SMSF? Watch out for non-arm’s length expenses!

Categories: Articles, Superannuation
10 November 2023

One of the golden rules about having a self-managed superannuation fund (“SMSF”) is that everything needs to be done at arm’s length. That is, everything needs to be done with proper market values – it needs to be “squeaky clean”. There are a range of serious consequences for a SMSF that doesn’t do things “right”.

At the time of writing there is proposed legislation being enacted by Federal Parliament that relates to a SMSF incurring non-arm’s length “general expenses”. Expenses are general expenses when the expenditure does not relate to any specific asset in the fund.

The new legislation will apply a multiple of two to any amount of non-arm’s length general expenses. This mount then becomes “non-arm’s length income” and is taxed at the highest rate possible, instead of the normal tax rate of a superannuation fund of 15%.

Here is an example:

Jack and his wife Jill operate the Pail SMSF. They engage Terry, who is a bookkeeper, to undertake the bookkeeping and record keeping for the SMSF. Terry is also the neighbour of Jack and Jill. Terry doesn’t charge anything for his services. In return, Jack and Jill do a few odd jobs for Terry.

Bookkeeping services are a general service to the fund as they do not apply to any specific asset.

The value of Terry’s services for a year are $2,000, but this amount is not paid by the SMSF. The new law will deem the Pail SMSF to have received 2 x $2,000 = $4,000 of non-arm’s length income, which will be taxed at the top marginal income tax rate to the fund.

Specific expenses

Also be aware that there is already legislation in operation that relates to specific non-arm’s length expenses of a superannuation fund. These are expenses that relate to a specific asset. These types of non-arm’s length expenses can have a very serious effect on the tax implications of an investment within a superannuation fund. This law has been in operation for some years.

For example, let’s say the Pail SMSF owns a rental property. Terry’s wife does some gardening at the rental property free-of-charge. As this is a specific non-arm’s length expense, all of the rental income from the property becomes “tainted” as non-arm’s length income and the whole of the income become subject to the top marginal tax rate.

Be on guard for non-arm’s length expenditure in your SMSF. It can have some really bad consequences.