The Government has released a consultation paper and exposure draft legislation to give effect to the following superannuation taxation integrity measures it announced in the 2017–2018 Federal Budget: 

  • the non-arm's length income (NALI) rules in s 295-550 of the Income Tax Assessment Act 1997 (ITAA 1997) for related-party superannuation fund transactions will be expanded from 1 July 2018 to also include expenses not incurred that would normally be expected to apply in a commercial arm's length transaction (eg reduced interest expenses, brokerage, accountancy fees or legal costs); and
  • a member's share of the outstanding balance of a limited recourse borrowing arrangement (LRBA) will be included in the member's "total superannuation balance" (TSB) for new LRBAs entered into on or after 1 July 2018.
The measures are designed to ensure that related-party transactions with super funds and LRBAs cannot be used to circumvent the reduced contribution caps operating from 1 July 2017. The changes should generally not affect LRBAs entered into with unrelated third parties for commercial rates of interest (and other expenses).

Non-arm's length income to include expenses not incurred

The current NALI rules address non-commercial arrangements that could potentially shift income from a related party to a super fund (where the amounts would be taxed concessionally). The new non-arm's length expense rules aim to prevent an increase in a fund's capital by not incurring arm's length expenses.

Under the proposed amendments to s 295-550 of ITAA 1997, non-arm's length expenses incurred by a superannuation fund in gaining or producing assessable income would result in such income being taxed as NALI, at the top marginal rate of 45%. This will be the case for expenses of a capital or revenue nature.

Example

A self managed super fund (an SMSF) acquired a commercial property from a third party at its market value of $1 million on 1 July 2015. The SMSF derives rental income of $1,500 per week ($78,000 per annum) from the property. The SMSF financed the purchase of the property under an LRBA from a related party on terms consistent with s 67A of the Superannuation Industry (Supervision) Act 1993 (SIS Act).

The LRBA was entered into on terms that include no interest, no repayments until the end of the 25-year term and borrowing of the full purchase price of the commercial real property (ie 100% gearing). The SMSF was in a financial position to enter into an LRBA on commercial terms with an interest rate of approximately 5.8%.

The proposed amendments to s 295-550 of ITAA 1997 would make it clear that, as the SMSF has not incurred expenses that it might have been expected to incur in an arm's length dealing in deriving the rental income, that income will be NALI. The income (less deductions attributable to the income) will form part of the SMSF's non-arm's length component and would be taxed at 45%.

For the NALI rules to apply to non-arm's length expenses, there must also be a sufficient nexus between the expenses and the income. That is, the expenditure must have been incurred "in" gaining or producing the relevant income. The amendments are also likely to require some sort of determination as to the expenses that a fund "might have been expected to have incurred" if the parties had been dealing with each other at arm's length.

LRBAs to count towards total super balance

An individual's TSB is used to determine eligibility for various super concessions, including the $1.6 million balance cap for making non-concessional contributions, transfer balance account reporting (TBAR) and whether an SMSF can apply the segregated method.

The definition of "total superannuation balance" in s 307-230 of ITAA 1997 will be amended to take into account the outstanding balance of an LRBA entered into by an SMSF.

An individual member's TSB will be increased by the share of the outstanding balance of an LRBA related to the assets that support their superannuation interests. This proportion would be based on the individual's share of the total superannuation interests supported by the asset that is subject to the LRBA. This will ensure that SMSF members who have attained a condition of release cannot circumvent the caps by withdrawing lump sums and re-contributing the funds as a loan.

For an LRBA-related increase in the individual's TSB, the SMSF must have used the borrowing to acquire one or more assets, and any such assets must support the superannuation interests of an individual at the time at which the total superannuation balance is determined.

This asset–member interest connection is determined by considering the way the fund has allocated its assets to meet its current and future liabilities in relation to each member's interests. This test will require the SMSF trustee to determine which of its LRBA assets support which members' interests, as well as the extent to which those interests are supported.

The outstanding balance of an LRBA is the amount still owing under the LRBA. Where an individual has a superannuation interest that is supported by an asset that is subject to an LRBA, the increase to their TSB is based on their share of this outstanding balance.

Including the proportion of the outstanding balance in a member's TSB seeks to prevent double-counting of the outstanding balance from occurring where more than one member has an interest supported by an asset that was acquired through an LRBA. While an individual's TSB can generally be measured "at a time", it is generally only relevant at the end of a particular income year on 30 June.

Example

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.

Under the current law, 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.

Under the changes proposed in the Draft Bill, Laura's TSB at 30 June 2019 will be $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 would not be able to make non-concessional contributions in the year ending 30 June 2020. Entering into a new LRBA arrangement with the SMSF would no longer increase Laura's capacity to make non-concessional contributions for that year. The trustee could continue to repay the LRBA but could not use non-concessional contributions to do so.