Jun 07, 2023 / News

Superannuation Newsletter Edition 17

The continuing saga of non-arm’s length expenses in super funds

The Budget included a disappointing announcement in relation to the long-running debate over the treatment of non-arm’s length expenses in super funds.

Readers may have seen our earlier article (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 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, audit 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).

In our Super Solutions Edition 16 we reported 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 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 consultation paper proposals, the maximum amount of fund income that could be treated as NALI for SMSFs and SAFs was to 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.

In the Budget, the Federal Government has announced that it intends to implement a modified version of the consultation proposals. In particular:

  • The NALE rules will only apply to SMSFs and SAFs. Large APRA funds will be completely exempted from the NALE rules for both general and specific expenses;
  • The maximum amount of fund income that can be treated as NALI for SMSFs and SAFs will be twice (rather than 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, and
  • Contributions will not be taxed at penalty rates as NALI in this calculation.

While it is good to see the level of NALI reduced from a multiple of five to a multiple of two, many will be disappointed by the Government’s decision. On 22 February seven tax and accounting bodies including CA ANZ, the Tax Institute and the SMSF Association released a Joint Submission to Treasury on NALE Rules for Superannuation, which argued cogently for a different approach to the issue. The joint submission makes the following perfectly reasonable points: 

  • The difference between general and specific expenses is often not straightforward, and the approach of the consultation paper will be costly for SMSF trustees to administer;
  • Professionals (eg. tax agents, accountants and solicitors) performing general everyday tasks for their SMSF are not performing these tasks to circumvent rules as suggested by the consultation paper. These tasks are completed personally by fund trustees, members, or by colleagues, because this is easier and is commercially sensible;
  • The superannuation sector is a dynamic market and there are often significant variations in the type and scope of services provided. Therefore, determining what is an arm’s length commercial expense is not always a simple task, and
  • The NALE rules conflict with the trustees’ duty to act in the best financial interests of their members by choosing a lower cost option.

The submission suggests that any significant NALE activity could be dealt with by the ATO by applying existing law and tax rulings.

Nor is it reasonable to focus the NALE penalties on only SMSFs and SAFs. It is tempting to think that they have been selected by the Federal Government as easy targets.

Indications are that this debate is still far from over.

Please contact your Nexia Edwards Marshall advisor if you have any questions on this or any other super related matter.

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.