to prevent income from being diverted into superannuation entities as a means of sheltering that income from the normal rates of tax applying to other entities, particularly rates applying to individual taxpayers.”

What is treated as NALI?

• Income derived from a scheme where parties are not dealing at arm’s length and income is > arm’s length

• Private company dividends unless satisfy requirements in s.295-550(3)

• All income from discretionary trusts

• Income from fixed trusts where parties are not dealing at arm’s length and income is > arm’s length

• Acquisition of entitlement under a scheme• Income derived under a scheme.

Examples

• ABC SF enter into a new lease agreement for it’s BRP leased to a related party for $80,000 pa

• Just prior, an updated property & lease valuation was obtained suggesting a market rate of rent as $60,000 pa

• XYZ SF purchased shares in a related party mining exploration company (Drilling Co) from one of its members

• 6 months later Drilling Co sells exploration licence to BHP• Drilling Co immediately pays a dividend to XYZ SF equal to

10 times the purchase price of the shares.

The impact of NALI

• Complying funds enjoy concessional rates of tax

• NALI at top marginal rate (45%)

• Top marginal rate applies even if ECPI is 100%

• NALI can be ordinary/statutory income

• May be reduced by deductions attributable to the NALI

• Must be identified as a specific amount.

NALI - purpose of change

Ensures a super fund’s non-arm’s length income includes income where expenditure

incurred in gaining or producing it was not an arm’s length expense. This includes

where no expense was incurred (but might be expected to have been incurred if the transaction were on arm’s length terms).

Possible technical deficiency ITAA 1997 Subdivision 295-H.

Seeks to remove any ambiguity whereby non-arm’s

length expenses (including where no expenses are

charged) may result in income not being treated as non-arm’s

length income as intended.

Schedule 2 of Treasury Law Amendment (2018

Superannuation Measures No. 1) Act 2019

S295-550(1) re-structured

From 1 July 2018 Income taxed as NALI if:

…exceeds amount

expected from an

arm’s length

dealing

Or…expenditure

incurred in gaining

or producing it was

less than expected

from an arm’s

length dealing

Attributing non-arm’s length expenses to particular amounts of income• Must be a sufficient nexus between the expense/s

and the income

SMSF

Property Listed

shares

No expense or a non-arm’s length expense

DividendsRent

NALI Not NALI

Attributing non-arm’s length expenses to particular amounts of income

• Must be a sufficient nexus between the expense/s and the income

LCR 2019/D3 – example 7

Sharon is a trustee of an SMSF of which she is the sole member. She is a licensed real estate agent and runs a real estate business which includes property management services for rental properties.

The SMSF holds a residential property which it leases for a commercial rate of rent. Sharon provides property management services to the SMSF as a licensed real estate agent. She utilises the equipment and assets of her business in performing these services. Her actions are covered by the applicable insurance policies in respect of the business. Accordingly, Sharon provides property management services in her individual capacity to the SMSF with respect to the residential property. She charges the SMSF 50% of the price for her services that she would otherwise charge a non-related party.

There is sufficient nexus between the non-arm’s length expenditure and the rental income derived from the residential property. The rental income will therefore be NALI for each income year the non-arm’s length dealing remains in place.

Case study 1 – acquisition of investment

• Russell holds BRP valued at $800,000

• He enters into a contract with his SMSF to sell the

property for $500,000

• NALI provisions will apply due to NALE

• Rental income from the property will be NALI

• Capital gains on sale of property will also be

NALI.

• Capital gain will be based on cost base of

$800,000 due to market substitution rules

• Other income of fund not subject to NALI.

Case study 1 – acquisition of investment

• Interaction with TR 2010/1

Transferring an existing asset (in specie contribution)

18. The fund’s capital will be increased when a person transfers an asset to the superannuation provider but the provider pays no consideration or pays consideration less than the market value of the asset.

19. For example, a person might transfer shares they own in a stock exchange listed company to the superannuation provider to make a superannuation contribution.

Case study 1 – acquisition of investment• Interaction with SMSFR 2010/1

152. If an asset is acquired for no consideration or for consideration less than its market value, it is the Commissioner's view that the market value requirement ensures that the acquisition of the asset is correctly reflected at its market value. Therefore, if the SMSF pays no consideration, or pays consideration that is less than the asset's market value, the market value requirement is satisfied if the asset is treated by the SMSF as an acquisition equal to the asset's market value to the extent that consideration was not given for it. For example, if business real property (with a market value of $200,000) is purchased by a trustee for $100,000 and the trustee treats the difference as a contribution of $100,000, the market value requirement is satisfied.

153. In the case of an in specie distribution to the SMSF, the market value requirement is considered satisfied if it is treated by the SMSF as a distribution equal to the market value of the asset.

Case study 1 – acquisition of investment

• LCR 2019/D3 – para 25• In-specie contribution can be made in conjunction

with the purchase if the contract reflects fund is only acquiring part of the property (for Russell - 5/8)

• Alternate: contract value $800,000• Account for as part purchase, part in-specie

contribution.

General expenses

Service or function

undertaken in its

capacity as trustee

Service or

function

procured as a

third party

Service or

function

undertaken by

the trustee

Cannot charge under 17A but

not NALI as services

fundamentally relate to the

trustee’s obligations

NALI rules

will not apply

in respect of

arrangements

that are

purely

internal

E.g. fund has

a property

portfolio

that they

manage

themselves

Must be a sufficient nexus

between the expense and

the income

‘Internal arrangements’

EM paragraph 2.33 – The requirement that parties not be dealing with each other at arm’s length means that the non-arm’s length income rules do not apply in respect of a super entity’s arrangements that are purely internal. This is because an entity’s internal functions are not undertaken with another party on any terms, non-arm’s length or otherwise.

Trustees/Directors

ATO LCR 2019/D3

NALI if expense not at arm’s length and

performed in their individual

capacity

e.g. Book keeping/ accounting servicesIndicators of

individual capacity:• Use of equipment

and other assets of their business

• Licensed to provide activity

• Activity is covered by an insurance policy relating to their business.

NALI – SIS Act v Tax Act

• SMSF must comply with SIS Act & EM acknowledges:

• “…the trustee of an SMSF is prevented from charging for the services it undertakes in its capacity as trustee by para 17A(1)(f) of the SIS Act”

• However the EM goes onto say s17B of the SIS Act:

• “…permits a trustee to charge up to an arm’s length amount for duties or services performed other than in the capacity as trustee.”

NALI – SIS Act v Tax Act

• S.17B “permits a trustee to charge up to an arm’s length amount for duties or services performed other than in the capacity as trustee”…provided:

• The trustee is appropriately qualified, and holds all necessary licences, to perform the duties or services; and

• 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

• 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.

NALI – SIS Act v Tax Act

• Can the SMSF trustee:• Show they are appropriately qualified?• Hold the necessary licenses to perform a

particular role?• Are carrying on a business in relation to that

particular role?• If not, they do not comply with s17B and cannot

charge• How many SMSF trustees will satisfy the

requirements of s17B?• Breach SIS, or incur NALI?

Case study 2 - General expenses

• Kylie is a CPA and employee accountant

• She is also a registered tax agent

• She recently established her own SMSF

• Now considering the best approach to dealing with the preparation of the fund accounts and lodgement of SMSF Annual Return.

Case study 2 – general expenses

Kylie’s considerationsOption 1

Prepare accounts & SAR herself using her own

computer.

Lodge SAR without using tax agent

registration

SMSF does not remunerate her

Option 2Prepare accounts & SAR herself using her work

computer

Lodge SAR using personal tax agent

registration

SMSF does not remunerate her

Option 3Engage firm to prepare

accounts & SAR

Lodge SAR via firm & their tax agent

registration

Firm charges SMSF 50% of standard fee as Kylie

is an employee

23

Case study 2 – general expenses

Key takeaways…

Activity performed by individual trustee/director:

• Not NALI if activity performed in capacity of trustee

• NALI if non-arm’s length expense and activityperformed in their individual capacity

Activity performed by another entity:

• Not NALI if terms consistent with normal commercialpractices.

25

Story so far….

S295-550 (5) re-structured

Examples:

• Fund incurs non-arm’s length expenditure in acquiring the interest in the trust

• Fund enters into an LRBA on non-arm’s length terms in order to obtain funds to

acquire the fixed entitlement.

SMSF

Unit trust

Ordinary & statutory income

Acquires units

EM paragraph 2.30 …ensures consistency between the general non-arm’s length income rules for the income directly derived …and where the super entity derives income through its fixed entitlement to the income of a trust.

LCR 2019/D3 – example 8

During the 2016-17 income year, Scott as trustee of his SMSF, entered into a non-commercial LRBA with himself in his individual capacity to purchase units, in a stock exchange listed unit trust.

The SMSF borrowed 100% of the purchase price and the terms of the loan included no interest being charged and repayments of principal not being required until the end of the 25-year term of the loan.

The terms of the LRBA constitute a non-arm’s length dealing between the SMSF and Scott, which resulted in the SMSF incurring expenditure in gaining or producing income that was less than would otherwise be expected if those parties were dealing with each other at arm’s length in relation to the scheme.

The non-arm’s length expenditure under the LRBA will also result in any capital gain that might arise from a subsequent CGT event happening in relation to the units being NALI.

Case study 3 – unrelated trust

• Harry, Curly & Mo are directors of Comical Enterprises

• Each has their own SMSF that have invested equally in Stooges U/T

• The Stooges U/T owns the property Comical Enterprises is operated from

• The property is in need of repair and trust is in need of money to fund the repair

• In lieu of receiving their distributions each SMSF converts their entitlement to a loan to the trust at 0% interest

• NALI?

Examples revisited

• Same scenario but,

• Property was held via a 13.22C trust

• NALI provisions will apply

Sharon – property agent

• Russell owned the units in a U/T that owned the property

• Rent continues to be received by the trust at market value

• SMSF acquires units at less than market value

• NALI provisions will apply

Russell – purchase of BRP

What’s to come?

• PCG 2020/5 - non compliance only relates to general expenditure

• LCR 2019/D3 was expected to be finalised by now • Delay due to COVID related measures

• Final version to include further guidelines and examples• Trustee services and interaction with remuneration

provisions

• Likely to be further consultation• ATO acknowledge calls for

• Adopting a de minimis approach to materiality or• Providing safe harbour rules.

Thank you