In the budget, the government revealed its intention to amend the non-arm’s length income (NALI) rules within s 295-550 of the Income Tax Assessment Act 1997 (ITAA) to deal with non-arm’s length expenditure (NALE) that relate to general expenses of a fund.

This followed a consultation released in January, identifying a proposal to apply a factor-based approach for SMSFs to deal with the severely disproportionate approach that could arise under the Commissioner’s current views expressed in LCR 2021/2.

The result was the announcement last week that the previous five times factor of the original consultation had been reduced to a two-times factor, and the exclusion of contributions from the NALI calculation.

“The result of this is that it sets an upper limit on the amount of fund income taxable as NALI due to a general expenses breach,” Mr Dunn said.

“The maximum amount of fund income taxable at the highest marginal rate is to now be two times the level of the general expenditure breach (or 90 per cent, being 2 x 45 per cent).”

Treasury has confirmed that post-budget the same approach referred to in the consultation paper will apply at this reduced factor level.

Mr Dunn said it can be assumed that the non-arm’s length expense (shortfall) is calculated as the difference between the amount that would have been charged as an arm’s length expense; and the amount that was actually charged to the fund.

“The consultation paper originally noted that where the product of factor-based approach breach is greater than all fund income, then all of the fund’s income will be taxed at the highest marginal rate.”

“If these changes now proceed, it is important to note that the current PCG 2020/5 will cease as of 30 June 2023, meaning that any existing non-commercial arrangements in place will need to comply with commercial terms – see LCR 2021/2 for more details.

“The ATO has already indicated that they do not intend to extend the practical compliance guidance beyond the end of this financial year.”

He added the decision to apply to SMSFs is that they have the potential for greater tax integrity risks, due to the capacity to control or influence the general expense arrangement and potentially leading to an inflation of their super balance through a non-arm’s length arrangement.

“These would include amongst other things, circumventing the contribution caps and Division 293 threshold,” he said.

“In reality, the question that needs to be asked is whether these measures are trying to solve a problem that no longer exists? It is worth noting that the genesis of this issue arose with the concept of zero-interest-related party loans for LRBAs which had been ‘put to bed’ through the safe harbour provisions within PCG 2016/5 as part of applying the NALI provisions.”

Lyn Formica, head of education & content at Heffron, said the only concessions in the NALI announcements were that large APRA-regulated funds will be exempted from these rules and none of their income will be considered NALI even if the fund’s administrative or investment related expenditure is lower than it would have been in an arm’s length situation.

“The news was not so good for SMSFs,” Ms Formica said.

“If an SMSF’s general expenditure such as accounting fees is lower than would be expected in an arm’s length situation, instead of all of the fund’s income being taxed as NALI, the amount of NALI will be limited to twice the general expense shortfall. For example, a $2,000 expense shortfall in a single year could result in tax of $1,800.”

“Given the government’s tweaks it could still result in a not insignificant tax bill for an SMSF, and SMSF trustees and their advisers should review their expense arrangements before 30 June 2023.”

She said for any services like accounting services provided post 30 June 2023, regardless of the year to which the service relates, if the services are provided to the SMSF by anyone other than a trustee/director of the corporate trustee, the SMSF needs to be charged an “arm’s length amount” for that service.