Non-arm’s length expense rules for superannuation funds

SMSF Auditors Association of Australia Ltd

ABN: 70 627 274 248

Email: admin@smsfaaa.com.au

Unit 1A, 267 – 277 Norton St Leichhardt NSW 2040

Tel: (02) 8315-7796

21st February 2023

Retirement, Advice and Investment Division

The Treasury

Langton Crescent

Parkes ACT 2600

Dear Sir/Madam,

RE: Non-arm’s length expense rules for superannuation funds

SMSF Auditors Association of Australia Ltd is an association of SMSF audit professionals. We were founded in July 2018 and, at the time of writing, have 677 financial members. Our members are solely comprised of ASIC approved SMSF Auditors. It is our estimation that our members assist over 600 accounting practices and have audited over 40,000 SMSFs in the last twelve months.

The SMSF Auditors Association of Australia Ltd welcomes the opportunity to comment on Treasury’s Consultation paper on Non-arm’s length expense rules for superannuation funds.

Our submission is in two parts:

Part A – responses to questions raised in the consultation paper

Part B – additional comments in relation to non-arm’s length expense rules for superannuation funds

Yours faithfully,

David Burrows

Director

Part A - responses to questions raised in the consultation paper

1. Are there any potential unintended adverse consequences for superannuation funds, their members, and other stakeholders from adopting a sector-specific approach to the NALI provisions related to general expenses which applies different treatment to large APRA-regulated funds and SMSFs and SAFs?

We believe it is crucial the taxation rules apply consistently across all superannuation sectors and are concerned that progressing with this solution would set a dangerous precedent.

It is imperative that the tax outcomes for superannuants be equal no matter which sector of the superannuation industry they choose for their retirement savings. Establishing a difference could lead to confusion, resentment, and loss of trust.

In addition to a different taxation outcome, different systems of taxation legislation could increase the administration burden of SMSFs and SAFs whilst at the same time, reduce the admin burden for APRA regulated funds. This could further impact member return differentials between the sectors.

2. Would the approach outlined of setting an upper limit on the amount of fund income that is taxable as NALI due to a general expenses breach be sufficient to mitigate the ‘tainting effect’, where all income of the fund is potentially subject to the top marginal tax rate due to a relatively minor breach of the rules due to a general expense?

Setting an upper limit on the amount of fund income that is taxable as NALI due to a general expenses breach is certainly a better outcome than the potential of a SMSF’s entire income being ‘tainted’.

It does mitigate the 'tainting effect' though if the total income is less than 5 times the NALE general expenses breach, then all the income is still 'tainted'.

Even with the upper limit on the amount of fund income that is taxable as NALI, the tax outcome still appears to be disproportionate to the benefit received from the general expenses breach.

3. Are there any potential unintended adverse consequences for SMSFs or SAFs from setting an upper limit on the amount of fund income taxable as NALI due to a general expenses breach? Would there be unintended consequences from calculating the upper limit using a factor of 5?

Due to the difficulties in determining the quantum of a general expenses breach (refer to Part B of this submission), a consequence of the upper limit may be that non-compliance remains. We formed this view because the likelihood of the breach being identified are extremely slim and where an SMSF is found to have a general expenses breach, the existence of an upper limit caps the adverse tax outcome.

Conversely, an unintended adverse consequence of what appears to be a disproportionate taxation outcome for the members, is the compounding effect this would have on an individual's superannuation balance upon their retirement.

4. Would carving out large APRA-regulated funds from the NALI provisions for general expenses appreciably lower the compliance burden for large APRA-regulated funds?

As our Association is not familiar with the compliance aspects of APRA-regulated funds, we are not able to provide an answer to this question.

5. Are there any unintended adverse consequences for large APRA-regulated funds, their members, and other stakeholders from carving out large APRA-regulated funds from the NALI provisions for general expenses?

As stated earlier, an unintended consequence is an unlevel playing field is established between different superannuation sectors.

Part B - additional comments in relation to non-arm’s length expense rules for superannuation funds

General expenses

Our Association has a concern that section 295.550 of the Income Tax Assessment Act 1997 is creating unnecessary and irrelevant red tape. In the experience of our members, general expenses of an SMSF are not significant.

The main general expense for each SMSF is accounting fees with other general expenses incurred by an SMSF that could be subject to manipulation including investment adviser fees and legal fees. In relation to accounting fees specifically, determining the quantum of a general expenses’ ‘breach’ would be very difficult.

For example, if we consider example 1A from the consultation paper, the first thing to be determined is what proportion of the $5,000 accounting fee related to the SMSF’s income tax affairs. This is because as highlighted in LCR 2021/2, it is only the accounting fees other than those incurred in complying with the, or managing, the fund’s income tax affairs and obligations which are ordinarily deductible under section 25-5 of the ITAA.

Our Association is not aware of any industry-wide accepted distinction between the proportion of accounting fees and income tax related fees. Therefore, for the Australian Taxation Office (ATO) to effectively administer the taxation law in relation to accounting fees and general expenses, it would need to publish a position on what is an appropriate split. We believe this would be an extremely difficult task as the industry would have a wide range of views on what is related to tax.

Even if an accepted proportion of the annual accounting fee which related to tax was determined, the ATO would then have to analyse the non-tax component of the accounting fee to determine if it was at arm’s length. Again, this would be very difficult and subjective which would make it rare for the ATO to determine a general expenses ‘breach’ had occurred. The accounting fees for an SMSF do not generally fall into a one-size fits all. Also, due to the relatively small amounts involved, we do not believe this would be the best use of the ATO’s limited resources.

Also, to be considered is do general expense ‘breaches’ constitute a significant problem which needs addressing? What proportion of SMSFs have a related party prepare accounting or investment advice? If it is a relatively small amount, is it an issue worth capturing within the NALE general expense legislation which then only serves to increase compliance costs?

Potential Solution

The simplest way to address the issue would be to remove general expenses from the application of section 295-550 of the ITAA 1997. It would remove both the complexity in administering this section’s application to general expenses, and the disproportionate tax outcomes for non-compliance.

Specific expenses

Our Association is also of the opinion the application of the NALI rules to specific expenses needs to be revisited. We have concerns with the following:

• The disproportionate tax outcomes.

• The fact the NALI rules apply to assets acquired before 1 July 2017 and the inability to rectify non-arm's length acquisition issues, i.e., that the assets are forever tainted