One of the many Self-Managed Superannuation Fund (SMSF) rules that trustees need to be mindful of is the requirement that all transactions in their SMSF need to be at ‘arm’s length’.
The Australian Taxation Office’s recent finalisation of ruling LCR 2021/2 has put the focus on all SMSFs to carefully consider if all fund transactions are occurring on arm’s length terms. This can apply to all of the SMSF’s transactions – including income, outgoings and expenditures.
Any transactions that do not meet the arm’s length requirements are a breach of Section 109 of the SIS Act and can result in a 45% tax rate on the SMSF’s income under the Non-Arm’s Length Income (NALI) rules.
What is a Non-Arm’s Length Income (NALI) Transaction?
Income that has been derived by an SMSF on terms not consistent with normal market rates is considered a ‘non-arm’s length’ transaction. For example, an SMSF that leases a commercial property to a related party tenant at below the market rate of rent would be seen as a non-arm’s length transaction.
Hence, it is vital that SMSF trustees are across these rules when dealing with related parties.
What is a Non-Arm’s Length Expense (NALE) Transaction?
A ‘non-arms length’ expense is an expense incurred that is less than what would be expected from an ‘arm’s length’ dealing. Examples of ‘non-arm’s length’ expense transactions include:
- A SMSF Trustee is a plumber by trade and carries out a renovation to an investment property owned by the SMSF for no charge
- A SMSF Trustee is a licensed real estate agent and provides property management services for the investment property owned by the SMSF at a discounted rate
It is important to highlight that the ‘non-arm’s length’ rules are not confined just to related parties. Parties do not always need to be related for these rules to apply.
Further examples of non-arms length expenses can be viewed in the ATO’s ruling LCR 2021/2. You can view this ruling here.
What do SMSF trustees need to look out for?
The implications of not adhering to the arm’s length rules can be severe and could result in all SMSF income and capital gains being taxed at 45%.
Therefore, it is crucial all transactions are commercial and consistent with market rates.
- For related party transactions, the SMSF trustee should always obtain evidence from an independent third party that the transaction reflects a market rate (e.g. for a related party lease a rental appraisal from a real estate agent would be appropriate).
- For SMSF trustees who provide services to their SMSF that are similar to their own occupation or line of work – it is important that a market rate is charged for the services (e.g. labour).
If you are an SMSF trustee and have any questions or require assistance to comply with the ‘non-arm’s length’ rules, we are here to help. Please get in touch by filling out our Contact Us form. Alternatively, contact Simon Abbott for specialist advice on (03) 5244 6867 or email@example.com.
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This article was written by our Manager of Self-Managed Super Funds Simon Abbott.
Disclaimer: This information is of a general nature and should not be viewed as representing financial advice. Users of this information are encouraged to seek further advice if they are unclear as to the meaning of anything contained in this article. Davidsons accepts no responsibility for any loss suffered as a result of any party using or relying on this article.