On 11 January 2018, the Minister for Revenue and Financial Services, the Hon Kelly O’Dwyer MP, released for public consultation draft legislation and a consultation paper entitled ‘Superannuation Taxation Integrity Measures’. [See her media release]
On the same date, Treasury uploaded a consultation page, with following documents.
- A Superannuation Integrity Measures (Consultation Paper).
- Treasury Laws Amendment (2017 Measures No. 12) Bill 2017 (exposure draft).
- Draft Explanatory Memorandum on expanding the Non-arm’s Length Income (NALI) provisions to cover Non-Arm’s Length expenditure.
1. The Government has announced two superannuation taxation integrity measures:
(a) The first measure includes a member’s share of the outstanding balance of a Limited Recourse Borrowing Arrangement (LRBA) in their total superannuation balance (TSB).
(b) The second measure ensures that non-arm’s length expenditure is taken into account when determining whether the non-arm’s length income (NALI) taxation rules apply to a transaction.
2. These measures are to protect two new ‘contribution caps’ (for making non-concessional’ contributions) from abuse. They are not intended to prevent the use of LRBAs. Readers will recall that the limit on ‘non-concessional’ contributions was reduced from $180k to $100k pa (with an equivalent 3 year bring forward).
3. There are two new thresholds (caps), which they wish to protect.
(a) The first is the $1.6m ‘total superannuation benefit’ amount, over which a member will not be entitled to make any ‘non-concessional’ contributions.
(b) The other threshold is the $500,000 ‘total superannuation benefit’, under which a member can make ‘catch-up’ non-concessional contributions (that is unused contribution limits on a rolling 5 year basis).
4. The LRBA abuse envisaged, is a member taking out a benefit (to get the ‘total superannuation benefit’ below the threshold), and then lending it back to the fund on a limited recourse basis. The following example is given in the Consultation Paper.
Laura is the sole member of her SMSF, which holds $2 million in accumulation phase.
- Laura takes a lump sum of $500,000 from the SMSF, on 1 June 2019 which reduces her TSB as at 30 June 2019 to $1.5 million;
- On 30 June 2019, Laura lends the $500,000 on commercial terms back to her SMSF under an LRBA;
- The SMSF uses $1 million of its existing assets and the borrowed $500,000 to acquire a $1.5 million investment property.
- Laura’s TSB as at 30 June 2019 is $1.5 million, comprising the net value of the property of $1 million ($1.5 million purchase price less the $500,000 LRBA) as well as the other assets valued at $500,000.
- As her TSB is below $1.6 million, Laura can make further non-concessional contributions of up to $100,000 in the year ending 30 June 2020.
- As the SMSF repays the LRBA, the net value of the fund will increase and Laura’s TSB will approach the $1.6 million threshold. However just prior to reaching the $1.6 million threshold, she could withdraw another lump sum and enter into a new LRBA to acquire another income-producing asset. This would reduce her TSB again, allowing more contributions to be made to the SMSF.
Proposed new law
- Laura’s TSB at 30 June 2019 is $2 million comprising the net value of the property of $1 million, the other assets valued at $500,000 and the $500,000 outstanding loan balance under the LRBA.
- As her TSB exceeds $1.6 million, Laura cannot make non-concessional contributions in the year ending 30 June 2020.
- Entering into a new LRBA arrangement with the SMSF will no longer increase Laura’s capacity to make non-concessional contributions for that year.
- The trustee can continue to repay the LRBA but cannot use non-concessional contributions to do so.
5. The Consultation paper makes this observation about the new measure.
(a) This measure should only affect those funds whose members have a TSB at, exceeding or approaching $1.6 million. It would only affect capacity to use an LRBA where the borrowing cannot be repaid using the fund’s own resources in combination with concessional contributions.
(b) The measure should not affect a fund’s ability to borrow in many situations, including:
(i) Where a member has a TSB of more than $1.6 million but the fund repays the LRBA with income from the LRBA asset, other fund earnings or concessional contributions.
(ii) Where the member’s TSB (including the outstanding balance of the LRBA) is below $1.6 million, allowing the member to make non-concessional contributions to help meet the LRBA repayments.
6. This measure will apply to new LRBAs entered on or after the new law commences on 1 July 2018. Refinancing of existing loans and certain contracts entered into prior to that date will also be excluded.
Terms of proposed law
7. Under proposed Treasury Laws Amendment (2017 Measures No. 2) Bill 2017, Parliament would amend s307-230 and add in 307-231 of the Income Tax Assessment Act 1997 (ITAA97) to include a member’s share of the outstanding balance of an LRBA. This will only affect SMSF’s or funds with less than 5 members.
8. The terms of the new s307-231, would be as follows
307-231 Limited recourse borrowing arrangements
(1) You have an amount under this section (an LRBA amount), in relation to a *regulated superannuation fund in which you have one or more *superannuation interests, if:
(b) the borrowing has not been repaid at the time of working out your *total superannuation balance; and
(c) at that time, the asset or assets that secure the borrowing support, to an extent, a *superannuation interest of yours; and
(d) the fund is covered by subsection (3) at the time of the payment. [which includes SMSFs and funds with less than 5 members]
NALI – extended to non-arm’s length expenses
9. This proposed amendment settles and old score for the ATO.
10. ‘Non-arm’s length income’ (NALI) had always been assessed, to superannuation funds, at the maximum marginal rate (rather than the 15% concessional rate). This was to stop feeding too much money into the concessionally taxed superannuation environment.
11. Then another idea sprang up, which had the same effect, but did not come within the reach of the NALI provisions (or so it was said).
12. The idea was to charge the superannuation fund lower expenses, than would otherwise apply – typically nil or low interest loans (done through the LRBA mechanism, which is the only way a superannuation fund can borrow).
13. The ATO tried to argue that a lower expense was higher income, but they now concede (in this Consultation Document) that is is ‘arguable’ the current law doesn’t catch sub-market expenses.
14. The proposed law is in the exposure draft of Treasury Laws Amendment (2017 Measures No. 12) Bill 2017.
15. The central provision in a replacement s295-550(1), which conspicuously now includes sub-market (non-arm’s length) expenses.
SECTION 295-550 Meaning of non-arm’s length income
295-550(1) An amount of *ordinary income or *statutory income is non-arm’s length income of a *complying superannuation fund, … if, as a result of a *scheme the parties to which were not dealing with each other at *arm’s length in relation to the scheme, [and] one or more of the following applies:
(a) the amount of the income is more than the amount that the entity might have been expected to derive if those parties had been dealing with each other at arm’s length in relation to the scheme;
(b) in gaining or producing the income, the entity incurs a loss, outgoing or expenditure of an amount that is less than the amount of a loss, outgoing or expenditure that the entity might have been expected to incur if those parties had been dealing with each other at arm’s length in relation to the scheme;
(c) in gaining or producing the income, the entity does not incur a loss, outgoing or expenditure that the entity might have been expected to incur if those parties had been dealing with each other at arm’s length in relation to the scheme.
This subsection does not apply to an amount to which subsection (2) applies or an amount *derived by the entity in the capacity of beneficiary of a trust.
16. The provisions still ‘income’ to tax at the higher rate (even if it is now enough for it to be tainted with sub-market expenses).
17. The examples given in the Consultation Document show some of the funds income as NALI and some not. For instance, rental income was NALI because the property was bought with a low interest loan. The rest of the Fund’s investment income was not NALI and taxed at normal rates.
18. The work of splitting the fund’s income into tainted NALI and untainted income, is done by new s295-550(1)(b), which talks about the ‘non-arm’s length’ (NAL) expenses.
(a) This provision talks about ‘ordinary’ or ‘statutory’ income being NALI, if a non-arm’s length expense was incurred in earning that income.
(b) If the NAL expense was not incurred to earn particular income, then that remains in the low tax component.
19. This measure is slated to commence in respect of income derived in the 2018/18 year (usually income derived on or after 1 July 2018).
Author’s note [design problem with the exposure mechanism]
20. In my opinion the idea of dividing the fund’s income into that which is tainted (because the NAL expense was incurred to earn it) and that which is not tainted, is faulty or unduly harsh.
(a) It has an inherently harsh aspect in that the fund is taxed on more than the NAL benefit.
(b) This is masked somewhat, by tainting only particular income – like the rent from the property funded by the non-arm’s length LBRA.
(c) But the full harshness is revealed where the NAL expense is incurred to earn the whole of the fund’s income. An example of this might be the member bearing the cost of the SMSF preparing it’s accounts. There a relatively modest expense saved, would taint the income of the whole fund. Another example might be a fund manager waiving his usual 0.5% fee for his own SMSF. Again, this would taint the income of the whole fund.
21. The preferable treatment, in my opinion, is to tax, at maximum rates, only the amount of the costs saved, by deeming that amount to be NALI.
22. This targets the offending amount and doesn’t insist on collateral damage, as well (sometimes modest damage, sometimes severe damage and, sometimes, in-between).
[FJM; LTN 8, 12/1/18; Tax Month January 2018]
- Is the $1.6m ‘total superannuation benefit’ cap, the only threshold the LBRA measure protects [hint: para 3]?
- Does the LBRA measure add the outstanding LBRA loan to the Member’s ‘total superannuation benefit’ [hint: para 7]?
- Is it new s307-321 that will add the outstanding LBRA balance [hint: para 8]?
- Is the NALI measure about the charging the superannuation fund lower than arm’s length expenses [hint: para 12]?
- Is the NALI provision, that will include NAL expenses, in s295-555 [hint: para 15]?
- Under this measure, is the tainted income that which the NAL expense was incurred to earn [hint: para 18]?