In this guide
Legislation that was initially introduced into Parliament 5 years ago has only just been finalised and has now become law. These laws relate to the tax treatment of non-arm’s length income and expenses for self-managed super funds and apply retrospectively from 1 July 2018.
SMSF trustees are often reminded of the need to ensure that all their fund’s transactions are entered into and carried out at ‘arm’s length’.
Trustees are also often told that failure to comply with this requirement can lead to some unwanted outcomes, including tax being applied to the fund’s income at the top 45% rate of tax.
This income is referred to as non-arm’s length income or NALI.
It can also result in breaches of the SIS Act that can result in the SMSF becoming non-compliant.
However, many SMSF trustees are not aware that their SMSF’s expenses are also considered when determining whether their SMSF’s income is to be taxed as non-arm’s length income. That is, the requirement to transact on arm’s length terms applies to both income and expense transactions within the super fund.
Where an expense transaction is entered into on terms that are not at arm's length (NALE), it can result in any income that is generated as a result of that transaction being caught as non-arm’s length income (NALI).
Learn more about the non-arm’s length income (NALI) rules for SMSFs.
Important: The non-arm’s length expense rules can apply in two scenarios:
- where an SMSF expense is incurred for an amount that is less than might have been expected to be incurred if the parties had been dealing at arm’s length, and
- where no SMSF expense is incurred but an expense might have been expected to be incurred had the parties been dealing at arm’s length.
Background to NALE
In October 2019, the ATO released a draft ruling on how certain changes to the tax rules could impact SMSF trustees who provide certain services to their own SMSF.
In particular, the ruling looked at arrangements where the SMSF was charged below market rates for these services or not charged at all.
Then in July 2021 the ATO further clarified these changes with the release of a law companion ruling, LCR 2021/2. The upshot of these changes is that SMSF trustees who provide non-trustee services to their SMSF will now be required to charge for those services.
“For example, the non-arm’s length expenditure provisions will apply where a trustee (an accountant by profession) contracts the bookkeeping or accounting services to their accounting firm, which charges non-arm’s length rates.” (Law Companion Ruling LCR 2021/2.)
This ruling proposed that where the related entity didn’t charge for their services or did not charge an arm’s length rate, then all of their SMSF’s income could be declared as NALI and taxed at 45%.
The SMSF industry lobby has raised concerns that by not charging for a service that would have cost minimal fees anyway (for example, in the case of accounting services), a fund could be penalised thousands of dollars if the income of its entire fund is taxed at the higher rate.
It therefore became apparent that there was a clear need for the government to provide more detailed information on:
- When a non-arm’s length expense of an SMSF would be seen to be a general expense and result in all income being deemed NALI
- When a non-arm’s length expense of a SMSF would be seen to be a specific expense and result in only income from that event being deemed NALI.
In response, the former federal government promised in March 2022 that it would “make legislative changes to ensure the non-arm’s length expense provisions operate as envisaged.”
To achieve this outcome, the Albanese Government sought consultation from the superannuation industry on these NALE rules which, after a lengthy delay, has led to the final legislation being signed off on the 28th June 2024 with a 1 July 2024 commencement date.
Important: Although the new non-arm’s length expenses (NALE) legislation commenced on 1 July 2024, these rules have application from 1 July 2018.
As per the explanatory memorandum to these laws:
“These changes apply to the 2018-19 income year and later income years and to expenses incurred or expected to have been incurred on or after 1 July 2018. This retrospectivity ensures that the benefits of the amendments apply from the date the non-arm’s length expenses rules were first introduced.
As these changes are to the benefit of taxpayers compared with the 2018-19 amendments this retrospectivity does not disadvantage any taxpayers.”
If you are concerned with any transaction that your SMSF may have entered into post 1 July 2018, then it would be a good idea to raise this with your SMSF administrator or fund accountant.
Read more about getting ATO advice for your SMSF.
What transactions can cause NALE?
The following information clarifies the way in which the NALE rules are intended to apply and differentiates between a general fund expense and a specific fund expense.
