SMSFs must transact on an arm’s-length basis. The purchase and sale price of fund assets should always reflect the true market value of the asset, and the income from assets held by a fund should always reflect the true market rate of return.

Any non-arm’s length income (NALI) is taxed at the highest marginal rate. The ATO states that broadly, income is NALI for a complying SMSF if it is:

• derived from a scheme in which the parties weren’t dealing with each other at arm’s length, and
• more than the SMSF might have been expected to derive if the parties had been dealing with each other at arm’s length.

When the ATO released the draft law companion ruling LCR 2019/D3 (Non-arm’s length income – expenditure incurred under a non-arm’s length arrangement) it also issued practical compliance guideline PCG 2019/D6 (Compliance approach for complying superannuation funds in respect of applying the non-arm’s length income provisions to ‘non-arm’s length expenditure’). This spells out the ATO’s transitional compliance approach regarding amendments to the NALI provisions.

The release of these guidance materials by the ATO underlines the revenue agency’s view that the amendments will apply to non-arm’s length expenditure of a general nature that has a sufficient connection to all ordinary and/or statutory income derived by the fund in an income year. 

It is also recognised that this applies to the 2018-19 and later income years, which may result in all income derived by a fund during the 2018-19 and 2019-20 income years being classified as NALI where it has incurred non-arm’s length expenditure of a general nature.

In these circumstances, the ATO considers it is appropriate to apply a transitional compliance approach for these income years by not allocating compliance resources to determine whether NALI applies:

• 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 (for example, non-arm’s length expenditure on accounting services); and
• where the fund incurred NALE that directly related to the fund deriving particular ordinary or statutory income during the 2018-19 and 2019-20 income year.

The implications of the new measures had much wider ramifications than the ATO initially thought. Trustees would be well advised to ensure that many of these arrangements are reviewed accordingly to avoid an unintended outcome.