NALE – be careful or get caught with a big tax bill

Late last year we finally saw the law changes to non-arm’s length income and expenses, backdated to operate from 1 July 2018. These impacts on any dealings by a super fund which are not on an arm’s length basis irrespective of the parties to the transaction. It’s important for the sector to come to grips with the wide-ranging implications of the change and not put its head in the sand. The danger is that any income and capital gains coming within the new legislation are taxed at 45%.

The legislation was accompanied by the usual explanatory memorandum which spells out that the application of the legislation depends on the capacity in which the trustee undertakes the relevant transaction. In addition, the ATO published two rulings which provided the Commissioner’s views on the legislation, Draft Law Companion Ruling (LCR 2019/D3) and Draft Practical Compliance Guideline (PCG 2019/D6).

LCR 2019/D3 indicates that the operation of the legislation is not limited solely to transactions that are attributable to the particular investment or transaction but can extend to general fund expenses as well. It would apply in situations where one or more of the expenses of running the fund are not on an arm’s length basis and in some situations may result in all of the income and capital gains of the fund being taxed at the 45% rate.

PCG 2019/D6 provides short-term relief for the 2018/19 and 2019/20 financial years where the general expenses of running the fund are not on an arm’s length basis. The ATO has said it will not apply compliance resources for those years if the fund has incurred expenditure during those years which is not on an arm’s length basis. This just means that the ATO will turn a blind eye to general fund expenses that are provided to the fund at less than a market price.

Unfortunately, the ATO drafts have left a number of unsolved issues which will be covered hopefully in the finalised rulings. Some of the scenarios require greater clarity as they impact on a wide range of trustees/members who provide their professional services or business premises to undertake work on behalf of the fund at no cost or at a discount. The question is, will the non-arm’s length rules apply to general fund expenses such as accounting or preparation of the fund returns and result in the fund’s income being taxed at 45%?

Our understanding is that we may see the final of PCG 2019/D6 in the near future, but it is the publication of LCR 2019/D3 which may be a little way off. Hopefully, it will provide the clarity required on those members who provide their skills or business premises at less than a commercial arm’s length rate. It would include accountants, administrators or lawyers who use their offices and work computers to do work on the fund’s behalf.

Real estate agents, trades people, art dealers and others who undertake work when acquiring, maintaining or disposing of fund assets could also be impacted. Maybe the introduction of safe harbour guidelines by the ATO for general fund expenses could be a sensible move here to prevent the whole of the fund’s income and taxable capital gains being unnecessarily taxed at 45%.

We hope that the ATO will not be too pedantic on the interpretation of these rules and take a common-sense and practical approach to services provided to the fund by members and trustees for expenses incurred at no cost or at a discount.

If you think you may have a non-arm’s length income issue that dates from 1 July 2018 contact your accountant or fund administrator to find out what needs to be done and whether any amendment to the fund’s annual returns is required.