Administration, Compliance, Management, NALI/NALE, SMSF

AAT overturns NALI interest ruling

NALI interest income AAT

The AAT has ruled interest derived from a complex lending arrangement established by an SMSF trustee was not NALI despite the arrangements being at non-arm’s length.

The Administrative Appeals Tribunal (AAT) has ruled interest income earned by a corporate trustee SMSF from a series of loans involving related entities should not be classified as non-arm’s-length income (NALI) as the potential benefits of the arrangements did not exceed what would be expected from a commercial transaction.

The AAT made the ruling in the case of BPFN and Commissioner of Taxation [2023] on 28 July in relation to an appeal made by the applicant to contest penalties imposed by the ATO.

Specifically, the applicant derived $7,669,327 in interest income as the beneficiary of a unit trust, JJUT, between 2015 and 2017 through a chain of loan agreements involving related parties, ABC Pty Ltd and DEF Pty Ltd.

Funds lent by JJUT to ABC were in turn lent to DEF, which issued loans to external parties on an arm’s-length basis for development projects, with interest charged at commercial rates.

The income earned from interest through these borrowings was distributed to the applicant as JJUT’s sole unitholder and was reported as exempt current pension income (ECPI).

However, following an audit, the ATO determined the income was NALI and therefore should not have been classified as ECPI, imposing fines along with a shortfall interest charge on the applicant, and providing revised assessment notices for those years.

AAT deputy president Ian Molloy considered whether the interest income distributions of the case complied with the NALI provisions set out in section 295-550 of the Income Tax Assessment Act 1997 (ITAA 97), and concluded the applicant, Mr J, had contravened the provisions and the arrangements related to NALI as he was essentially dealing with himself.

“As to section 299-550(5)(a) of the ITAA 97, in my view the parties were not dealing with each other at arm’s length. There is no dispute that DEF was dealing with the third parties at arm’s length. But that cannot be said of the dealings between JJUT, ABC and DEF,” Molloy said.

“The directing mind of each of JJUT, ABC and DEF, in relation to these dealings, was Mr J. Nothing that could be described as ‘real bargaining’ occurred in respect of the respective dealings between JJUT, ABC and DEF,” he added, noting Mr J controlled and directed all three entities.

Molloy also considered whether the interest income was greater than what would be expected if the parties had conducted the dealings at arm’s length and based on testimony and evidence from several witnesses related to fees, interest rates and risk-sharing arrangements concluded that income did not constitute an infringement of the NALI provisions.

“I am satisfied based on the evidence … that JJUT did not derive income that was ‘more than the amount that the entity might have been expected to derive…when dealing at arm’s length’. I am satisfied that the relevant interest income received by the applicant in the 2015, 2016 and 2017 income years was not NALI,” he said.

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