A superannuation lawyer has advised capital losses sustained by an SMSF in an income year can effectively be used to reduce or even neutralise what might otherwise be a non-arm’s-length income (NALI) tax liability.
Specifically, DBA Lawyers senior associate William Fettes made reference to Tax Determination (TD) 2024/5, which was released by the ATO last month and clarifies the regulator’s view on how the NALI rules interact with capital gains tax provisions.
“This has slipped under the radar for many … but capital losses can reduce NALI arising from tainted capital gains,” Fettes noted during a briefing held by his firm last Friday.
“It’s expressly stated in paragraph 15 that where a fund’s net capital gain is nil due to capital losses in the current year and unapplied net capital losses, then you can have no amount of NALI even though you have a non-arm’s-length capital gain. That’s the commissioner’s view, but it’s really an exercise of determining the net capital gain.”
To illustrate his point, he used an example directly from TD 2024/5, where an SMSF had made $2.5 million in capital gains, which included both arm’s-length and non-arm’s length gains. However, the SMSF also had a large capital loss of $6 million.
Fettes explained even though the SMSF made a non-arm’s-length capital gain, which would typically trigger a NALI tax liability, the losses were so significant that they wiped out all the capital gains, resulting in a net capital gain of zero. Therefore, no NALI tax was applied because there was no taxable capital gain left.
“In that case, you’ve got a situation where both the tainted and the non-tainted gains are reduced to nothing. You might get into more complex territory where you’ve got a capital loss that covers part of it and that might get you into more debatable territory,” Fettes said.
“There is some commentary in the tax determination that might be helpful, but I think it’s more of an open question about how the commissioner might treat that situation where it’s a question of a choice of losses.
“With the capital losses removed, there was a zero amount for the net capital gain and therefore there’s a nil amount of NALI because [the] NALI [penalty] cannot exceed the superannuation fund’s net capital gain.”
