In this blog post, we delve into the realm of NALI, exploring its definition, implications, and recent developments. We’ll uncover how NALI is determined and the factors that contribute to its existence, shedding light on the Income Tax Assessment Act 1997 and its significance in this context. Additionally, we’ll examine the Australian Taxation Office’s (ATO) recent scrutiny of specific arrangements, uncovering concerns related to profit diversion and the potential tax advantages enjoyed by certain entities.
Table of Contents
Introducing NALI: Understanding Non-Arm’s Length Income
Non-arm’s length income (NALI) is a term defined within the Income Tax Assessment Act 1997. It encompasses income earned by a fund in cases where the parties involved are not dealing at arm’s length, and the income exceeds what would be expected if they were conducting arm’s length transactions.
This definition also includes specific scenarios such as dividends received from a private company unless they align with arm’s length dealings, as well as trust distributions received by the fund from a trust, excluding fixed entitlements where all dealings are conducted at arm’s length.
On 1 January 2020, the definition underwent further amendments to include the process of gaining or producing income. This entails instances where the entity incurs a lower loss, outgoing, or expenditure than what would be expected in arm’s length dealings, or when the entity avoids incurring a loss, outgoing, or expenditure that would typically occur in arm’s length dealings.
Recent Developments and Concerns
The Australian Taxation Office (ATO) has scrutinised arrangements involving one or more self-managed superannuation funds (SMSFs) with direct or indirect ownership of a special purpose vehicle (SPV) engaged in a property development project. Due to non-arm’s length arrangements between the SPV and other entities, the SPV generates profits that benefit SMSFs in excess of what would have been achieved through arm’s length transactions.
This resulted in ATO’s concerns about the lack of commerciality in some of these arrangements, as they divert profits from property development projects (which would normally be subject to corporate or applicable tax rates) to SMSFs, which enjoy favourable tax treatment.
According to the ATO’s clarification, an SMSF cannot claim compliance with NALI obligations on the basis that it did not directly participate in non-arm’s-length transactions. This clarification is in response to an appeal to the Federal Court in which a $2.5 million capital gain distributed from a fixed trust to a super fund was classified as “special income” and taxed as such.
Furthermore, the ATO emphasises that any non-arm’s length interactions by any scheme participant can result in NALI, as defined by section 295-550 of the Income Tax Assessment Act 1997. In light of these concerns, the ATO is undertaking a comprehensive review of similar arrangements and will scrutinise taxpayers and advisors involved in or planning to participate in similar schemes. Bulletin 2021/1 of the SMSF Regulator provides guidance for funds contemplating participation in real estate development projects.
Rise in Disqualified SMSF Trustees
The ATO revealed in a separate statement that during the March quarter, 201 SMSF trustees were disqualified. For the first three quarters of the 2023 financial year, the ATO has added 588 disqualified SMSF trustees to its Disqualified Trustees Register, a significant increase of 134% from the previous financial year, when only 251 disqualified trustees were added to the register.
Therefore, disqualified trustees must immediately resign from their posts and are barred from creating any new SMSFs.
The need for SMSF trustees to understand and fulfil their regulatory responsibilities to avoid disqualification and related penalties has been highlighted by these recent events, as has the need of maintaining arm’s length interactions and following to NALI obligations.
Participants in self-managed superannuation funds (SMSFs) and other financial arrangements would do well to familiarise themselves with non-arm’s length income (NALI) and its ramifications. Recent investigations by the Australian Taxation Office (ATO) into schemes designed to funnel money from real estate developments into SMSFs have brought home the need of being businesslike and sticking to fair dealing practises. SMSF trustees can protect their money from risk, comply with the law, and keep their word if they keep up with NALI laws. In order to protect the interests of SMSF beneficiaries and make sense of the tangled web of non-arm’s length income, it is crucial to seek the advice of knowledgeable specialists and adhere to ATO recommendations.
We recognise the challenges you face when trying to grasp the interplay between NALI and SMSFs. But, worry not! As our staff here at Mint Super Audit are experienced professionals is here to answer any questions you may have or offer any additional support you may need with respect to NALI rules, compliance requirements, or SMSF-related issues.
Please don’t be hesitant about contacting us. To help you make educated decisions and protect the financial future of your beneficiaries, we’re here to ensure sure your SMSF is running in accordance with the latest legislation.