The information in this presentation has been prepared by Mark Ellem ABN 69 989 271 960 and Accurium Pty Ltd ABN 13 009 492 219 (Accurium). It is general information only and is not intended to be financial product advice, tax advice or legal advice and should not be relied upon as such. Whilst all care is taken in the preparation of this presentation, no warranty is given with respect to the information provided and Mark Ellem or Accurium is not liable for any loss arising from reliance on this information. Scenarios, examples and comparisons are shown for illustrative purposes only and should not be relied on by individuals when they make investment decisions. We recommend that individuals seek professional advice before making any financial decisions. This presentation was accompanied by an oral presentation, and is not a complete record of the discussion held. No part of this presentation should be used elsewhere without prior consent from the author.

New rules for NALI and NALEWhat it means for your SMSF clients

Compliance with non-arm’s length rules under SIS

Avoid being caught by non-arm’s length rules in Tax Act

3

SMSFs and Non-Arm’s Length Income (NALI)

4

NALI – SIS v TaxSISA – section 109:

Investments of superannuation entity to be made and maintained on arm's length basis

If not arm's length transaction – SMSF is not is worse position (if was arm's length)

- Eg – SMSF receiving less income than would expect from arm's length party

- Market rent on business real property (BRP) = $90k

- SMSF receives $70k (non COVID-19 reason)

SMSF receives less than market value from related party (RP) – SISA s.109 problem

Part B compliance audit issue.

5

NALI – SIS v TaxITAA 97 – section 295-550:

Income is greater than what would be received if dealing at arm's length

- No requirement for parties to be 'associates' for tax or a 'related party' for SIS

All income from that source is NALI

- Eg – SMSF receiving more income from RP than arm's length (commercial)

- Market rent on BRP = $90k

- SMSF receives $110k

SMSF receives more than market value from RP – Income Tax problem

Part A compliance audit issue – understatement of tax liability or overstatement of tax refund asset.

6

SMSF & other party not dealing at arm’s length

Income less than commercial – SIS

issue (Part B)

Income more than commercial – Tax

issue (NALI) (Part A)

7

NALI consequences

All income from source is NALI

NALI less attributable

deductions = Non arm's length component

Taxed at top marginal rate (45%)

Cannot be claimed as 'Exempt Current

Pension Income' (ECPI)

8

When can an SMSF have NALI

Income exceeds amount expected from an arm's length dealing

Expenditure less than amount expected from an arm's length

dealing

From 1 July 2018NALE

9

Income – what’s NALI Income (ordinary or statutory) greater than would be expected if dealing at arm's length

- E.g. SMSF leases BRP to RP – rental income greater than commercial

- E.g. SMSF acquires BRP from RP for less than market value & leases at commercial rate

- Rental income is NALI (despite being commercial)

- Capital gain on sale is NALI

Distributions from discretionary trusts

Dividends from shares in a private company (unless satisfy requirements in s.295-550(3))

Scheme where parties are not at arm’s length and income is more than arm’s length

- E.g. SMSF enters into limited recourse borrowing arrangement (LRBA) with less than commercial interest rate (rental income is commercial)

- pre 1 /7/2018: TD 2016/16

- post 30/6/2018: amendment to s.295-550(1)) + any capital gain made on disposal (ref Example 4 LCR 2019/D3)

Income from fixed trusts where parties are not at arm’s length and income is more than arm’s length.

10

Expenditure – what’s NALE Scheme under which parties not dealing with each other at arm's length

- Any arrangement, scheme, plan, proposal, action, course of action, or course of conduct

Loss, outgoing or expenditure incurred in gaining or producing income that is less than expected if parties dealing at arm's

length

No loss, outgoing or expenditure incurred in gaining or producing income, which is less than expected if parties dealing at

arm's length

Loss, outgoing or expenditure incurred (or not incurred) may be of a revenue or capital nature – includes capital outlay for

acquiring asset

- Capital gain resulting from disposal of asset acquired at less than market value where parties not dealing at arm's

length will be NALI.

Identify the scheme

- E.g. the transaction

- Acquiring an asset; acquiring a service; leasing an asset

Sufficient nexus between non arm's length expenditure and income

- Expenditure can be revenue or capital in nature

- Expenditure can have sufficient nexus to specific income

- E.g. rental property expenditure nexus to rental income from particular asset

- Expenditure can have sufficient nexus to all fund income

- E.g. accounting fees; audit fees, admin fees; tax return preparation fees

Not intended to apply to services provided by trustee (or director) of SMSF in their capacity as trustee (or director).11

Requirements for NALE

12

Specific v general expenditure treated as NALE – the effect

Specific expenditure:

E.g. Rental property expenditure < commercial

All income from rental property → NALI

Non arm's length component:

- Rental income less attributable expenses

Low tax component:

- All other assessable income:

- Interest , dividend, trust distributions, capital gains

- Assessable contributions

- Claim ECPI

General expenditure:

All income is NALI

- All assessable investment income

- All assessable capital gains

- All assessable contributions

Non arm's length component:

- Net income of the fund

Low tax component:

- Nil

No claim for ECPI

13

Example – comparison

Specific:

Rental income $110K (arm's length $90k)

- Rental expenses $20k (arm's length)

Other assessable income $20k

Assessable contributions $50k

General expenses - $5k (arm's length)

Non arm's length component - $90k

- Tax $40,500

Low tax component - $65k

- Tax $9,750

General:

Rental income $90K

- Rental expenses $20k

Other assessable income $20k

Assessable contributions $50k

General expenses - $2k

Non arm's length component - $138k

- Tax $62,100k

Low tax component - Nil

- Tax $Nil

$11,850

14

Assessable contribution treated as NALIFund:

Taxed at 45% (rather than 15%)

Member subject to Division 293 additional tax:

Effective 60% tax on assessable contribution (45% NALC + 15% Division 293)

Member with excessive concessional contributions:

Excess concessional contributions taxed at member’s marginal tax rate

- Tax offset 15% (not 45%) (s.291.15 ITAA 97)

- Division 293 tax does not apply to excessive concessional contributions

If top MTR - [45%+2%-15%] + 45% NALC = 77%.

15

Trustee services – SIS v Tax

SISA s.17A(1)(f) & (g) - trustee/director cannot receive remuneration for duties or services performed by the trustee/director

S.17B “permits a trustee to charge up to an arm’s length amount for duties or services performed other than in the capacity

as trustee”………..provided:

1. the trustee is appropriately qualified, and holds all necessary licenses, to perform the duties or services; and

2.the trustee performs the duties or services in the ordinary course of a business, carried on by the trustee, of performing

similar duties or services for the public; and

3. the remuneration is no more favourable to the trustee than that which it is reasonable to expect would apply if the

trustee were dealing with the relevant other party at arm's length in the same circumstances.

16

Individual capacity v capacity as trustee/director Capacity of trustee/director = internal arrangement ≠ NALE

Individual capacity = subject to NALE provisions

LCR 2019/D3 - factors that indicate performing activities in individual capacity:

- Individual charges SMSF for performing services (nil charge can still mean acting in individual capacity)

- Individual uses equipment's and other assets of their business, or used in their profession or employment

- Individual performs activities pursuant to a license and/or qualification relating to their business, or their profession or employment

- The activity is covered by an insurance policy relating to their business, or their profession or employment, e.g. indemnity insurance.

Draft LCR provides examples of services provided by individual in capacity as trustee/director

- Bookkeeping or accounting services

- Beware if involves use of equipment, license or covered by indemnity insurance

17

Moratorium on general expenditure & NALE

Sets out ATO's transitional compliance approach for application of amendments to NALI to include non

arm's length expenditure of a general nature

ATO will not allocate compliance resources to determine whether NALI provisions apply in 2018-19 &

2019-20 income years where fund incurred NALE of a general nature

Does NOT apply to NALE related to specific/particular ordinary or statutory income

- E.g. NALE property expenses that relate to a specific property

PCG 2019/D6:

Extended transitional compliance approach period to include 2020/21

PCG 2020/5 (finalised version of PCG 2019/D6):

18

NALE connected to specific income

Applies from 1 July 2018

- 2018-19; 2019-20; 2020-21 & following

In which capacity is trustee/director providing the service?

- Personal = potential NALE

- Trustee ≠ NALE

If trustee/director does charge must comply with SISA s.17B.

19

Acting in capacity as trustee – not NALE

Leonie is a trustee of an SMSF of which she is the sole member. She is a chartered accountant and registered tax agent who is employed in an accounting and tax agent business.

Leonie in her capacity as trustee, prepares the accounts and annual return for the fund. She does not use the equipment or assets of her employer, nor does she lodge the annual return using her tax agent registration.

As she performs these duties or services as trustee of the SMSF, she does not charge the fund for this work.

Example 6 – LCR 2019/D3

20

Acting in individual capacity – NALE (specific)

Sharon is a trustee of an SMSF of which she is the sole member. She is a licensed real estate agent and runs a real estate business which includes property management services for rental properties. The SMSF holds a residential property which it leases for a commercial rate of rent.

Sharon provides property management services to the SMSF as a licenced real estate agent. She utilises the equipment and assets of her business (including the business’ website) in performing these services. Her actions are covered by the applicable insurance policies in respect of the business.

Accordingly, Sharon provides property management services in her individual capacity to the SMSF with respect to the residential property. She charges the SMSF 50% of the price for her services that she would otherwise charge a non-related party.

Example 7 – LCR 2019/D3

21

Acting in Individual capacity – NALE (general)

BUT.......

Applying PCG 2020/5:

ATO will not allocate compliance resources to determine whether the NALI provisions apply where the SMSF incurred NALE of a general nature for 2018-19; 2019-20 & 2020-21 income years.

For the 2020–21 income year, Mikasa as trustee of her SMSF, engages an accounting firm, where she is a partner, to provide accounting services for the fund. The accounting firm does not charge the fund for those services.

22

NALE – rule of thumb (subject to final ruling)

Trustee/director provides service or performs activity for SMSF:

Service provided or activity performed in capacity as trustee → not NALE

Service provided or activity performed in individual capacity and expenditure is less than commercial → NALE

Another party provides service or performs activity:

Terms & price are in accordance with commercial practices → not NALE.

23

Ordinary & statutory income – NALI?During the 2018–19 income year, Kellie as trustee of her SMSF, entered into a non-commercial limited recourse borrowing arrangement (LRBA) with herself in her individual capacity to purchase a commercial property valued at $2 million.

Her SMSF borrowed 100% of the purchase price and the terms of the loan included interest being charged at a rate of 1.5% per annum and repayments only being made on an annual basis over a 25-year period.

Kellie’s SMSF received a commercial rate of rent from the property of $12,000 per month.

NALI Rental income Capital gain on

disposal

Example 4 – LCR 2019/D3

24

Ordinary & statutory income – NALI?

During the 2019–20 income year, Armin holds commercial property with a market value of $800,000.

During the income year, he sells the commercial property to himself acting as trustee of his self-managed superannuation fund (SMSF) for $200,000.

The SMSF leases the property to a third party.

NALI Rental income Capital gain on

disposal (market value substiutionrule may apply)

SISA section 66 issue

Example 1 – LCR 2019/D3

25

Ordinary & statutory income – NALI?

During the 2019-20 income year, Harold holds a commercial property with a market value of $800,000. During the income year, he sells the commercial property to himself acting as trustee of his self-managed superannuation fund (SMSF) for $800,000.

The SMSF leases the property to a company, controlled by Harold, for business purposes. The annual market rental is $80,000. Harold's company pays annual rent of $100,000.

NALI Rental income

Capital gain on disposal should

not be NALI

Not an LCR example

26

NALE – what’s to come

Finalisation of draft LCR 2019/D3:

Who or how to determine arm's length value for NALE?

- Application of de minimis rule?

- "Goods for own use" type ruling?

Extent to which business equipment, license and insurance is used

Review affected arrangements and modify by 1 July 2021

2019-20 compliance:

NALI rules continue to apply

Review NALE with direct nexus to specific income.

In summary What to remember: NALI and NALE

27

Summary points:

Expanded application of NALI applies from 1 July 2018

PCG 2020/5 only applies to expenditure that’s general in nature

Consider fund expenditure that relates to specific income

Determine if individual is providing or performing service in

their capacity as trustee/director or personal capacity

Where a trustee is remunerated ensure compliance with SISA

section 17B

Stay tuned for finalization of LCR 2019/D3

QUESTIONS?

Contact us

The information in this presentation has been prepared by Mark Ellem ABN 69 989 271 960 and Accurium Pty Ltd ABN 13 009 492 219 (Accurium). It is general information only and is not intended to be financial product advice, tax advice or legal advice and should not be relied upon as such. Whilst all care is taken in the preparation of this presentation, no warranty is given with respect to the information provided and Mark Ellem or Accurium is not liable for any loss arising from reliance on this information. Scenarios, examples and comparisons are shown for illustrative purposes only and should not be relied on by individuals when they make investment decisions. We recommend that individuals seek professional advice before making any financial decisions. This presentation was accompanied by an oral presentation, and is not a complete record of the discussion held. No part of this presentation should be used elsewhere without prior consent from the author.

28