NALE legislation finally becomes law

Legislation that includes the non-arm’s length expense (NALE) changes has finally become law almost five years from the date the legislation now takes retroactive effect (ie, from 1 July 2018).

The Treasury Laws Amendment (Support for Small Business and Charities and Other Measures) Act 2023 (Act) includes a limit on general NALE for SMSFs. Royal assent was granted on 28 June 2024 and therefore the NALE changes commence on 1 July 2024 with retroactive application to 1 July 2018.

There is now greater clarity in relation to NALE exposure for lower or nil general expenses incurred by an SMSF. However, there are still many questions regarding the application of the non-arm’s length income (NALI)/NALE provisions in practice.

Proposed NALE changes

By way of background we have extracted some key paragraphs that provide a brief summary of the NALE changes from our previous article ‘Status update on the non-arm’s length expense legislation as Senate approves’:

The Bill will, when it becomes law, reduce the tax impact where a lower or nil general expense is incurred by an SMSF by imposing an upper cap on the amount that is taxed as NALI under s 295-550(1)(b) and (c) of the Income Tax Assessment Act 1997 (Cth) (ITAA 1997).

This cap is in the form of a two times (ie, 2 x) multiplier of the amount of the lower general expense for an SMSF or a small APRA fund. The example below outlines how this cap will apply.

Take an SMSF trustee that uses their brother’s accounting firm’s services, which would usually cost $8,000 under an arm’s length relationship and is not charged any fee. This scenario is considered NALE as the parties were not dealing at arm’s length. Therefore, the tax payable would be calculated as follows:

• • 2 x $8,000 = $16,000 NALE
  • $16,000 x 45% = $7,200 tax payable by the fund.

Note that where the product of 2 x the NALE is greater than the fund’s actual taxable income, an “upper cap” will be the SMSF’s taxable income for the FY (not including any assessable contributions or any deductions against those assessable contributions).

Referring to the example above, the amount under a 2 x multiplier is $16,000. However, if the fund’s actual taxable income is only $6,000, the upper cap would result in total NALE being $6,000 for that financial year.

More clarity for SMSFs for NALE general expenses

Prior to the changes under the Act, an SMSF incurring a general fund expense that is NALE, or a nil expense where an expense should have been incurred if the parties were dealing at arm’s length, could result in a 45% tax liability applying to the following:

• all of the fund’s ordinary income;
• all the fund’s statutory income (including net capital gains and franking credits); and
• assessable contributions received by the fund.

A 45% NALI tax rate also applies if an SMSF is in pension or retirement phase.

However, the changes in the Act limit the 45% tax rate exposure for NALE general expenses to an upper (2 x) cap providing greater certainty for SMSFs and small APRA funds.

Specific expense risk

A specific expense is any expense other than a general expense that relates to ‘gaining or producing income in relation to any particular asset or assets of the fund.’ Specific expenses can still have a substantial impact on SMSFs as the Act provides no relief for a non-arm’s length specific expense. Specific expenses are therefore subject to the usual NALI rules in s 295-550 of the ITAA 1997 and can potentially taint an asset for life with a 45% tax rate.

Conclusions

Advisers must be aware of the potential NALI/E impact on their clients, especially the risk of specific expenses. Firms offering discounts without a properly documented SMSF staff discount policy are still exposing themselves and their staff to risk despite the new NALE cap. DBA Lawyers offers advice, training and an SMSF Staff Discount Policy. For more information on our SMSF Staff Discount Policy offering, please click here.

Related articles:

• Status update on the non-arm’s length expense legislation as Senate approves
• NALE changes introduced as Bill on 13 September 2023
• Firms providing discounted SMSF services to staff need an appropriate discount policy ASAP
• SMSF Staff Discount Policy
• New SMSF case demonstrates how not to have non-arm’s length income
• Non-arm’s length income – A history and overview

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This article is for general information only and should not be relied upon without first seeking advice from an appropriately qualified professional. The above does not constitute financial product advice. Financial product advice can only be obtained from a licenced financial adviser under the Corporations Act 2001 (Cth).

For more information regarding how DBA Lawyers can assist in your SMSF practice, visit www.dbalawyers.com.au.

By Daniel Butler ([email protected]), Director and Fraser Stead ([email protected]) Lawyer.

DBA LAWYERS

1 July 2024