Major SMSF dangers under revamped non-arm’s length income provisions
The non-arm’s length income (‘NALI’) provisions are anti-avoidance rules that are primarily contained in S.295-550 of the ITAA 1997. The NALI provisions are designed to prevent SMSFs from entering into non-arm’s length transactions/arrangements which result in an SMSF artificially inflating its taxable income (i.e., for the purposes of this income being taxed at the concessional rates that apply to complying SMSFs).
Broadly, a transaction will be regarded as ‘non-arm’s length’ where individuals or entities involved with the transaction are not dealing with each other on commercial terms. It is important to note that the NALI measures can apply to transactions even if the parties to the transaction are not regarded as ‘associates’ for taxation purposes (or ‘related parties’ for SIS purposes).
Any income that is generated by a complying SMSF that is considered NALI is taxed at the highest marginal tax rate (i.e., 45% in the 2020 income year).
In recent years, the ATO has raised concerns about whether the NALI provisions contained technical deficiencies resulting in these measures not applying in circumstances where they were intended to apply. One of the main areas of concern centred around whether the NALI provisions could apply where non-arm’s length expenditure (sometimes referred to as ‘NALE’) is incurred by an SMSF in relation to income derived by the SMSF.
In response to these concerns, on 24 July 2019, Treasury Laws Amendment (2018 Superannuation Measures No. 1) Bill 2019 (‘the Bill’) was introduced into Parliament to effectively confirm that the NALI provisions can apply to arrangements involving SMSFs incurring non-arm’s length expenditure. The Bill was eventually passed by both houses of Parliament and received Royal Assent on 2 October 2019.
The amendments made by the Bill will apply in relation to income derived in the 2019 income year and later income years, regardless of whether the relevant scheme was entered into before 1 July 2018.