Speaking at the recent Tax Institute Superannuation Intensive Series 2021, ATO assistant commissioner Justin Micale said that, in December last year, the ATO took further industry consultation and since then has continued to receive submissions on draft Law Companion Ruling LCR 2019/D3 Non-arm’s length income – expenditure incurred under a non-arm’s length arrangement.

“The ruling clarifies the ATO’s view on how the law applies where parties do not deal with each other at arm’s length and the trustee incurs non-arm’s length expenditure including where they incur general expenditure that relates to all income that is derived by the fund,” Mr Micale said.

“The draft ruling incorporates examples to assist with determining whether services have been performed as a trustee or in an individual/professional capacity, and provides guidance on factors to be considered when determining whether the expenditure has been incurred on arm’s length terms.”

Mr Micale said that given the complexity and level of interest in this issue, the ATO will be seeking independent, specialist advice from the public advice and guidance panel before finalising this product.

“This panel is chaired by the Deputy Chief Tax Counsel for Public Advice and Guidance and consists of respected tax specialists including tax practitioners and academics. I will still push hard to finalise the LCR as soon as possible, but taking this to the panel is likely to delay the release of the LCR.”

Mr Micale said to ensure the delay in finalising the draft LCR does not add to community uncertainty for the 2021–22 financial year, the ATO will be extending the transitional compliance approach in PCG 2020/5 by another 12 months.

“This means we will not allocate compliance resources in the 2021–22 financial year to determine whether the NALI provisions apply to all the income of the fund where it incurs non-arm’s length expenditure of a general nature,” he said.

“PCG 2020/5 is to be read with draft Law Companion Ruling 2019/D3.

“It’s important to recognise the transitional compliance approach does not apply in other circumstances where the fund incurs non-arm’s length expenditure that directly relates to that particular income.”

Chartered Accountants Australia and New Zealand (CA ANZ) superannuation leader Tony Negline welcomed today’s announcement from the ATO to delay the commencement of the Law Companion Ruling.

“This gives the SMSF sector a much-needed 12-month extension at a time when they are helping many Australians navigate their super like never before,” Mr Negline said.

“We understand that in due course the ATO will issue a new Practical Compliance Guide stating that it will not apply any compliance resources in relation to section 295-550 (ITAA97) from 1 July 2018 until 30 June 2022. 

“However, the final LCR will apply to income derived in the 2018–19 income year and later income years, regardless of whether the scheme was entered into prior to 1 July 2018.”

Institute of Public Accountants general manager of technical policy Tony Greco said that the ATO’s transitional relief will allow the profession and SMSF trustees to adjust their practices to avoid the draconian consequences of NALI.

“This is particularly for nil expenses, what the SMSF would otherwise have been expected to incur if the parties were dealing on an arm’s length basis,” he said.

“Transitional relief is also necessary for the SMSF sector in particular as they need to adjust for the revised independence guide.”

This comes after the joint accounting bodies CA ANZ, CPA Australia and IPA wrote to the ATO earlier this month, requesting a delay in the LCR’s commencement.

As part of that request to the ATO, the accounting bodies said: “We believe the impact of LCR 2019/D3 if it remains as currently drafted will have a significant impact on our members both personally and on many of their clients.

“The terms of the LCR mean that if an SMSF’s affairs are not structured correctly then, even for a minor expenditure, all the income of the super fund — revenue and statutory income — could face income tax at the highest marginal tax rate. Overall, we think, to put it mildly, that this is an inappropriate outcome in many cases.

“Each SMSF is unique and given the potential consequences for even minor errors, solutions need to be worked through very carefully which will take considerable time and expertise.”

Mr Negline said the industry bodies believe that corrective legislation may be required to correct this policy.

Speaking also at the recent Tax Institute Intensive Series, DBA Lawyers director Daniel Butler said the industry would like substantial further clarification and refinement of the LCR.

“Ideally, we would like legislative changes to nexus — e.g. a lower revenue expense taints ordinary income and a lower capital cost taints a capital gain, general expense where it does not taint everything (including any asset then held by that fund) and express apportionment,” Mr Butler said.

“Furthermore, only the excess of the income being NALI or NALE should be taxed at 45 per cent, not the whole lot.

“Bear in mind, this is a very important distinction that NALE does not require the fund to get any more revenue; it is just purely the fact that there is a lower expense, as you know, with a low interest loan where the property is rented to a third party, there is no more income; just one dollar less of expense exposes all of the income to that property and the capital gain to NALI.

“Hopefully, the ATO will administer NALI in a practical and reasonable manner. After all, NALI is an anti-avoidance provision and should be applied in practice to schemes that are intended to obtain significant or material advantage of the concessionally taxed super environment. 

“Otherwise, significant downside consequences may arise if NALI is applied, for instance, to an SMSF for a trifling matter as a $100 discount on an adviser fee.”