ATO, Tax

Not all NALI is off ATO radar

ATO NALI provisions

The recent ‘no-action’ stance from the ATO on some non-arm’s-length income (NALI) positions has overshadowed the fact that other provisions still apply.

Non-arm’s-length arrangements that involve expenses linked to a particular investment of an SMSF will still be taxed under non-arm’s-length income (NALI) provisions and are not covered by the recently announced ‘no-action’ position from the ATO, the SMSF Association has reminded advisers and trustees.

SMSF Association deputy chief executive and director of policy and education Peter Burgess said the non-arm’s-length expense (NALE) provisions within the ATO’s Practical Compliance Guideline (PCG) 2020/5, which relate to expenses linked to a particular investment or asset, have received less attention than general expenses, such as accounting or book-keeping fees, related to the fund.

Under PCG 2020/5, the ATO extended the time frame in which it would not allocate compliance resources to determine if NALI applied where NALE of a general nature may have a nexus to ordinary and/or statutory income derived by the fund. This extension would include the 2021 income year, as well as 2018/19 and 2019/20, as stated in an earlier PCG released by the ATO.

Burgess highlighted this compliance approach has not, and will not, apply to expenses linked to a particular investment or asset and trustees are expected to apply the new NALI provisions across all three income years listed.

“For example, where an SMSF owns direct property, and does not incur an expense on arm’s-length terms for the property management services provided by a third party, then the ordinary or statutory income that the fund receives from that property for that income year will need to be taxed as NALI,” he noted in a post on the SMSF Association website.

“There was certainly no indication in PCG 2020/5 that the ATO is looking to take a relaxed approach to the application of the new NALI rules to expenses which relate directly to a particular investment of the fund – only a transitional compliance approach to NALE that have no such direct relationship.

“In fact, in the compendium to PCG 2020/5, the ATO provides a gentle reminder that they expect the industry to be applying the new NALI rules from the 2018/19 income year and beyond where the fund incurs NALE that directly relates to the fund deriving particular ordinary or statutory income in those income years.”

He added these conditions would apply regardless of whether the activity or service that would normally give rise to an arms-length expense being incurred by the fund was provided by a third party or by the trustees in their individual capacity.

Commenting on NALE that was related to general expenses, which was first outlined in Legal Compliance Ruling (LCR) 2019/D3, he said: “Given the extensive industry feedback received by the ATO following the release of LCR 2019/D3, the SMSF Association has proposed a further round of consultations to ensure the final outcome is both balanced and practical.”

He added the ATO had stated in the compendium to PCG 2020/5, following requests from the industry to adopt a safe harbour rule to avoid nonsensical outcomes where a small or immaterial expense could result in NALI, the regulator was considering a further PCG as part of the finalisation of LCR 2019/D3.

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