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12 October 2023

The importance of adequate evidence to fight a non-arm’s length income (NALI) assessment in an SMSF – the AAT speaks!

Authored by: Scott Hay-Bartlem
Income that is NALI is taxed to the SMSF at the top marginal tax rate rather than the usual concessional rates, so having additional amounts deemed to be NALI can result in a significant increase in tax for an SMSF.

Broadly, income will be NALI when it is more than would have been received by the SMSF had the SMSF been dealing with the other party on arm’s length terms.

So, it is vital where income might be received from a non-arm’s length dealing that the SMSF has evidence to support the income that was received (or the expense that was paid).

The importance of this has been reinforced by the recent AAT decision in BPFN and Commission of Taxation (Taxation) [2023] AAT 2330.

In that case, the SMSF loaned funds ultimately to unrelated parties, but through two interposed entities controlled by the member of the SMSF.

The ATO challenged the return paid to the intermediaries on the basis it was lower that what would have been paid to arm’s length parties doing the same roles. As a result, it assessed all the return from the loans as NALI to the SMSF at the top tax rate.

Before the AAT, the SMSF provided evidence from the lawyer who prepared the documents for the arrangement, an independent lawyer and the SMSF’s general adviser as to what their experience was with the reasons for and terms of these arrangements. The AAT accepted their evidence for the reasons for the structure, and preferred their evidence as to the arm’s length nature of the arrangements in general, and the returns specifically. The ATO’s expert was not experienced in these types of private lending arrangements and their evidence was not sufficient to support the ATO’s contention.

The NALI assessment was overturned by the AAT on the basis the SMSF established the return to the SMSF was not more than would have been paid had the parties been dealing at arm’s length.

This case highlights the importance of obtaining sufficient evidence of the reasons for arrangements, and that the return reflects what would have been achieved had the parties actually been dealing at arm’s length.

If you have any questions about the NALI or NALE rules, or the evidence you should hold, please contact a member of our SMSF team.

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This publication is for information only and is not legal advice. You should obtain advice that is specific to your circumstances and not rely on this publication as legal advice. If there are any issues you would like us to advise you on arising from this publication, please let us know.

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