The government has released a consultation paper to canvass options to amend the non-arm’s length income (NALI) provisions that will apply differently to SMSFs/small APRA funds and large APRA-regulated funds. The NALI provisions are an integrity measure to prevent income being diverted into super funds to benefit from lower rates of tax compared to other entities. For example, generally, income of super funds has a concessional tax rate of 15% along with a 1/3 discount for capital gains tax.

Broadly, non-arm’s length income may arise in relation to amounts received via private company dividends, trust distributions or income from non-arm’s length transactions. This also includes expenses not incurred that would normally be expected to apply in a commercial arm’s length transaction. All these transactions are not subject to the concessional 15% tax rate but are taxed at the top personal marginal rate of 45%. To avoid the operation of NALI provisions, it is necessary to be able to satisfy the ATO that such distributions are reasonable arm’s length transactions.

In 2020, when the ATO published a Practice Compliance Guideline (PCG 2020/5) which established its initial transitional approach to the NALI provisions compliance, consultation with the wider community lead to the ATO realising that not all trustees may have been aware that NALI provisions also apply to non-arm’s length expenses (NALE) of a general nature which is linked to all income of the fund (ie general expenses).

In PCG 2020/5 the ATO announced it would not allocate compliance resources to determine whether the NALI provisions applied to a complying superannuation fund for the 2018-19, 2019-20, 2020-21 income years where the fund incurred NALE of a general nature that has a sufficient nexus to all ordinary and/or statutory income derived by the fund in those respective income years. This transitional approach was subsequently extended twice to include the 2021-22 and 2022-23 income year and only applies to general expenditure that is incurred on or before 30 June 2023.

To provide certainty to trustees ahead of the expiry of the transitional approach in PCG 2020/5, the government intends to confirm that the rules continue to operate in line with their original policy intent. The potential amendments proposed will apply to general expenses which have sufficient nexus to all ordinary and statutory income derived by the fund.

Potential proposed amendments to the NALI provisions for super funds are as follows:

• SMSFs and small APRA funds – factor-based approach that would set an upper limit on the amount of fund income taxable as NALI due to a general expenses breach. The maximum amount of fund income taxable at the highest marginal rate would be five times the level of the general expenditure breach, calculated as the difference between the amount that would have been charged as arm’s length expense and the amount that was actually charged to the fund. Where the product of five ties the breach is greater than all fund income, all fund income will be taxed at the highest marginal rate.
• Large APRA-regulated funds – exempted from NALI provisions for general expenses, while remaining subject to the provisions for specific expenses linked to specific asset and income sources.