ATO preparing to contact SMSFs about NALI

ATO letter, SMSF trustees, tax agents, non-arm's length income (NALI)The ATO appears to be preparing to send letters to SMSFs about unreported non-arm’s length income.

The focus of this campaign is likely the non-reporting, or under-reporting, of distributions to SMSFs from discretionary trusts. The ATO says that such income is non-arm’s length income (NALI), which is not taxed at the ordinary rates for an SMSF, but at 45% (or 47% for years in which the Temporary Budget Levy applies).

It is unclear at this stage if the letters will be sent directly to the SMSF trustees or to their Tax Agent.

The Tax Institute has made a submission to a consultation process started by the ATO in March 2015, which is titled Trust/SMSF Compliance Update Briefing/Discussion Paper. This document doesn’t appear to have been widely released. Given the short window for consultation it is likely the ATO will soon be sending the letters out.

Groups included in the consultation were seemingly given a draft letter, and asked several questions, including:

Do the members have any thoughts as to why the level of reporting of non-arm’s length income in the SMSF annual return is so low?

The Tax Institute says the issue may be coding errors, either in terms of misunderstanding the SMSF annual return or issues created when investments are entered into accounting software.

It seems that the ATO will encourage SMSF trustees which have failed to, or under-reported, NALI to come forward. The Tax Institute says that offering a relief from penalties to trustees “who readily seek to correct their returns,” would assist in this regard.

“A ‘voluntary amnesty’ for taxpayers to disclose their positions in this area would be welcome, similar to the recent offshore income disclosure initiative ‘Project DO IT’ last year,” said the Tax Institute submission.

Though generally accepting of the tone of the draft letter, the Tax Institute said that additional information should be included, “to ensure that clients respond with accurate disclosures, for example, a fact sheet or explanation of the different types of trusts and distributions and when NALI applies.”

The Tax Institute also says the ATO should follow this letter campaign with “better disclosure” of NALI issues in the SMSF annual return form and guides.

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