NALI/NALE, Property

Compliance risks with property developments

NALI property development

SMSFs risk tainting an entire property development project with NALI if they use non-arm’s length arrangements at any point which give the fund any sort of advantage.

SMSF trustees and advisers engaged in property development schemes through special purpose vehicles (SPV) have been cautioned by a specialist auditor that any non-arm’s-length dealings could taint the entire scheme and the fund with non-arm’s-length income (NALI).

Pointing to the recently released ATO Taxpayer Alert 2023/2, ASF Audits head of education Shelly Banton noted that in the event an SMSF and its interposed entities fail to establish arm’s-length arrangements in regards to a property development project, they will be liable for NALI breaches and the entire project could be subjected to increased scrutiny by the ATO.

“[Non-arm’s-length dealings] encompass every party involved in a scheme, whether directly or indirectly, at every step along the way, which means that if anything at all doesn’t pass the smell test, not only will [all of] the income be considered NALI, but also, depending on the facts, the capital gain on disposal may also be considered NALI,” Banton told attendees at an ASF Audits webinar today.

Banton added that even if an SMSF had initially conducted transactions with a special purpose vehicle on an arm’s-length basis, this does not exempt the entity from fulfilling its obligations under the Income Tax Assessment Act 1997.

“Even though the fund may acquire those shares in an interposed entity at an arm’s-length price, the interposed entity may not have acquired shares of another entity which may be interposed or not at an arm’s-length price, which means that NALI is going to kick in,” she noted.

“The interposed entity could enter into an arrangement to subcontract the property development on non-arm’s-length terms to increase profit, which is going to ultimately benefit the fund. The interposed entity could borrow money from another entity on non-arm’s-length terms with interest to, once again, maximise those profits.

“The ATO has put out a very clear warning that any involvement in a scheme is going to be subject to increased scrutiny. Warn your clients if they’re contemplating property development or when they’re in the middle of one to be very careful and make sure that they colour within those lines.

“The ATO is really on top of this [issue] and it’s going to stop these arrangements happening before it all goes to custard.”

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