General non-arm’s length expense rules for superannuation funds

In a 2020 Practical Compliance Guidance the Commissioner indicated that a 45% tax rate could apply to all the income of a super fund – making a super fund useless from a tax perspective – if there were “non-arm’s length expenses of a general nature”. These are expenses linked to all income of the fund. This would mean that having a non-arms length accounting fee, being say $1,000 less than other pay, could see all of the income of the fund taxed at 45%, rather than 15% or even 0%.

My fund has a yearly income of $100,000 but underpaid its accounting fee by $1,000, so instead of paying $15,000 in tax the fund will now pay $45,000… That’s is a appropriate outcome… Not.

Its taken the Treasury 3 years to do something about it but finally they are proposing that if this occurs, Self-Managed Super Funds would only pay the highest marginal tax rate on five times the difference between what was paid for the general expense, and what would have been the arm’s-length amount.

This would mean that a fund that paid that $1,000 under the arm’s-length price, the fund would now pay 45% tax on $5,000, rather than all the income of the fund, and pay 15% (or 0%) on the other $95,000 of income.

And here is an example;

An SMSF trustee uses his brother’s accountancy services, which would usually cost $5,000 if provided under an arm’s length arrangement. As his brother charges the SMSF $0 for these services, this is a non-arm’s length arrangement.

The SMSF’s income (after relevant expenses) in the 2023-24 financial year is $100,000. The applicable rate of tax on this income would have otherwise been 15 per cent.

Under the current NALI rules, there is a sufficient nexus between the accounting services expense and all income of the SMSF. The SMSF’s total income in the financial year would be taxed at the highest marginal tax rate of 45 per cent. The SMSF would pay $45,000 in tax in 2023-24, resulting in $55,000 in after-tax income.

Under the potential amendments, the income ‘tainted’ as NALI would be limited by the market value of the accounting service, since no fee was charged to the SMSF. The amount of income would be calculated by applying a factor of 5 on the difference between the market value of the accounting service and the actual fee charged the fund. The trustee would pay tax at a rate of 45 per cent on $25,000 of fund income, and at a rate of 15 per cent on the remaining $75,000 of income. The SMSF would pay $22,500 in tax in 2023-24 and have after tax income of $77,500.

In comparison, if the fund had incurred an expense for the accountancy services as per its usual cost of $5,000, the SMSF would pay $14,250 in tax (i.e., 15 per cent of $95,000) and have after tax income of $80,750.

That seems a bit better… but this still scares me. What happens if a member of a fund you manage does his/her own maintenance on a property of their super fund and does not charge the fund for the work (let’s make them a builder). As this is a specific asset relating to a specific asset this change has not effect and all the rent from that property should now be taxed at 45%… Ouch

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