The New Expense Rules for Super Funds

New legislation will change how the non-arm's length expense rules are managed for superannuation funds.

As you know, the non-arm's length income (NALI) rules were extended in 2018 to prevent superannuation trustees artificially increasing the balance of the fund, and accessing preferential tax treatment on the higher amount, by failing to recognise expenses incurred by the fund provided by a related party at a reduced rate. For example, your brother is a qualified accountant and does your SMSF’s accounting work for free (that he would normally charge $5k for).

Currently, where general expenses incurred by the fund are below market rates, any income derived by the fund could be deemed to be non-arm’s length income and taxed at the top marginal tax rate.

The proposed changes

Treasury Laws Amendment (Support for Small Business and Charities and Other Measures) Bill 2023 amends the rules around non-arm’s length expenses of superannuation funds (excluding large APRA-regulated funds, exempt public sector superannuation funds, PSTs and ADFs).

The type of expenses makes a difference

The tax treatment of expenses that are incurred on a non-arm's length basis will depend on whether you are dealing with a general or specific expense:

• General expense - an expense that is not related to gaining or producing income from a particular asset of the fund.
• Specific expense – an expense that relates to a specific asset of the fund. For example, a property.

General expenses

Under the new rules, general non-arm’s length expenses will result in a maximum of twice the difference between the amount that would have been expected at arm’s length and the amount actually incurred being treated as NALI, with no deductions applying against that amount. The total amount taxed at the highest marginal rate is then capped to no more than the income of the fund minus deductions, excluding assessable contributions and deductions against them.

General expenses most commonly include:

• Actuarial costs
• Accountant fees
• Auditor fees
• Administrative costs in managing the fund
• Trustee fees
• Costs of complying with the regulatory obligations of the fund
• Investment adviser fees, where those fees relate generally to the operation of the fund and not to a specific investment or a particular pool of investments

Specific expenses

The existing treatment will continue to apply. The amount of income that will be taxed as NALI will be the amount of income derived from the 'scheme' in which the parties were not dealing at arm’s length.

Specific expenses (related to gaining or producing income) could include:

• Maintenance expenses for a rental property
• Investment advice fees for a particular pool of investments
• A limited recourse borrowing arrangement for the purchase of a specific asset
• The purchase of an asset such as a rental property or shares
• An expense incurred in relation to gaining or producing income as a beneficiary of a trust through holding or acquiring a fixed entitlement to the income of a trust will always be a specific expense.

What’s a scheme?

NALI applies where the ATO considers that a scheme exists.

Let’s look at what’s not a scheme first. It’s not a scheme where it is an internal arrangement between the fund and the trustee. For example, if the trustee performs a bookkeeping function for the fund as part of the trustee's obligations to maintain the fund (the trustee cannot charge for these services under 17B of the SIS Act).

A scheme does exist where the:

• Trustee is not acting as a trustee but is instead providing services that are procured as a third-party; and
• Amount charged for their services is less than what would have been charged if the parties were dealing at arm’s length.

Note also that the trustee cannot charge more than what would have been charged if the parties had been dealing at arm’s length under section 17B of the SIS Act.

So, what does all of that mean in practice?

Let’s dissect that with example 7.1 from the explanatory memorandum.

The example set’s out that the accounting services provided to Al’s SMSF for free are caught by the NALI rules to the amount of $6,000 (twice the value of the services - 2 x $3,000). As the $6,000 is less than the SMSF’s cap of $15,000 (in this case total income minus deductions), tax will apply to the whole of the NALI component.

If however, the SMSF’s cap had been $5,000, the NALI component would be capped to $5,000.

Timing

The amendments will apply to expenses incurred or expected to be incurred from 1 July 2018.