The superannuation rules apply tax at the highest marginal personal tax rate on any income of an SMSF which is not earned on an “arms-length” basis.
NALI Tax Rate
The Non Arms Length Income (NALI) tax rate is set at the highest marginal tax rate, currently 45%.
Income which is more than might be expected from transactions where the parties are related are caught by these rules.
SMSFs are required to transact on an arms-length basis.
- the transfer values of assets must be at market value
- certain ‘non-commercial’ arrangements, such as LRBAs with zero interest loans are considered to be non-arms length
- discretionary trust income is considered to be non-arms-length
- private company dividends may also be non-arms length unless consistent with an arm’s length dealing
Non Arms Length Expenses
The government has legislated to extend the NALI rules to situations where the expenses of an SMSF are less than would be expected from an arm’s length dealing.
An example (provided by Treasury) is an SMSF trustee using his brother’s accountancy services, which would usually cost $5,000 if provided under an arm’s length arrangement.
His brother waives the fee for the services, a non-arm’s length arrangement which would be penalised as such under the NALE rules.
Those rules have application from 1 July 2018. See Treasury Laws Amendment (2018 Superannuation Measures No. 1) Bill 2018.
As a result of changes foreshadowed in the 2023 Budget, the penalty tax will only be applied to income equivalent to 2 times (instead of 5 times as had been proposed) the difference between market and the price charged for a relevant non arms length expense.
An explanation and example of how this will work is set out here.
Application of the rules – LCR 2021/2
Thirteen examples of the application of the NALI rules are provided in Law Companion Ruling LCR 2021/2 Non-arm’s length income – expenditure incurred under a non-arm’s length arrangement. (Previously issued as draft LCR 2019/D3).
A summary of examples provided in the Ruling LCR 2012/2 (from para. 22):
- The rental income derived from a commercial property which had been transferred from Armin to his SMSF at less than market value, together with any future capital gain on disposal is NALI.
- Mikasa’s accounting firm (of which she was a partner) provided accounting services unrelated to tax compliance to her SMSF for free (not as part of a discount policy), resulting in all the SMSF’s income for that year being NALI.
- Russell’s SMSF purchased listed shares from a related entity at less than market value, resulting in any dividend income derived by the SMSF from the shares and any future capital gain on disposal being treated as NALI.
- The rent earned by Kellie’s SMSF from a property acquired via a non-commercial LRBA entered into with herself in her individual capacity is NALI for all income years, and regardless of whether the LRBA is subsequently refinanced on arm’s length terms. Any subsequent capital gain from a disposal of the property would also be NALI.
- Nadia sells her commercial property for a market value consideration which was partly funded in cash, and the remainder in-specie, treated as a non-cash non-concessional super contribution by Nadia to the fund. The rent income (at full market value) earned by the SMSF is not NALI, nor is any subsequent capital gain on disposal.
- Leonie is an employee chartered accountant and tax agent who is also trustee and sole member of her SMSF. As trustee, and at no charge, she prepares the accounts and annual return for the fund, without utilising her employer’s resources or her own tax agent registration. The non-arms length expenditure provisions do not apply.
- Levi is trustee and the sole member of his SMSF, and also has a financial advisory business for which work is often (but not solely) undertaken at home using equipment provided by his business. Levi also does unbilled work at home as trustee for the SMSF using his business’s equipment to do bookwork or make investments. The equipment use is considered minor and incidental, and does not “of itself” indicate work in any capacity other than as trustee.
- Sasha as trustee of her sole member SMSF engages her employer to provide accounting services to her SMSF, taking advantage of a staff discount which is available to all staff. NALI provisions do not apply.
- Trang is a plumber by trade and performs a small plumbing installation using her tools of trade and for no charge at an investment property owned by her SMSF of which she is trustee and sole member. The work is considered minor and infrequent, and undertaken in a trustee capacity. The NALI provisions do not apply.
On a second SMSF-owned investment property Trang carries out a complete renovation using her tools of trade and with assistance of an employee apprentice, again for no charge. The property’s rental income and any subsequent capital gain on disposal is considered NALI.
- Jean is a licensed electrician who carries out work requiring a license and charged at full market value on a residential rental property owned by his SMSF. The property is rented at full market value and the entire arrangement is not considered to attract application of the NALI provisions.
- Sharon is a licensed real estate agent who utilised the assets (including insurance coverage) of the real estate business of which she is a director to provide property management services to her SMSF which owns a residential property. She provides the services in an individual capacity at 50% of the rate the real estate business would normally charge. NALI applies to the rental income, but there is no impact on any capital gain on a future disposal.
- Scott’s SMSF entered into a non-commercial LRBA with himself in his individual capacity to purchase units in a stock exchange-listed unit trust. Distributions from the unit trust for all years and any future capital gain are considered NALI.
- Following Example 3, the capital gain on a subsequent disposal of the shares is calculated using the market value at the time of acquisition as the (subsituted) cost base, and any resulting gain is considered NALI. That market value is also the value of capital proceeds received by the related entity when the shares were originally transferred into Russell’s SMSF.
NALI, NALE Further Info and Commentary
- Non-arm’s length expenses (NALE) and self-managed superannuation funds (SMSFs) – new rules finally released – Cooper Grace Ward
- ATO Partially Softens Its View On Non-Arm’s Length Expenditure – Sladens
- Non-arm’s length income and self-managed superannuation funds – AAT reminder: it’s wider than the actions of the SMSF! – Cooper Grace Ward
- SMSFRB 2020/1 Self-managed superannuation funds and property development
- Practical Compliance Guideline PCG 2016/5 Income tax – arm’s length terms for Limited Recourse Borrowing Arrangements established by self-managed superannuation funds
- Practical Compliance Guideline PCG 2020/5 (previously issued as a draft PCG 2019/D6) – a transitional compliance approach for years 2018-19, 2019-20, 2020-21, 2021-22 and 2022-23 (the ATO will not allocate compliance resources to determine whether the NALI provisions apply)
- Government Media Release March 21, 2022: Government to ensure non-arm’s length expense provisions operate as intended
- Explainer March 24, 2022: Government offers ‘umbrella of hope’ in NALI storm – accountantsdaily.com.au
- Non-arm’s length income – ATO
- Taxation Ruling TR 2006/7 (‘special income’)
- NALI and CGT: Draft Tax Determination TD 2023/D1 How the non-arm’s length income and capital gains tax provisions interact to determine the amount of statutory income that is non-arm’s length income
This page was last modified 2023-06-28