Government announces welcome NALE changes

After months of industry lobbying around the NALI/NALE rules, the Government announced yesterday that they intend to “amend the law to ensure it operates as intended”.  What does this mean and who will benefit from the changes?

The investment income of both APRA regulated funds and SMSFs is generally taxed at the concessional rate of 15%, or even 0% where the assets of the fund are solely supporting retirement phase pensions. But any amounts regarded as “non-arm’s length income” or NALI are taxed at 45%. 

The NALI rules were initially designed as a deterrent to taxpayers channelling income, which would otherwise be taxable at company/individual rates, into concessionally taxed superannuation funds. They had been unchanged for many years until 1 July 2018 when they were expanded to include a focus on a fund’s expenses as well as their income. In essence, if a fund’s expenses were lower than they would have been in an arm’s length situation (ie they were non-arm’s length expenses or NALE), all or part of the fund’s income could be regarded as NALI and taxed at 45%.

The 1 July 2018 changes seemed harmless enough until you realised they could be applied to very common fund arrangements. For example, an SMSF trustee undertaking a renovation on the fund’s property and not charging the fund for their labour. Or administrative services being provided to APRA regulated funds at discounted rates.

Thankfully the Government has now recognised that the 1 July 2018 changes are unworkable in their current form and legislative change is needed to ensure they operate as intended.

Where to from here?

The Government intends to now commence consultation with industry representatives with the legislative changes to apply from 1 July 2022.

What does this mean for SMSFs?

Until we see the amending legislation, it is difficult to know exactly which SMSF arrangements with non-arm’s length parties will remain caught by the NALE rules. However, given the Government’s commitment to finding a workable solution whilst still meeting NALI’s policy intent, during the consultation process we would be looking to:

• gain clarity on the types of services which can be provided to SMSFs without triggering a NALI issue,
• identify whether the trustees of the unit trusts in which SMSFs invest can provide services to the trust without causing NALI issues for the funds,
• understand the ATO’s expectations where SMSFs purchase assets partly for cash and partly in specie,
• ensure the penalty for incurring NALE is proportionate to the mischief involved, and
• ensure there is no NALI risk for funds given the Government’s legislative changes are intended to apply from 1 July 2022 but the NALE provisions have application from 1 July 2018.

Note, earlier this week, we did gain welcome clarity on one issue regarding NALI – the position for trustees who restructured their related party limit recourse borrowing arrangement in the lead up to 31 January 2017 to comply with PCG 2016/5. The ATO has now amended PCG 2016/5 to confirm that the Commissioner will not seek to apply the NALI provisions to these arrangements for the 2018/19 and later years.

Whilst the NALI/NALE story is not yet complete, thanks to the tireless lobbying of the various professional bodies and industry associations, it seems we are now on the path to finding a long-term pragmatic solution.