He said that if a specific asset breaches non-arm’s length income (NALI), both its income and future capital gains can be permanently affected and result in a 45 per cent tax impost.

He said there are three examples from Law Companion Ruling 2021/2 that indicate the unreasonableness of this rule.

The LCR 2021/2 outlines the application of the Australian Taxation Office’s view on the non-arm’s length expenditure (NALE) provisions and clarifies when and where an outgoing, expenditure or loss can constitute NALI.

The ATO’s view is that where an expense is incurred by a fund that is less than an arm’s length amount, all of the fund’s ordinary income and statutory income (including net capital gains and concessional contributions) is NALI and, after attributable expenses, is taxed at 45 per cent.

Mr Busoli said the first example in the LCR 2021/2 concerns Russell, whose SMSF purchases $900,000 of listed shares from a related entity for $500,000.

“He doesn’t take measures to have the difference treated as a non-concessional contribution,” Mr Busoli said.

“All future dividends and eventual net capital gain will be NALI and taxed at 45 per cent.”

He said that if Russell were trying to limit his capital gains tax (CGT) on the sale of the shares to his fund, he would have failed as the market substitution rules would revalue the transaction, for CGT purposes, to $900,000.

“In keeping with this principle, the cost base shown by the SMSF, for eventual CGT purposes, would also be $900,000,” Mr Busoli said.

In the second example, Kellie lends her SMSF 100 per cent of the $2 million required for the fund to purchase a property from an unrelated party using a related-party limited recourse borrowing.

“The interest rate is 1.5 per cent, paid annually over 25 years. The property is rented to an unrelated party at commercial rates,” Mr Busoli continued.

“Because the terms of the loan are not allowable under the safe harbour provisions, the net rent, and subsequent taxable capital gain on sale of the property, will be NALI and subject to 45 per cent tax. This is a permanent position. Even refinancing the loan through a bank won’t help.”

The final example involves Trang, who is the trustee of her sole member SMSF. She is also a plumber and runs her own plumbing business as a sole trader.

“Trang renovates the bathroom and kitchen and doesn’t charge the SMSF. Trang has permanently tainted the asset, so it will be treated similarly to Kellie’s,” Mr Busoli said.

“Clearly, the punishment far outweighs the crime, but the regulator is reticent to consider changes simply because it doesn’t believe the provision has ever been applied to this type of scenario.”

Keeli Cambourne
27 November 2023 
smsfadviser.com