Triggering NALI when part purchasing a property as an in-specie contribution
Why in the world would my SMSF trigger the Non Arm’s Length Income (NALI) rules if my fund purchases the office used in my business from me at market value?
- I understand I must get an independent market valuation. The trustees went to a qualified valuer and obtained a formal written report which valued the property at $750,000. ✓
- I checked with my SMSF specialist and advised her the property is being used 100% in my business, and she confirmed it meets the definition of business real property. ✓
- As the property is in NSW the title will be transferred from me to the trustee of my SMSF. The trustee of my SMSF is a corporate trustee. ✓
- The SMSF is paying 60% in cash, and the remainder is being contributed as an in-specie non concessional contribution for myself as I meet the criteria to use the bring forward contribution rule and can contribute $300,000 to my SMSF on 20 January 2025. ✓
- The trustees updated the investment strategy and confirmed the purchase of the property will meet the members retirement objectives. ✓
- The trust deed was reviewed to make sure the purchase could be made, and part in-specie contributions are not prohibited. ✓
- The trustees obtained a formal valuation of the rent and prepared a formal contract between my SMSF and myself. The terms and conditions are in accordance with the marketplace. ✓
- The fund’s solicitor prepared a contract between myself and my SMSF. The contract states the purchase price is $750,000. ×
Under these circumstances the ATO are flagging that the contract for the full purchase price as possibly being a Non-Arms’s Length (NALI) issue. The contract is an agreement between two parties and is likely to be a scheme which is a necessary part to determine if Non-Arm’s Length Expense (NALE) is incurred. As the contract is for $750,000 but the cash payment is only $450,000 the expense is a lot less than expected. The NALI provisions are triggered when there is a shortfall in the expected expense.
NALI opens the fund up to the risk of being taxed at 45% on the net rental income and the capital gain (special rules apply in calculating the capital gain) on disposal of the property in the future.
Previously, the ATO have accepted that a sales contract can be satisfied by a partial cash payment and an in-specie contribution. However, the clarification of the NALI rules have highlighted that an in-specie contribution is not a contribution where the legal right is obtained under a sales contract, see LCR 2021/2DC among others.
What can I do?
Your SMSF is able to pay part cash and receive an in-specie contribution as payment for the property.
The paperwork supporting the transaction can be split between the acquisition of the proportion of the property where cash is being paid, and the proportion of the property being transferred into the fund as an in-specie contribution.
The SMSF would acquire 60% interest in the property paid in cash. The contract has to acknowledge the purchase of 60% of the property for $450,000. The second part of the transaction is the transfer of 40% of the property from me to my SMSF as an in-specie contribution.
Example – Purchase price of a property satisfied by cash and an in-specie contribution
On 20th January 2025 Jo owns an office where she carries out her business as a solicitor. The office was valued by a qualified valuer at $750,000. She wants to sell the office to her SMSF. Jo enters into a rental agreement with her SMSF at market value, supported by a qualified valuer, and pays monthly rent to her fund. The fund has cash of $450,000 plus some other investments in shares and managed funds. Jo engages the fund’s solicitor to prepare a purchase contract for 60% of the property for a purchase price of $450,000. In addition, Jo makes a non-concessional contribution of $300,000 for the remaining 40% of the property. The SMSF trustee considers the written request by Jo and records the deliberation by the trustee in a minute and then it is confirmed to Jo in a letter that this is acceptable and the non-concessional contribution is recorded in the fund’s accounts.
The accounting entries are summarised as follows:
Property $750,000 -Debit
Non-concessional contribution for Jo ($300,000) -Credit
Cash withdrawal ($450,000) -Credit
There is no red flag in relation to NALI as the purchase price is correctly recorded as 60% acquisition by the fund for $450,000 as identified in the contract. The contribution is a transfer of 40% ownership by Jo to her SMSF in full satisfaction of it being recorded as a non-concessional contribution. The office was acquired by Jo’s SMSF at market value for $750,000, rent is being charged at market value and the non-concessional contribution is correctly recorded in the fund’s accounts.