Date posted: 30/07/2021 4 min read

ATO publishes final ruling on non-arm’s length tax rules for all super funds - Part 3

Chartered Accountants ANZ provides information on ATO ruling non-arm’s length expenditure and resulting much higher tax rates

The ATO has released its ruling, LCR 2021/2, on non-arm’s length income and expenditure provisions that apply to all super funds. 

The ruling was released on 28 July 2021.

This article should be read in conjunction with ATO publishes final ruling on non-arm’s length tax rules for all super funds Part 1 and ATO publishes final ruling on non-arm’s length tax rules for all super funds Part 2.

Trustees performing duties in trustee capacity or personal capacity

LCR 2021/2 also deals with trustees performing their duties in their personal capacity or their capacity as a trustee.

In example 11 (referred to above) the ATO says that the use of all related business services and equipment meant that Sharon was no longer performing duties in her trustee capacity.

The SIS Act ordinarily prevents a SMSF trustee from charging any remuneration for the duties they perform in managing their fund. Some limited exceptions are provided for recognised specialists who receive “remuneration that is no more favourable to them than that which it is reasonable to expect would apply if they were dealing with the relevant other party at arm’s length in the same circumstances” (LCR 2021/2, par 41).

The ATO says a trustee could be deemed to be acting in their individual capacity if any of the following apply:

  • The individual charges for their services
  • The individual uses the equipment or other assets of their business, profession or employment in a material manner; “…minor, infrequent or irregular use of equipment will not, of itself, indicate the individual is acting in their individual capacity”
  • The individual uses a license and/or qualification relating to their business, profession or employment – that is, the activity can only be performed by using the specific license or qualification
  • The activity is covered by an insurance policy relating to the business, profession or qualification.
If a trustee is acting in an individual capacity, then it is likely that the non-arm’s length penalty tax rate will apply to some or all of the fund’s income.

Non-arm’s length limited recourse borrowing arrangements (LRBA)

A non-arm’s length LRBA will typically arise if the requirements of PCG 2016/5 – including annual interest rate adjustments published by the ATO – or current terms offered by an arm’s length lender are not followed.

LCR 2021/2 says that if a fund acquires an asset via a non-arm’s length LRBA then all the income and resultant capital gain on the asset is subject to the super non-arm’s penalty tax rate.

Interaction with ATO Super Contribution Tax Ruling 2010/1

At the same time as releasing LCR 2021/2, the ATO released a draft revised version of TR 2010/2 dealing with superannuation contributions.

For over a decade when a super fund’s capital increased, TR 2010/1 typically deemed the value of that increase to be a super fund contribution.

This would be changed. In the first instance the income tax non-arm’s length income tax provisions need to be assessed first and then if they do not apply then a determination needs to be made on the contribution status in any increase in the fund’s capital value under TR 2010/1.

This means that “non arm’s length expenditure incurred to acquire an asset (including associated financing costs) will have a sufficient nexus to all ordinary or statutory income derived by the complying superannuation fund in respect of that asset. This includes any capital gain derived on the disposal of the asset … There will still be a sufficient nexus between the initial non arm’s length expenditure incurred to acquire an asset (including associated financing costs) and any capital gain derived on the disposal of the asset for the capital gain to be NALI even where the trustee subsequently refinances the borrowing arrangement on arm’s length terms.” (LCR 2021/2, par 18)

Interaction with PCG 2020/5

The ATO Practical Compliance Guide was recently re-published with updated terms. This essentially says that the ATO will not consider the impact of the new non-arm’s length rules for general expenses for all financial years between 1 July 2018 and 30 June 2022. However, it will consider this issue for specific expenses or outgoings from 1 July 2018.

SMSF auditors

Clearly, given the financial impact of the non-arm’s length provisions, it is possible that if this issue is not considered by auditors then the financial statements of a super fund could be materially misstated.

SMSF auditors may consider requesting trustees issue a representation letter stating if, and how, they have considered the non-arm’s length tax issues when preparing their fund’s financial accounts.

SMSF auditors might also consider stating in their engagement letter, or other method of reporting to trustees, that they have taken the trustees declaration about this issue into account when auditing the fund.

Many unanswered questions

There are many unanswered questions about this Law Companion Ruling and how it will apply in practise. We will endeavour to speak with the ATO about these issues and advise once we have answers.

Seeking legislative amendments

Because of the tax concessions attaching to superannuation there needs to be anti-avoidance provisions. We believe the current version of the anti-avoidance rules is too harsh and potentially targets many benign arrangements which involve no tax planning or avoidance motivations. We further believe it may be necessary to seek a legislative amendment to ensure the current anti-avoidance rule is narrowed.

CA ANZ Member queries

CA ANZ members with questions about this ruling should contact us at: [email protected].

Further reading

Read Part 1 and Part 2 for the complete breakdown of the final ruling on non-arm’s length tax rules for all super funds

Read Part 1Read Part 2