Mar 16, 2023 / News

Superannuation

NALE Consultation Paper Released

After years of lobbying from interested parties, Federal Treasury has finally produced a proposed solution to the knotty problem of non-arm’s length general expenses in super funds. But the proposal seems to punish SMSFs and give large APRA funds a free pass.

We have written previously (Super Solutions Edition 9) about the non-arm’s length expenses (NALE) provisions that have been effective from 1 July 2018. These are intended to ensure that expenses incurred by funds in deriving income are commercial and not artificially reduced in order to shelter net income in the tax-advantaged environment of a super fund. Broadly, when expenditure incurred in deriving income is less than would be expected in an arm’s length dealing, the income related to the expenditure will be treated as non-arm’s length income and taxed at the penalty rate of 45% instead of the usual rate of 15% for a super fund.

The provisions are very widely drawn, and can potentially apply to any expenses incurred by super funds. The issue of “general expenses” is of particular concern. A number of super fund expenses such as accounting fees, audit fees and actuarial fees potentially relate to all income derived by a fund. In a situation where, for example, the fund is provided with free accounting services by a firm related to a member, the non-arm’s length nature of this relatively minor expenditure could result in the entire income of the fund being treated as non-arm’s length income (NALI).

This problem was pointed out at the time the legislation was introduced, but protests from professional bodies fell on deaf ears in Treasury. Initially the ATO issued Practical Compliance Guideline PCG 2020/5 which stated that that they would not allocate compliance resources in relation to general expenses, for the period 1 July 2018 up to 30 June 2021. This was intended to allow the ATO sufficient time to consider industry submissions before issuing a final ruling and for trustees to make changes where required. This ad-hoc approach has been extended by the ATO a number of times, the latest to 30 June 2023. Professional bodies and other stakeholders have called repeatedly for the legislation to be amended to provide a satisfactory solution, arguing that is not reasonable to expect fund trustees, accountants and auditors to have to rely on the ATO’s assurance it will not enforce the law as it stands. 

The latest development is the issue by Treasury of a consultation paper Non-arm’s length expense rules for superannuation funds, in which Treasury puts forward a proposal to amend the legislation and seeks feedback on the proposals. 

The proposed changes will apply differently to SMSFs and small APRA-regulated funds (SAFs) on the one hand and large APRA-regulated funds (basically retail and industry funds) on the other.

Under the proposals, the maximum amount of fund income that could be treated as NALI for SMSFs and SAFs would be five times the difference between the amount that would have been charged as an arm’s length expense and the amount that was actually charged to the fund. So, in the example of free accounting services, if we assume the arm’s length charge for the accounting services was $5,000, the maximum amount of fund income that could be treated as NALI would be ($5,000 - $0) x 5 = $25,000. It is of course still possible that this could represent the entire income of the fund in the given year.

In contrast, large APRA-regulated funds would be exempted from the NALI provisions for general expenses.

The Paper argues that there is a need to retain “a significant, but still proportional, tax penalty” for  SMSFs and SAFs, as members have the capacity to control or influence the general expense arrangements of the fund in a way which could directly inflate their superannuation balances, including though non-arm’s length arrangements. On the other hand, it argues that the approach to large APRA-regulated funds is intended to lower the compliance burden as there is a lower level of tax integrity concern for non-arm’s length arrangements involving general expenses for these funds. 

The paper makes a strange distinction, that non-arm’s length arrangements providing general services to large APRA-regulated funds are generally entered into with the primary intention of reducing cost and passing savings on to members, while such arrangements in SMSFs and SAFs are for the dominant purpose of obtaining a tax benefit. Many will find this hard to accept, and it should be pointed out that large-APRA regulated funds are just as capable of seeking to obtain a tax benefit and SMSFs are also interested in reducing costs and passing the savings on to their members.

It will be interesting to see how these proposals are received by interested stakeholders.

One possible solution which has been suggested but so far not taken up by Treasury is to adopt a de minimis rule, under which general expenditure up to a certain limit would escape treatment as NALE. This would reflect the fact that general expenses in super funds are usually small in nature, and even if not commercial, do not represent a significant tax advantage.

Please contact your Nexia Edwards Marshall advisor if you have any questions in relation to NALI or NALE.

The material contained in this publication is for general information purposes only and does not constitute professional advice or recommendation from Nexia Edwards Marshall. Regarding any situation or circumstance, specific professional advice should be sought on any particular matter by contacting your Nexia Edwards Marshall Adviser.