The Australian government recently passed new legislation concerning Non-Arm's Length Income (NALI) and Non-Arm's Length Expenditure (NALE). These changes are critical for trustees of Self-Managed Super Funds (SMSFs) as they can have significant tax implications for super funds that fail to comply with arm's length requirements.

What is NALI and NALE?

Non-Arm's Length Income (NALI) refers to income derived from a transaction that is not conducted on an arm's length basis. This could mean that the income is higher than what would be expected in a normal commercial transaction due to a non-arm's length arrangement. Such income, when identified, can be taxed at the highest marginal tax rate (45%) rather than the concessional tax rate that usually applies to superannuation funds (15%).

Non-Arm's Length Expenditure (NALE), on the other hand, pertains to expenses or costs that are less than what would be expected in an arm's length transaction. NALE applies when a super fund incurs expenses on a non-arm's length basis, potentially leading to higher NALI, as the fund may not have been charged market rates for services or goods.

The Recent Legislative Changes

The key changes in the NALI/NALE legislation focus on broadening the scope of the rules to capture not just specific transactions but also general expenses. These changes were aimed at addressing concerns that the prior NALI/NALE framework was too narrow, allowing some super funds to structure their affairs in a way that could lead to a favourable tax outcome.

Under the new legislation:

1. General Expenses Now Captured

The legislation now includes non-arm's length dealings in respect of general expenses incurred by the superannuation fund, such as administration fees, accounting fees, and other general operating costs. Previously, the rules primarily focused on specific expenses related to generating income (e.g., property transactions). This expansion means that trustees need to ensure that all fund expenses, not just those directly tied to an asset or income stream, are at arm's length.

2. Increased Scrutiny and Potential Penalties

The changes have increased the scope for the Australian Taxation Office (ATO) to scrutinise SMSFs and APRA-regulated funds to identify and penalise non-arm's length arrangements. Super funds found to be in breach may be subject to punitive tax rates, which could significantly erode the value of the retirement savings within the fund.

3. Trustee Responsibilities

As a trustee, it is now more important than ever to ensure that all transactions, including both income and expenses, are conducted on commercial terms. This involves reviewing service agreements, contracts, and transactions to verify that they meet market standards. If trustees or related parties provide services to the fund, these services must be charged at market rates to avoid NALE implications.

Practical Implications for Trustees

For SMSFs in particular, the new NALI/NALE rules mean that trustees must be vigilant about how they manage the fund's operations and relationships with service providers, including any services provided by related parties.

Here's what trustees should consider:

1. Review All Arrangements

Trustees should conduct a thorough review of all existing arrangements, including property management, legal services, accounting services, and any other transactions with related or external parties. Ensure that all payments reflect market rates, and document the basis for any pricing decisions.

2. Seek Independent Valuations

In cases where it might be challenging to establish a market rate, consider obtaining independent valuations or quotes to substantiate that the fund is not benefiting from non-arm's length arrangements. This can provide a layer of protection in case of an ATO review.

3. Document Everything

Proper documentation is crucial. Keeping detailed records of all decisions, pricing, and agreements can serve as evidence that transactions were conducted at arm's length, should the need arise.

4. Engage Professional Advice

Given the complexity and potential risks associated with the new NALI/NALE rules, trustees may need to seek professional advice from accountants or legal professionals who specialise in superannuation law. Engaging experts can help ensure that the fund's operations comply with the new requirements and avoid costly penalties.

The Road Ahead

The passage of the new NALI/NALE legislation reflects the government's continued focus on ensuring that superannuation funds are operating fairly and within the bounds of the law. For trustees and accountants, this means heightened responsibility to scrutinise fund operations and ensure that all transactions are conducted at arm's length.

While the changes may introduce new compliance challenges, they also reinforce the importance of sound governance in managing superannuation funds. By staying informed, conducting regular reviews, and seeking professional advice when necessary, trustees can protect the integrity of the fund and safeguard the retirement savings of its members.

For more information on understanding your obligations and assistance with compliance, contact us.