When a SMSF derives income through transactions that are not at arms-length, the income is taxed at 45%. This type of income is called NALI - ‘non-arm’s length income’.
This high rate of tax is designed to act as a deterrent to taxpayers who might be tempted to redirect income from being taxed at company and individual rates into the lower tax (or zero tax) of superannuation funds. Recent ATO publications have raised the tax audit focus on NALI
What triggers the NALI tax?
The essence of the NALI provisions is to capture transactions where:
- a super fund and another party or parties are not dealing at arm’s length, and
- the fund’s share of the income from the transaction is more than would have been expected for an arm’s length situation.
How does a trustee of a super fund know that the fund is dealing at arm’s length?
In nearly every case, it’s about transacting with related parties, and the general inference is that related parties are not dealing at arm’s length unless it can be established otherwise. This usually means obtaining third party evidence that the terms of the transaction are the same as one would expect if the fund had been dealing with a stranger.
Examples of SMSF transactions that could trigger NALI.
- Investing in private companies or private unit trusts;
- Leasing assets to related parties;
- Loans to or from related parties;
- Engaging related parties to provide services.
What can be done to reduce the risk of a transaction triggering NALI?
All SMSF transactions must be at arm’s length and the trustee needs to be able to prove it. Here are examples of potential NALI transactions and steps to address the risk of attracting a 45% tax:
If the fund will invest in a private company or fixed unit trust:
- the issue price should be calculated based on the market value of the company or trust at that time (i.e. not a standard $1 per share/unit);
- the price should not be discounted for particular investors because of the “value they bring to the table”;
- if the SMSF member works in the investment entity, they must be remunerated at market rates.
If the fund leases assets to related parties, the fund should:
- obtain a third party written opinion of the terms and conditions (including market rent) that would apply if the property were leased on commercial terms;
- enter into a written lease agreement with the other party on normal commercial terms.
These rules also cover non arm’s length expenditure.
When a fund has non arm’s length expenditure, the income connected to that expenditure will also be taxed at 45%. This could apply to related party loans or asset purchases. If a SMSF bought an asset for less than market value from a related party then NALI will apply to the income from the asset and also to any capital gain on the disposal of the asset.
The application of these rules can become quite outrageous. For example, when a fund incurs expenditure that does not relate to any particular asset, such as accounting fees, and that expenditure is not at arm’s length rates – then because accounting costs relate to all income derived by the fund, then all of the fund’s income will be taxed at 45% under NALI. This is a disproportionate consequence of not paying a market rate on accounting fees!
What should trustees of self-managed super funds do?
If you have a SMSF that has dealings with related parties - for example, renting commercial property to a related business – then get professional advice to ensure that appropriate action is undertaken to ensure the dealings are demonstrably at arm’s length.
If you would like advice or have any queries around SMSF and NALI, please contact your usual Mazars advisor, the author or one of our Super specialists via the form below or on:
Author: Michael Jones
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