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SMSF Non-Arm’s Length Expenditure (NALE)

What is Non-Arm’s Length Expenditure (NALE) and why is it REALLY important?

If you, as a trustee of your SMSF incur expenditure that is not at arm’s length and it is connected to producing income for your SMSF, then that income can be taxed at 45% as Non-Arm’s Length Income (NALI)

The ATO has clarified how fund expenses must be at arm’s length or risk being treated as NALI and taxed at the top marginal tax rate. This change is backdated to 2018/19.

Key takeaways from this ruling:

  1. SMSF’s must make a “reasonable attempt” to determine any non-arm’s length expenditure amounts

  2. The ruling applies to anyone who uses their education, training or experience to provide service to their SMSF for free or below market value

  3. It is important for trustees to know what activities are considered “acting as an individual” or “acting as a trustee” when dealing with their SMSF

  4. The ATO has clarified that if a SMSF receives a discount as a result of a member’s employment, then NALI will not apply as long as the discount is available to all other employees

  5. The ATO highlights the importance SMSF’s acquiring assets at market value to ensure non-arm’s length expenditure does not arise (either by way of in specie contribution or under the terms of a contractual arrangement)

So, what are some examples of what this means?

Examples scenarios:

1. SMSF trustee carrying out duties – individual capacity

  • Jean is the sole member of his SMSF, he is also a licensed electrician.

  • His SMSF owns a residential property which is leased at a commercial rate

  • Jean performs electrical work at the property that can only be done by a licensed electrician

  • The ATO will consider this work to be done by Jean in his individual capacity and not in his capacity as trustee of his SMSF

  • In this case, Jean charges his SMSF the commercial rate for the work done, therefore the non-arm’s length provisions will not apply

2. Non-arm’s length expenditure was incurred to acquire an asset

  • In 2019/20 Armin holds commercial property with a market value of $800,000.

  • During the year he sells the property to himself acting as trustee of his SMSF for $200,000. Following this the SMSF leases the property to a third party.

  • Because the SMSF acquires the commercial property from Armin for less than market value

  • The ATO will consider any rental income earned from the property be NALI

  • The ATO will also consider any capital gains on the disposal of the property to be NALI.

3. Purchase less than market value and no in specie contributions

  • During 2018/19, Russell (as trustee of his SMSF) purchased listed shares from a related entity for $500,000.

  • The market value of the shares was $900,000. Accordingly, the arrangement did not involve an in-specie contribution made to the SMSF.

  • The ATO will consider this scheme to be a non-arm’s length dealing between Russel’s SMSF and his related entity.

  • The capital expenditure to acquire the shares was significantly less than would be expected if the parties were dealing “at arm’s length”.

  • Because of this and dividend income the SMSF earns from the shares will be considered NALI and taxed at 45%

4. SMSF trustee carrying out duties – different capacities

  • Trang is the sole member of her SMSF

  • She is also a plumber with her own business, which she runs as a sole trader

  • She employees and apprentice, Novee

  • Trang’s SMSF owns 2 investment properties, both leased for a commercial rate

  • After the end of her workday, Trang stops by the first properties to help the tenant install a water filter

  • The water filter is provided by the tenant and will be removed at the end of the lease

  • Trang uses some of her work tools for the installation

  • The ATO considers this activity to be Trang acting in her capacity as a trustee of her SMSF, and the use of her work tools to be minimal and infrequent, the non-arm’s length expenditure provisions will not apply

  • At the second property Trang completes a full renovation of the Kitchen and Bathroom

  • She schedules the renovation into her work calendar, uses her work tools, and engages her apprentice Novee in all works

  • In this case Trang’s use of her work tools will not be considered minor and infrequent

  • Considering all of her activities, Trang will be considered to be acting in her individual capacity at the second investment property

  • Trang not charging her SMSF for the renovations will be considered non-arm’s length expenditure

  • Rental income earned and any capital gains from the sale of the property will be considered NALI

Examples come from LCR 2021/1 ATO LAW Companion Ruling

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