ATO, Tax

Tax case law has NALE solution

Tax case law NALE

Established and tested tax case law should inform how the ATO will treat non-arm’s-length expenditure (NALE) within an SMSF, an SMSF lawyer has suggested.

The ATO should draw on a ‘general deductibility’ approach contained within tax case law to deal with non-arm’s-length expenditure (NALE) within an SMSF, despite not taking that approach in its draft ruling on the issue, according to an SMSF legal expert.

DBA Lawyers senior associate William Fettes said while there were a number of questions relating to how NALE would be implemented, the general deduction approach was first suggested by Treasury in the explanatory memorandum to the legislation that contains the provisions.

“How do we get a grasp on the ATO’s approach to the nexus between NALE and the income derived? We have seen commentary in the explanatory memorandum that the nexus idea would be similar in context to that of general deductibility, which has a rich case law behind it and where we have lots of learned judicial opinions on that front,” Fettes said as part of a recent webinar.

“Even though Treasury has made that linkage, the ATO document has not fleshed it out in a very clear way drawing on that case law. Clarification on how that nexus would be approached would give us more tools in the toolkit.”

The NALE provisions were included as part of the Treasury Laws Amendment (2018 Superannuation Measures No 1) Act 2019, which received royal assent on 2 October 2019 but carried an original start date of 1 July 2018, and were followed by the release of the draft ATO Law Companion Ruling (LCR) 2019/D3 on 9 October 2019. The draft LCR outlines how the ATO will administer the legislation, including its approach to NALE within an SMSF.

Fettes also called for greater clarification about how the ATO might analyse situations where NALE could affect only ordinary income or ordinary and statutory income and to put “some flesh on the bones” on when that might happen.

“There are some situations where an asset is purchased for appropriate arm’s-length commercial consideration and everything is arm’s length in relation to the acquisition, but where a NALE event occurs only in a revenue account and affects income for that year,” he said.

“In the future, if there is net capital gain, such as appreciation of the asset – a lazy capital gain not attributable to the NALE – can we quarantine the non-arm’s-length income just to the ordinary income of that asset for that year or will we always be in the gun sight for the gain?”

“The provisions are broadly drafted and NALE is addressed to ordinary and statutory income so it is still an open question as to how the ATO is going to administer this law.

“We would hope for a sensible approach, but from the examples in the LCR we don’t have any comfort that there will be lines drawn in the sand to quarantine gains from something that is revenue account NALE.”

Other SMSF experts have suggested the ATO adopt a ‘personal use’ provision used in other professions to reduce the unintended impact of NALE, particularly where advisers and accountants engage in professional services for their own SMSFs.

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