The recently released draft taxation determination (TD) detailing how non-arm’s-length income (NALI) and capital gains tax (CGT) provisions interact is a practical approach by the ATO, according to an SMSF lawyer.
DBA Lawyers special counsel Bryce Figot considers Draft TD 2023/D1 to be a reasonable measure because it clearly clarifies how and to what extent a capital gain might be considered NALI as opposed to the existing ruling.
“What [generally] happens if an SMSF acquires an asset at below market value? I have a very easy and very nasty answer – the asset is tainted forever,” Figot told attendees at a recent DBA online SMSF legal update.
“More specifically, there’s a ruling from two years ago which says a consequence of the non-arm’s-length expenditure is that all the income derived from that asset will be non-arm’s-length income, including any capital gains from the disposal of the asset.
“Now we have the draft TD that explains exactly how the CGT provisions integrate because the thing that becomes non-arm’s-length income is not the capital gain.
“The thing that becomes non-arm’s-length income is statutory income and a capital gain is not statutory income; a net capital gain is statutory income.
“At the risk of oversimplifying, the draft taxation termination says non-arm’s-length income is the lesser of the non-arm’s-length capital gains with no reduction for discount percentage or capital losses. So it’s the lesser of the gross non-arm’s length capital gain or the net capital gain, the lesser of those two things.”
He gave an example where an SMSF sells two assets in the 2024 financial year, one asset on a non-arm’s-length basis acquired below its market value for $90 and another real estate asset acquired on an arm’s-length basis, sold for $600,000.
In this example, he considered whether selling the NALI asset would taint the entire capital gain made by the SMSF of selling both assets.
“There’s sort of two capital gains that go into the pot to make up a net capital gain. Is the whole thing tainted? I think yes, the whole thing was tainted. I think that is the correct legal view,” he noted.
“[However] the ATO considered that in the draft TD, and they say no, that is only an alternate view on that issue, so the ATO has come up with something which I think is far more practical and for which I applaud them.”