1.0 Audit Procedures for NALI/E in SMSF
1.1 The audit procedures required to be undertaken in relation to NALI/E are as follows:
a. Examine any income received from non-listed equity investments or rental properties to ascertain whether the income reflects a commercial rate of return,
b. Ensure the criteria for private investments distributions are not breached.
c. Examine rental property arrangements to ensure these are on commercial terms.
d. Where members or entities associated with members supply business services to their fund, ensure these are supplied on a commercial basis, or are being provided by members only in their role as trustee. Pay particular attention to funds with members who are accountants, financial planners, real estate agents or who are in the construction industry, or any member who may supply services to their Fund at noncommercial rates.
e. Examine any capital assets purchased by the Fund to ensure the consideration is at a commercial level.
f. Where an actual or possible NALI/E situation exists, and the annual return does not apply the penalty tax rate, (currently 45%), and the amount of tax is potentially significant or material, we must obtain in writing an opinion, with a reasonable argument, of a tax expert to support the treatment reflected in the annual return and financial statements. We consider tax agents to be experts in these matters for their clients and for support of the tax treatment of the transactions.
g. Where a possible NALI/E arrangement or situation is detected, ensure that it is brought to the attention of trustees of the Fund in our Auditors Trustee Letter. Any alert should be moderated by the compliance approach the ATO has announced.
h. Any audit report covering a potential NALI/E situation should be reviewed by a second SMSF audit practitioner before the report is signed.
2.0 Tricks and Traps in NALI/E Penalty Tax Rate a Contingent Liability
2.1. If a SMSF receives services for a non-commercial cost, the whole income of the fund is potentially non-arm’s length income and will be taxed at the penalty tax rate. This is so even for funds with assets in pension phase.
2.2 The compliance approach of the ATO will be moderated because of the extreme effect described in 2.1, in the light that all the income of the fund will be potentially taxable. (see Ruling Paragraph 91 and 92 below). The measures will not be enforced before July 1, 2022 and thereafter, parties are only required to make a “reasonable attempt” to ascertain the commercial rates to be charged for non-arms-length services to a fund.
2.2. If an asset is purchased at a non-commercial amount, the subsequent capital gain will be fully taxable, no CGT discount and taxed at the penalty rate.
2.3. Where a fund receives income in excess of a commercial rate, that portion of the fund income will be subject to tax at the penalty rate.
3.0 The ATO Ruling and definitions of NALI/E
3.1 The ATO Ruling LCR 2021/2, NALI is defined in paragraph 10.
a. there is a scheme in which the parties were not dealing with each other at arm's length, and
b. the fund incurs a loss, outgoing or expenditure of an amount in gaining or producing the income, and
c. the amount of the loss, outgoing or expenditure is less than the amount that the fund might have been expected to incur had those parties been dealing with each other at arm's length in relation to the scheme.
3.2 Paragraph 11 adds
Further to paragraph 10 of this Ruling, the income is also NALI if the fund does not incur a loss, outgoing or expenditure that the fund might have been expected to incur if those parties had been dealing with each other at arm's length in relation to the scheme.
4.0 Examples given in the Ruling help in understanding the ATO opinion and the nature of NALI/E.
4.1 Example 1 – commercial property bought for less than market value from a member. The property is then leased at commercial rates to a third party. Both the rental income stream and the capital gain on the disposal of the property would be penalty taxed.
4.2 Example 2 – a fund receives services from a firm of accountants of which a member is a partner. The services are provided at no cost or less than commercial rates. The whole of the income of the fund becomes taxable at penalty rates.
4.3 Example 6 & 7 – describe situations where trustees provide accounting and financial services to their funds at no charge. This does NOT create a NALI/E situation, because the use of related business resources is minor or incidental.
4.4 Example 9 & 10 – examples of members of trades, (plumbers and electricians are highlighted), who can get caught in NALI/E situations.
4.5 Example 11 – highlights the risks for real estate agents.
5.0 ATO Compliance Audits – paragraphs 91 & 92 of the Ruling.
5.1 Paragraph - 91. Nevertheless, the Commissioner is alive to concerns that a finding that general fund expenses are non-arm's length is likely to have a very significant tax impact on the complying superannuation fund, even where the relevant expenses are immaterial.
5.2 Paragraph - 92. For this reason, from 1 July 2022, where the ATO applies any compliance resources for such general fund expenses, they will only be directed:
- toward ascertaining whether the parties have made a reasonable attempt to determine an arm's length expenditure amount for services provided to the fund, other than services provided by an individual either acting in the capacity as trustee of the SMSF or as a director of a body corporate that is a trustee of the fund.
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