House of Representatives

Explanatory Memorandum

(Circulated by authority of the Assistant Treasurer and Minister for Financial Services, the Hon Stephen Jones MP)

Chapter 7 Non-arm's length expenses of superannuation funds

Outline of chapter

7.1 Schedule 7 to the Bill makes changes to the rules for non-arm's length expenses for superannuation entities. For ease of reference, the word "expense" is used to refer to a loss, outgoing or expenditure throughout this explanatory memorandum in relation to Schedule 7 to the Bill.

7.2 The changes made by Schedule 7 to the Bill improve the operation of the rules in relation to non-arm's length expenses that were introduced by the Treasury Laws Amendment (2018 Superannuation Measures No. 1) Act 2019. Non-arm's length expenses arise in two ways: where an expense is incurred for an amount that is less than might have been expected to be incurred if the parties had been dealing at arm's length, and where no expense is incurred but an expense might have been expected to be incurred had the parties been dealing at arm's length.

7.3 Schedule 7 to the Bill exempts large APRA-regulated funds, including exempt public sector superannuation funds, PSTs and ADFs from the non-arm's length income rules to the extent they relate to non-arm's length expenses. However, these entities are still subject to the remaining non-arm's length income rules for income derived on a non-arm's length basis.

7.4 For SMSFs and small APRA-regulated funds these amendments apply different treatment depending on the type of non-arm's length expense incurred.

7.5 Any non-arm's length expense is either a specific expense or a general expense. A general expense is an expense that is not related to gaining or producing income from a particular asset or assets of the fund. A specific expense is any other expense. 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 is always a specific expense.

7.6 For specific expenses the previous treatment continues to apply, and the amount of income that is taxed as non-arm's length income is the amount of income derived from the scheme in which the parties were not dealing at arm's length.

7.7 For general expenses the amount of income that is taxed as non-arm's length income is twice the difference between the amount of the expense that might have been expected to be incurred had the parties been dealing at arm's length, and the amount the entity did incur. Where the entity did not incur any expense, the amount of income that is taxed as non-arm's length income is twice the amount that might have been expected to be incurred had the parties been dealing at arm's length.

7.8 The total amount of an SMSF or small APRA-regulated fund's non-arm's length component is capped at an entity's taxable income for the year not including any assessable contributions or any deductions against assessable contributions.

7.9 These changes apply to income derived in the 2018-19 income year or a later income year, but not to expenses incurred or expected to have been incurred prior to 1 July 2018.

Context of amendments

7.10 Superannuation industry stakeholders raised a range of concerns with the original 2019 non-arm's length expense provisions contained in the Treasury Laws Amendment (2018 Superannuation Measures No. 1) Act 2019. Stakeholders also raised concerns with potential amendments to the non-arm's length expense provisions released for consultation in January 2023. Stakeholders expressed concerns that the law prior to these amendments led to harsh outcomes for relatively minor breaches in respect of expenses, such as accounting fees, that have a sufficient nexus to all income of the fund. In these circumstances, a small advantage obtained by minimising an expense through a non-arm's length transaction can result in all income of the fund for that year being taxed at the highest marginal rate.

7.11 When the original 2019 non-arm's length expense provisions were enacted, they applied to the 2018-19 income year and following income years. This resulted in the highest marginal tax rate applying in respect of income derived in the 2018-19 income year, despite the expenses giving rise to that income being incurred prior to the provisions being enacted.

7.12 Prior to these amendments, the provisions applied equally to all complying superannuation entities, rather than being tailored to the level of risk. For large APRA-regulated funds there is a lower risk that these funds will gain a tax advantage by engaging in schemes with related parties to incur expenses at less than arm's length. These funds are exempt from additional compliance burdens to account for this lower tax integrity risk.

Comparison of key features of new law and current law

Table 7.1 Comparison of new law and current law

Detailed explanation of new law

7.13 These amendments change the non-arm's length expense rules for complying superannuation entities. These changes restrict the operation and application of the rules.

Different approaches for different funds

7.14 These amendments apply different rules to different entities based on the size of the entity. The non-arm's length expense rules only apply to small APRA-regulated funds and SMSFs. The existing definition of SMSF in section 995-1 of the ITAA 1997 is used. A small APRA-regulated fund is any regulated superannuation fund that has 6 or fewer members other than an SMSF. [Schedule 7, item 3, paragraph 295-550(5)(b) and (c) of the ITAA 1997]

7.15 All other complying superannuation entities are exempt from the non-arm's length expense rules. These entities include APRA-regulated funds with more than 6 members, PSTs, ADFs, and exempt public sector superannuation funds. The size of these entities means that they are less likely to be influenced by individual members or related parties, and those related parties will also have less incentive to enter into schemes of the kind which result in tax arbitrage. [Schedule 7, items 1, 2 and 3, subsections 295-545(2) and 295-550(1) and 295-550(5) of the ITAA 1997]

7.16 By contrast, members of smaller funds may have the capacity to control or influence the arrangements of the fund to directly inflate their superannuation balance though non-arm's length expenses to take advantage of lower tax rates. The tax penalty for non-arm's length expenses is a strong disincentive from using non-arm's length arrangements for small funds which cannot be adequately addressed through other provisions such as those related to contributions and trustee responsibilities.

7.17 For small APRA-regulated funds and SMSFs, the rules apply a different approach based on the kind of expense that is, or might have been expected to be, incurred. Whilst specific expenses continue to be subject to the same treatment as prior to these amendments, the consequences of gaining an advantage through a non-arm's length transaction in relation to general expenses are lessened.

7.18 This is achieved by amending the existing non-arm's length expense provision in paragraph 295-550(1)(b) so that it does not apply to expenses incurred that are covered under subsection 295-550(8), which covers general expenses incurred for an amount that is less than what might have been expected to be incurred at arm's length. [Schedule 7, item 2, subsection 295-550(1) of the ITAA 1997]

7.19 Similarly, paragraph 295-550(1)(c) is amended so that it does not apply to expenses covered under subsection 295-550(9), which covers general expenses which are non-arm's length expenses where no expense was incurred but might have been expected to be incurred at arm's length. [Schedule 7, item 2, subsection 295-550(1) of the ITAA 1997]

7.20 For small APRA-regulated funds and SMSFs with a general non-arm's length expense, the resulting non-arm's length income is calculated under subsection 295-550(8) where an expense is incurred and subsection 295-550(9) where no expense is incurred. Where an expense is incurred, the resulting non-arm's length income is the amount that might have been expected to be incurred if the parties had been at arm's length, minus the amount actually incurred, with the resulting number multiplied by two. Where no expense is incurred, the resulting non-arm's length income is twice the amount that might have been expected to be incurred if the parties had been at arm's length. [Schedule 7, item 4, subsections 295-550(8) and 295-550(9) of the ITAA 1997]

7.21 To implement this approach, the amendments change the way that the non-arm's length component is calculated with a different approach for small funds, meaning SMSFs and small APRA-regulated funds, and other complying superannuation entities. [Schedule 7, item 1, subsections 295-545(2) and 295-545(2A) of the ITAA 1997]

7.22 Large APRA-regulated funds, PSTs, ADFs and exempt public sector superannuation funds continue to calculate their non-arm's length component in the same way as prior to these amendments, but the rules in relation to non-arm's length expenses do not apply to these entities. [Schedule 7, item 1, subsection 295-545(2) of the ITAA 1997]

7.23 For small APRA-regulated funds and SMSFs, there is a change to the deduction rules in relation to general expenses. The actual amount incurred for a general non-arm's length expense will not be deductible against the non-arm's length component. This is because the new approach for calculating the consequence of incurring a general non-arm's length expense already takes into account any amount actually incurred in relation to the general expense, by subtracting it from the amount that might have been expected to be incurred if the parties had been at arm's length, before multiplying the result by two to arrive at the non-arm's length income. Therefore, in calculating the non-arm's length income relating to a general non-arm's length expense, there is no deduction available for the amount actually incurred so that there is not double counting of that amount. [Schedule 7, item 4, subsections 295-550(8) and 295-550(9) of the ITAA 1997]

7.24 For small APRA-regulated funds and SMSFs a cap is introduced on their total non-arm's length component to ensure that assessable contributions minus related deductions are always part of the low tax component. Assessable contributions are subject to other taxing provisions, and it is not intended that they be subject to higher rates of tax under the non-arm's length income provisions.

7.25 These amendments do not alter the existing meaning or definition of 'contribution'. Contribution takes its ordinary meaning as it does in other parts of the ITAA 1997, for example in section 285-1 of the ITAA 1997, and nothing in Schedule 7 to the Bill disturbs that meaning.

7.26 A small APRA-regulated fund or SMSF's non-arm's length component is calculated as the lesser of:

•

the sum of:

-

any non-arm's length income amount (other than non-arm's length income as a result of a general expense) less any deduction attributable to that non-arm's length income amount; and

-

any non-arm's length income as a result of a general expense that is a non-arm's length expense; and

•

the total of an entity's taxable income for the year, excluding any contributions that are part of an entity's assessable income (this is achieved by subtracting them from the calculation), and excluding any deductions against those contributions (this is achieved by adding them to the calculation).

[Schedule 7, item 1, subsection 295-545(2A) of the ITAA 1997]

Meaning of non-arm's length and internal arrangements

7.27 For the non-arm's length income rules to apply to a scheme, it is necessary that the parties to the scheme were not dealing with each other at arm's length.

7.28 The requirement that parties not be dealing with each other at arm's length means that the non-arm's length income rules do not apply in respect of a superannuation entity's arrangements that are purely internal. This is because an entity's internal functions are not undertaken with another party on any terms, non-arm's length or otherwise.

7.29 For example, an SMSF trustee may undertake bookkeeping activities for no charge in performing their trustee duties. Such internal arrangements are outside of the scope of the non-arm's length income rules as they do not constitute a scheme between parties dealing with one another on a non-arm's length basis.

7.30 In certain cases, the trustee of a fund may undertake particular activities in performing its duties or choose to outsource those functions to third parties (for example, if the fund had a real estate portfolio, the trustee may be able to manage the properties or contract the services of a real estate agent). The question of whether the non-arm's length income rules apply in respect of services or functions that are undertaken by the trustee depends on the capacity in which the trustee undertakes those activities.

7.31 As a general rule, the trustee of an SMSF is prevented from charging for the services or functions that it undertakes in its capacity as trustee by paragraph 17A(1)(f) of the SIS Act. Services of this kind do not involve a scheme between parties as they fundamentally relate to the trustee's obligations in respect of the fund.

7.32 If the trustee is not acting as a trustee but is instead providing services that are procured as a third-party, the non-arm's length income rules are intended to apply. Provided that the amount charged for any such services is not less than that which would be expected to be charged between parties dealing at arm's length, the dealings are not subject to the non-arm's length income rules. In such cases, the trustee of an SMSF may also be prevented from charging any more than the arm's length price because of the regulatory requirements in the SIS Act (see section 17B of the SIS Act, which permits a trustee to charge up to an arm's length amount for duties or services performed other than in the capacity as trustee).

Types of expenses

7.33 When a small APRA-regulated fund or an SMSF incurs an expense as a part of a scheme with related parties and that expense is related to earning income from a particular asset of the fund, that is referred to here as a specific expense. [Schedule 7, item 2, paragraphs 295-550(1)(b) and (c) of the ITAA 1997]

7.34 This also applies where an expense is not incurred but is expected to be incurred, which is referred to as an expected expense.

7.35 A general expense is an expense that is incurred otherwise than in gaining or producing income from any particular asset or assets of the fund (including the acquisition of the asset itself). [Schedule 7, item 4, subsections 295-550(8) and 295-550(9) of the ITAA 1997]

7.36 For the purposes of this explanatory memorandum, any other expense incurred as part of a scheme where parties are not dealing with each other at arm's length and where the expense is less than would have been expected to have been incurred had the parties been dealing with each other at arm's length (including not being incurred where it would have been expected to have been incurred) and that expense is in relation to a particular asset or assets, is referred to as a specific expense. This term is not defined in the legislation but is used to differentiate these expenses from general expenses.

7.37 Even where the income from the particular asset or assets comprises all of the income of the fund in a particular year, the expense is still a specific expense if it relates to the particular asset or assets.

7.38 To establish which category an expense falls into, it is necessary to examine whether or not the expense is incurred in relation to a particular asset or assets of the fund. Where an expense is incurred in relation to a particular asset or assets of the fund it is a specific expense. In addition to the acquisition of an asset itself, some examples of specific expenses include:

•

maintenance expenses for a rental property;

•

investment advice fees for a particular pool of investments; and

a

limited recourse borrowing arrangement for the purchase of a specific asset.

7.39 Although this list provides some guidance about what types of expenses are specific expenses, it is not intended to be an exhaustive list and each expense must be considered in relation to the facts and circumstances in which it is incurred. For example, expenses related to income derived by an entity as a beneficiary of a trust through holding or acquiring a fixed entitlement to the income of a trust are always specific expenses. This is because such expenses are always related to a particular asset or assets as a fixed entitlement is itself a particular asset. No changes are made to how the provisions apply in circumstances where specific expenses are non-arm's length expenses beyond excluding large APRA-regulated funds, exempt public sector superannuation funds, PSTs and ADFs. [Schedule 7, item 3, paragraphs 295-550(5)(b) and (c) of the ITAA 1997]

7.40 Where a specific expense is incurred as a result of a scheme in which the parties are not dealing with each other at arm's length and the entity is a small APRA-regulated fund or SMSF, the amount of income that is non-arm's length income is the same as the treatment prior to these amendments. All of the ordinary or statutory income that results from the scheme is non-arm's length income. [Schedule 7, item 2, paragraphs 295-550(1)(b) and (c) of the ITAA 1997]

7.41 As general expenses have a sufficient nexus to the entirety of the income of the fund, rather than a particular asset or assets of the fund, general non-arm's length expenses are treated differently from specific expenses. These expenses usually relate to the operation or obligations of the fund as a whole. [Schedule 7, item 4, paragraph 295-550(8)(b) of the ITAA 1997]

7.42 Prior to these amendments, this resulted in the entire income of the fund becoming non-arm's length income and being taxed at a higher tax rate, even when the expense that is incurred on a non-arm's length basis, or not incurred at all, can be relatively small.

General expenses treatment

7.43 Under these amendments, when the expense that is incurred on a non-arm's length basis is a general expense, the income that is non-arm's length income as a result of the scheme is limited to twice the amount of the difference between the actual amount of the expense incurred and the amount of the expense that might have been expected if the parties had been dealing at arm's length. Where no expense was incurred, the amount would be twice the amount that might have been expected if the parties had been dealing at arm's length. [Schedule 7, item 4, subsections 295-550(8) and 295-550(9) of the ITAA 1997]

7.44 As the amount of any expense actually incurred has already been taken into account under the approach outlined in the paragraph above in calculating the amount of non-arm's length income that results from a non-arm's length general expense, the amount actually incurred for a non-arm's length general expense cannot be deducted against a fund's non-arm's length component. [Schedule 7, item 1, subsection 295-545(2A) of the ITAA 1997]

7.45 The non-arm's length component is capped at an amount equal to the entity's total taxable income for the year other than assessable contributions and excluding deductions against assessable contributions. This cap applies where it results in a smaller amount than the total of all amounts of non-arm's length income calculated for all general and specific non-arm's length expenses and any other non-arm's length income arising from the non-arm's length income provisions that aren't related to expenses. If the cap calculation results in a negative number, the non-arm's length component is zero. [Schedule 7, item 1, subsection 295-545(2A) of the ITAA 1997]

7.46 In this way the maximum amount of non-arm's length component does not exceed taxable income for the year and never includes contributions even if there is no other income of the fund.

7.47 Although not intended to be an exhaustive list, some of the items that would be expected to fall within the category of general expenses are:

•

actuarial costs;

•

accountant fees;

•

fees to an auditor;

•

administrative costs in managing the fund;

•

trustee fees;

•

costs of complying with the regulatory obligations of the fund; and

•

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.

Example 7.1

Al is the director of Purple Co. Purple Co is the corporate trustee of an SMSF of which Al is the sole member. Al, through his accounting firm Al Accountants, provides general accounting services to his SMSF in circumstances such that these services are provided in a capacity other than as a trustee and meet the other requirements of section 17B of the SIS Act. Although Al's accounting firm charges his clients $3,000 for these types of services, his SMSF acquires the services free of charge.

The acquisition of accounting services by the SMSF constitutes a scheme between Al and their SMSF in which the parties were not dealing with each other at arm's length. No expense was incurred when the SMSF would have been expected to have incurred an expense in respect of acquiring the accounting services had the parties been dealing at arm's length, so the non-arm's length expense provisions apply. The accounting services were general in nature and did not relate to any particular asset or assets so are a general expense that is a non-arm's length expense captured under subsection 295-550(9).

The total income of the SMSF in 2023-24 is $20,000 in rent from a rental property to which $5,000 in eligible deductions for maintenance apply, resulting in a taxable income in 2023-24 of $15,000. No assessable contributions were made in that income year.

As no expense was incurred towards the general accounting services, the amount of non-arm's length income under subparagraph 295-545(2A)(a)(ii) is twice the amount that might have been expected to have been incurred, or twice the $3,000 value of the services, which is $6,000.

Applying the cap on the total non-arm's length component, the cap amount is the total of income other than assessable contributions, minus deductions other than deductions against assessable contributions. In this case, the cap is the $20,000 in rental income minus the $5,000 in deductions against that rental income, giving $15,000. As the cap on the total non-arm's length component is higher than the non-arm's length component arrived at above, the non-arm's length component remains at $6,000 to be taxed at the highest marginal rate. This leaves a low-tax component of $9,000. The low tax component is any remaining taxable income after calculating the non-arm's length component.

Example 7.2

Min is a trustee of an SMSF. The members of the SMSF are Min and Min's spouse Tony. Min is a lawyer and through her law firm, Min Lawyers, provides general legal services, worth $10,000 to their SMSF which the SMSF acquires for $5,000. These services were provided in circumstances such they were provided in a capacity other than as a trustee and meet the other requirements of section 17B of the SIS Act.

Min offers the same services she provides to the SMSF to the general public and the market value of these services is readily apparent from the fee schedule available on Min's website.

The acquisition of legal services by the SMSF constitutes a scheme between Min and their SMSF in which the parties were not dealing with each other at arm's length, and the expense was incurred at a value less than what the SMSF would have been expected to have incurred as an expense had the parties been dealing at arm's length, so the non-arm's length expense provisions apply. The legal services were general in nature and did not relate to any particular asset or assets so are a general expense that is a non-arm's length expense captured under subsection 295-550(8).

The total income of the SMSF in 2023-24 is $23,000 in rent from a rental property to which $10,000 in eligible deductions for maintenance apply. No assessable contributions were made in that income year.

The taxable income is calculated as $23,000 in rent income minus $10,000 in deductions minus $5,000 charged for legal services, equalling $8,000.

As a general expense of $5,000 was incurred, which would have been $10,000 if the parties had been dealing at arm's length, the amount of non-arm's length income is twice the amount of the difference between what was incurred and what would have been expected to have been incurred had the parties been dealing at arm's length, which is $10,000.

Applying the cap on the total non-arm's length component, the cap amount is the total of income other than assessable contributions, minus deductions other than deductions against assessable contributions. In this case, the cap is the $23,000 in rental income minus the $15,000 in deductions, giving $8,000. This cap is lower than the non-arm's length component arrived at above, so the non-arm's length component becomes $8,000 instead of $10,000, as previously calculated.

This leaves a low-tax component of $0. The low tax component is any remaining taxable income after calculating the non-arm's length component.

Example 7.3

Andrew and Stephanie are married and are trustees of their SMSF and the only members of the fund.

Andrew is a lawyer and through his law firm, Andrew Lawyers, provides general legal services, which the SMSF acquires at no charge. The market rate for these services is $2,000 which is readily apparent from the fee schedule available on Andrew's website. These services were provided in circumstances such they were provided in a capacity other than as a trustee and meet the other requirements of section 17B of the SIS Act.

The acquisition of legal services by the SMSF constitutes a scheme in which the SMSF and Andrew are not dealing with each other at arm's length, and the expense was incurred at a value less than what the SMSF might have been expected to have incurred at arm's length. The legal services were general in nature and did not relate to any particular asset or assets so are a general expense that is a non-arm's length expense captured under subsection 295-550(9).

Stephanie is an investment advisor and through her business, Steph's Advisory Firm, provides investment services to her SMSF. Stephanie provides her SMSF with investment services for the fund as a whole, not on any specific investment or pool of investments. The market value of these services is $2,000 which the SMSF acquires at no charge. These services were provided in circumstances such they were provided in a capacity other than as a trustee and meet the other requirements of section 17B of the SIS Act.

The acquisition of investment advice for free constitutes a scheme in which the SMSF and Stephanie are not dealing with each at arm's length, the advice is valuable and is provided at no cost and the facts establish that Stephanie can and does charge $2,000 for the same service provided to unrelated parties. These services were general in nature, being advice acquired by the SMSF on its general investment strategies, and do not relate to any particular asset or assets of the fund. They are therefore a general expense that is a non-arm's length expense captured under subsection 295-550(9).

The total income from the SMSF in 2023-24 is $22,000, this is earned from a rental property. There are $7,000 of deductions associated with this income resulting in taxable income for 2023-24 being $15,000.

There were two general expenses that are non-arm's length expenses for which a total of $4,000 might have been expected to be incurred had the parties been dealing at arm's length, but no expense was incurred for either. The amount of non-arm's length income would be $8,000 representing twice the amount of the expenses that were not incurred but would have been if the parties had been dealing at arm's length.

Applying the cap on the total non-arm's length component under the 295-545(2A)(b), the non-arm's length component cap is $15,000. As the cap is higher than the amount previously calculated, the non-arm's length component remains $8,000.

This leaves a low-tax component of $7,000. The low tax component is any remaining taxable income after calculating the non-arm's length component.

Example 7.4

Jai is the sole director of Yellow Co. Yellow Co is the corporate trustee of an SMSF of which Jai is the sole member. Jai is an accountant and through his accounting firm Jai Accountants, provides general accounting services to their SMSF worth $3,000 which the SMSF acquires free of charge. These services were provided in circumstances such they were provided in a capacity other than as a trustee and meet the other requirements of section 17B of the SIS Act.

The acquisition of accounting services by the SMSF constitutes a scheme between Jai and their SMSF in which the parties were not dealing with each other at arm's length, and no expense was incurred when the SMSF would have been expected to have incurred an expense had the parties been dealing at arm's length. The accounting services were general in nature and did not relate to any particular asset or assets so are a general expense that is a non-arm's length expense captured under subsection 295-550(9).

The total income of the SMSF in 2023-24 is $20,000 in rent from a rental property to which $5,000 in eligible deductions for interest apply. No assessable contributions were made in that income year.

Jai's spouse Sam is a licensed builder and blocks time out of his work calendar to conduct renovations on the SMSF's rental property worth $3,000 for which nothing is charged. These services are provided by an entity (Sam) who is separate from the SMSF and as such, should have been on arm's length terms to avoid non-arm's length income consequences. The renovations were an expense incurred in deriving income from a particular asset, the asset being the rental property. The renovations are a specific non-arm's length expense to which paragraph 295-550(1)(c) applies.

The taxable income of the fund in 2023-24 is $20,000 in rental income minus $5,000 in deductions, which equals $15,000.

When calculating the non-arm's length component, the fund must account for a non-arm's length specific expense related to the $20,000 in rental income and a general expense that is a non-arm's length expense related to the accounting services.

In relation to the specific expense, the amount under subparagraph 295-545(2A)(a)(i) is the non-arm's length income arising from the specific non-arm's length expense under subsection 295-550(1) minus attributable deductions, which is the $20,000 in rental income minus the $5,000 in rental attributable deductions resulting in $15,000.

In relation to the general expense, the amount under subparagraph 295-545(2A)(a)(ii) is the non-arm's length income arising from the general expense that is a non-arm's length expense under subsection 295-550(9), which in this case is 2x $3,000 which equals $6,000.

The sum of the amounts under subparagraphs 295-545(2A)(a)(i) and (ii) is $15,000 + $6,000 which equals $21,000.

The cap on the non-arm's length component under paragraph 295-545(2A)(b) is the entity's taxable income excluding assessable contributions and any deductions against assessable contributions. In this case, this is $15,000 as there are no assessable contributions or deductions against them.

The amount of the non-arm's component is the lesser of the amount under paragraph 295-545(2A)(a) and the amount under paragraph 295-545(2A)(b). As $15,000 is less than $21,000, the total non-arm's length component is $15,000.

This leaves a low-tax component of $0. The low tax component is any remaining taxable income after calculating the non-arm's length component.

Example 7.5

Malia is one of four members of a small APRA-regulated superannuation fund. She is not a trustee of the fund because small APRA-regulated superannuation funds need to have a licensed corporate trustee. Malia is an accountant and provides general accounting services to the small superannuation fund worth $10,000 which the small superannuation fund acquires for $5,000.

The acquisition of accounting services by the fund constitutes a related party scheme between Malia and the small superannuation fund. As the amount of the expense the small superannuation fund would have been expected to have incurred had the parties been dealing at arm's length, the non-arm's length expense provisions apply. The accounting services were general in nature and did not relate to any particular asset or assets so are a general expense that is a non-arm's length expense captured under subsection 295-550(8).

The total income of the small superannuation fund in 2023-24 is $23,000 in rent from a rental property which is rented to Malia's accounting business. Had the property been rented at arm's length, it might have been expected to receive $15,000 in rent based on known rents for comparable tenanted commercial properties.

The rental arrangement constitutes a scheme between Malia's accounting business and the small superannuation fund at arm's length, resulting in a higher rental income than the rental income that might have resulted had the property been rented at arm's length. The non-arm's length income provisions apply under paragraph 295-550(1)(a) to make the rental income non arm's length income.

Maintenance was carried out on the commercial property at arm's length constituting $10,000 in eligible deductions. No assessable contributions were made in that income year.

The taxable income of the fund in 2023-24 is $23,000 rental income minus $10,000 in deductions for property maintenance and minus $5,000 incurred for accounting services, which equals $8,000.

Under 295-550(1), the $23,000 of property income of the fund is non-arm's length income. The non-arm's length component is calculated by adding the non-arm's length rental income of $23,000 minus the related deduction of $10,000 plus the amount derived for the general expense that is a non-arm's length expense, being $10,000, giving a total of $23,000. However, the non-arm's length component cap in paragraph 295-545(2A)(b) equivalent to taxable income of $8,000 will limit the non-arm's length component to $8,000.This leaves a low-tax component of $0. The low tax component is any remaining taxable income after calculating the non-arm's length component.

Example 7.6

Tanya is a trustee of her SMSF. Tanya is a lawyer and through her firm Tanya Solicitors, provides general legal services to her SMSF worth $17,000, which the SMSF acquires for $12,000. These services were provided in circumstances such that they were provided in a capacity other than as a trustee and meet the other requirements of section 17B of the SIS Act.

Tanya offers the same services she provides the SMSF to the general public and the market value of these services is readily apparent from the fee schedule available on Tanya's website.

The acquisition of legal services by the SMSF constitutes a scheme between Tanya and their SMSF in which the parties were not dealing with each other at arm's length, and the expense was incurred at a value less than what the SMSF would have been expected to have incurred as an expense had the parties been dealing at arm's length, so the non-arm's length expense provisions apply. The legal services were general in nature and did not relate to any particular asset or assets so are a general expense that is a non-arm's length expense captured under subsection 295-550(8).

The taxable income of the SMSF in 2023-24 is $34,000 in rent from a rental property, to which $15,000 in eligible deductions for property maintenance apply, together with a $12,000 deduction for the legal services, plus $10,000 in assessable contributions to which a $1,000 deduction applies. The taxable income of the fund is $16,000.

In relation to the general expense, the approach under subsection 295-550(8) gives twice the difference between the $12,000 that was incurred for legal services and the $17,000 value of the expense had parties been dealing at arm's length, which gives $10,000.

The cap on the non-arm's length component for the purposes of paragraph 295-545(2A)(b) is calculated as $16,000 in taxable income less the $10,000 in assessable contributions plus the $1,000 deduction incurred in relation to the assessable contributions, equalling $7,000. As this is lower than the $10,000 previously calculated, the cap applies to limit the non-arm's length component to $7,000.

This leaves a low-tax component of $9,000. The low tax component is any remaining taxable income after calculating the non-arm's length component.

The low tax component for this fund would be equal to the amount of assessable contributions excluded from the non-arm's length component minus deductions attributable to them. This ensures the assessable contributions are never taxed at the highest marginal tax rate.

Commencement, application, and transitional provisions

7.48 The amendments commence on the start of the first quarter after the day the Act receives Royal Assent. [Schedule 7, item 5, Application provision]

7.49 These amendments apply to income derived in the 2018-19 income year or later years, and any expense incurred, or not incurred but which might have been expected to have been incurred, in the 2018-19 income year or later.

7.50 To avoid doubt, although the amendments apply to income derived in the 2018-19 income year or a later year, they do not apply if that income is derived in relation to an expense that is incurred, or was not incurred but might have been expected to have been incurred, prior to the 2018-19 income year.

7.51 For the avoidance of doubt, because of Schedule 7 to the Bill there is no time at which the amendments made by Schedule 2 to the Treasury Laws Amendment (2018 Superannuation Measures No. 1) Act 2019 apply.

7.52 When the non-arm's length expense rules were introduced, they applied to income derived in the 2018-19 and later income years. Schedule 7 to the Bill amends the non-arm's length expense rules retrospectively from their first operation. This retrospectivity was requested by taxpayers during consultation on the draft legislation, to provide certainty and to ensure that the benefits of the amendments are backdated. Under Schedule 7 to the Bill, the non-arm's length expense rules will never have applied to large APRA-regulated funds or exempt public sector superannuation funds, PSTs and ADFs and the consequences of a general non-arm's length expense for small APRA-regulated funds and SMSFs will always be limited to the approach set out in Schedule 7 to the Bill.

7.53 As these changes are to the benefit of taxpayers compared with the 2018-19 amendments this retrospectivity does not disadvantage any taxpayers.

7.54 Accepting the concerns raised by stakeholders as outlined in para 7.10 about the potential for harsh consequences as a result of the amendments made by Treasury Laws Amendment (2018 Superannuation Measures No.1) Act 2019, making these changes retrospective ensures there is no period where those harsh consequences apply and provides consistency by ensuring the new approach to non-arm's length expenses applies instead.