A senior superannuation executive has highlighted the egregious nature of the non-arm’s-length income (NALI) rules with regard to any capital gains an SMSF generates.
Institute of Financial Professionals Australia head of superannuation and financial services Natasha Panagis illustrated her point using an example from Taxation Determination (TD) 2024/5 where an SMSF realised an arm’s-length capital gain of $500,000 and a non-arm’s-length capital gain of $2 million, which should have been $1.3 million had the asset in question been acquired at market value. Further, the fund had incurred a capital loss of $200,000.
The fund then reported a net capital gain of $1,533,333, however, this amount was incorrect. The capital gain that should have been recognised was $1,066,667 after the market substitution rule and capital gains tax (CGT) had been applied.
Panagis pointed out on face value it would appear the NALI provisions and associated penalty, taxing the gain at 45 per cent, should in this instance be applied to the $1.3 million.
However, given $1,066,667 is less than $1.3 million and the rules state the NALI penalty cannot be applied to an amount that is greater than the net capital gain of the super fund in a particular financial year, the tax rate of 45 per cent will be calculated on the lower amount.
Panagis said the example showed how the NALI rules in practical terms can affect all capital gains of an SMSF and not just those generated by the tainted asset.
“This final [determination] runs counter to the industry’s understanding of how the NALI provisions are intended to work. The industry [believes] where a capital gain arises because of non-arm’s-length dealings, only the net capital gain that relates to that particular CGT asset should be treated as NALI,” she told attendees of a webinar held last week.
“But the ATO’s view in this tax determination is that any NALI capital gain can taint other capital gains incurred by the same fund in that income year.”
