ATO, Compliance, NALI/NALE, Property

SMSF projects probed for NALI breaches

SMSF property NALI

The ATO has cautioned SMSF trustees and advisers about potential NALI breaches in property development projects and, in an unrelated announcement, disqualified over 200 SMSF trustees.

The ATO has warned SMSF trustees and advisers that property development projects set up through separate legal entities, such as special purpose vehicles (SPV), are currently under review due to concerns about violations of non-arm’s-length income (NALI) provisions.

In the recently issued Taxpayer Alert 2023/2, the regulator stated these arrangements may allow profits to be transferred from entities with higher tax rates to SMSFs, which are typically taxed at a lower concessional rate.

“[The ATO] are currently reviewing arrangements under which one or more SMSFs have, or acquire, direct or indirect ownership of a special purpose SPV that undertakes a property development project, and because of the non-arm’s-length arrangements between the SPV and other entities, the SPV derives a profit that ultimately benefits the SMSFs, which is more than what it would have been if all the parties had dealt with each other at arm’s length,” it said.

“We are concerned that some of [these] arrangements lack commerciality and result in diverting profits attributable to a property development project (that would otherwise be taxed at the corporate, or other applicable, rate) to an SMSF, being a concessionally taxed entity.

“Depending on the facts, our concern also extends to any capital gain derived from the subsequent disposal of the SPV or other entity in which the SMSF has an indirect or direct interest.”

The ATO further clarified that an SMSF cannot claim compliance with non-arm’s-length income (NALI) obligations on the basis the fund did not directly participate in non-arm’s-length dealings.

This clarification was made following a Federal Court appeal where a $2.5 million capital gain distributed from a fixed trust to a super fund was classified as ‘special income’ and taxed accordingly.

“A view has been expressed that as long as the SMSF is not directly involved in any non-arm’s-length dealing, the non-arm’s-length income provisions cannot apply. These views are not correct and have been addressed judicially,” the ATO said.

“Non-arm’s-length dealings by any party in respect of any step in relation to the scheme can give rise to NALI as defined in section 295-550 of the Income Tax Assessment Act 1997.”

The regulator noted it is conducting a review of these arrangements and will closely scrutinise taxpayers and advisers who engage in or plan to engage in similar schemes and said SMSF Regulator’s Bulletin 2021/1 provided guidance for funds looking to participate in a property development.

In a separate announcement, the ATO revealed 201 SMSF trustees were disqualified during the March quarter.

This brings the total number of disqualified SMSF trustees added to the ATO’s Disqualified Trustees Register for the first three quarters of the 2023 financial year to 588, an increase of 134 per cent on the previous financial year, in which 251 disqualified trustees were added to the register.

Disqualified trustees are required to promptly step down from their positions and are prohibited from establishing new SMSFs.

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