General expense upper cap

The Treasury Laws Amendment (Support for Small Business and Charities and Other Measures) Act 2023 (Cth) brought a welcome change in relation to the NALE exposure for a lower or nil general expense incurred by a self managed superannuation fund (SMSF). A general expense is an expense that is not related to gaining or producing income from a particular asset (eg, general accounting expenses for an SMSF).

These changes have effect from 1 July 2018 and impose an upper cap on the amount that is taxed as NALI under paragraphs 295-550(1)(b) and (c) in the form of a two-times multiplier of the amount of the lower (or nil) general expense for an SMSF or a small APRA fund. Further, under the recent changes, larger funds are no longer subject to the general or specific NALE rules.

However, the recent changes did not contain any relief in relation to specific expenses (ie, any expense other than a general expense, such as an expense that relates to gaining or producing income in relation to a particular asset). Thus, the usual NALI rules apply, and a lower specific expense in relation to acquiring an asset can potentially taint that asset for life, with a 45% tax rate on the asset’s ordinary income as well as on the capital gain when the asset is finally realised (this could be 20+ years later).

CGT and NALI interaction

The ATO recently released TD 2024/5 which outlines the interaction between the NALI and CGT provisions of the ITAA 1997. This determination states that the NALI provisions apply where:

· the amount of the capital gain is more than the amount that the fund might have been expected to derive if the parties had been acting at arm’s length in relation to the scheme; or

· for SMSFs or small APRA funds –– when gaining or producing the capital gain, NALE is incurred (including nil expenditure) in respect of a CGT asset that is less than the amount of a loss, outgoing or expenditure that the fund might have been expected to incur if those parties had been dealing with each other at arm’s length in relation to the scheme.

Example 3 of TD 2024/5 considers where a $1 million arm’s length capital gain was tainted and taxed at 45%. This example demonstrates that a non-arm’s length gain effectively taints an arm’s length gain if derived in the same income year. This outcome would appear to be unintended as, based on the ATO’s interpretation of the legislation, a $100 tainted gain would taint a $1 million arm’s length capital gain. Urgent legislative action is needed to correct this disproportionate and, most likely, unintended outcome.

Further serious defects with NALI/E

What activities can a trustee safely undertake?

In addition to the above defects, there is still considerable uncertainty regarding what SMSF trustees and members can and cannot do with respect to their SMSF. For example, if an accountant maintains the books and records of their own fund using more than minor, irregular or infrequent use of business resources, the fund can be rendered subject to the general, or potentially the specific, NALI provisions resulting in significant tax and penalties.

The ATO has provided limited guidance in LCR 2021/2 to help identify in what capacity an SMSF trustee/director may be operating, noting that ‘it is necessary to carefully weigh up all the relevant facts, circumstances and factors in deciding whether the individual is acting in a capacity other than as trustee, or as a director of a corporate trustee, of an SMSF.’

Broadly, an SMSF trustee/director is precluded from being remunerated by an SMSF in relation to performing trustee functions on behalf of the fund under s 17A of the Superannuation Industry (Supervision) Act 1993 (Cth) (SISA). However, an SMSF trustee/director may be remunerated in accordance with s 17B of the SISA. Broadly, s 17B provides for an exception to the prohibition on trustee remuneration contained in s 17A where a trustee/director performs non-trustee duties or services in a capacity other than as an SMSF trustee (or director of a corporate trustee). Remuneration can be paid by an SMSF for non-trustee type services provided the four criteria in that section are complied with (for example, providing services that are similar to what you do in business and being covered by an insurance policy).

Example 9 in LCR 2021/2 involves Trang, an astute plumber, who completes a bathroom/kitchen renovation on a rental property owned by her SMSF (Trang example). This act means she has forever tainted all the rental income and future capital gain derived by her SMSF from that property even if the property is disposed of in 20 years’ time. Being a registered plumber who carries on a business serving the public and who is licensed and qualified, Trang would be required to charge an arm’s length fee to ‘avoid’ specific NALE (resulting in NALI) unless the service was minor, infrequent and irregular.

These types of issues give rise to considerable additional work and grey areas for advisers and clients to deal with, and are likely to increase costs on all funds where advisers will need to spend more time considering the practical application of these rules. Take, for example, the current ASIC fee of $310 for a corporate trustee that acts for an SMSF and in some other capacity such as a trustee of a family trust. Consideration will need to be given as to whether:

· the fee should be split 50/50;

· the fee should be split $63 to the SMSF trustee and $247 in respect of the family trust; or

· this is a minor benefit that should not be an issue in practice.

However, there is no de minimis rule. The ATO’s ruling gives rise to issues unless the item is minor, infrequent and irregular, and in a fringe benefit tax (FBT) context, an occasional benefit less than $300 that is minor, infrequent and irregular is exempt from FBT. Advisers must therefore consider how low to go for NALI/E and whether the time and effort involved with considering and advising on many of these trivial matters will prove more costly than seeking to do the job properly.

Contributions and NALE

There is also significant uncertainty in relation to knowing the dividing line between what counts as a contribution and what counts as NALE. On 28 July 2021, the ATO issued a draft for consultation Taxation Ruling, TR 2010/1-DC, that outlines its initial thinking in this regard where part of an asset such as property was given to an SMSF as a contribution and the balance of the property was purchased by the fund.

Traditionally, if an expense was paid on behalf of a fund or an asset was acquired by a fund for less than market value, the ATO would treat the ‘discount’ or lower cost as a non-concessional contribution. This position was reflected in the ATO’s comprehensive ruling on what is a contribution that it issued in 2010, ie, TR 2010/1, which the superannuation industry and the ATO have relied on for many (14+) years as the main guide on this important topic.

However, the ATO seems to be adopting the view in the revised draft TR 2010/1-DC that NALI/E now prevails. Discounts on employee share ownership plans (ESOPs) where the shares are nominated by the employee to their SMSF would seem tainted and in ‘troubled waters’ given this view. This is certainly a limit to many ESOPs.

Since TR 2010/1-DC is still in draft and has had limited consultation given the industry has been waiting on the passage of the NALE legislation and for the ‘dust to settle’ on this important topic –– the divide between a contribution and NALI/E remains a real and disturbing one. Giving clear advice has become far more complex and is becoming beyond the reach of many accountants and tax advisers.

The complexity and uncertainty relating to NALI/E is also giving rise to considerable additional costs and work, as advisers need to analyse how to apply these rules. Returning to the example of the ASIC fee for an SMSF corporate trustee that also acts as trustee of a family trust, how should the fee be split between the fund and the family trust? If the cost is not split, that would likely result in a general NALE exposure to the fund unless it should indeed be treated as a contribution. There is conflicting ATO material on this point. Until draft TR 2010/1-DC is finalised and further ATO information released, advisers should obtain expert advice if there is any doubt.

Mistakes and forgiveness

Humans are prone to making mistakes and a particularly concerning aspect of NALI/E is that the Commissioner has no discretion to disregard honest mistakes and inadvertent oversights.

Conclusion

Advisers and SMSF trustees/members must be aware that the complex nature of the NALI/E provisions can easily expose SMSFs to a 45% tax rate for comparatively minor oversights, resulting in unfair and disproportionate outcomes. Although the recent NALE changes are welcome, the NALI/E provisions remain in need of further legislative change.