The ATO’s recent ruling, LCR 2021/2, which relates to non-arm’s length expenditure provisions in super funds, states that where a super fund incurs expenditure to acquire an asset for less than an arm’s length amount, then all the fund’s ordinary income and statutory income in respect of that asset will be considered non-arm’s length income (NALI) and subject to tax at the top marginal tax rate of 45%.
One area where these rules have brought about substantial uncertainty is where an employee nominates their SMSF to acquire shares under an Employee Share Scheme (ESS).
An ESS is generally a scheme whereby a company offers its employees the opportunity to acquire shares in the company at a discounted price to their market value. Under LCR 2021/2 however, it appears that when an SMSF purchases shares at a discounted price, this will result in all future dividends (including franking credits) and any net capital gains made on the future disposals of the shares being recognised as NALI.
Moreover, these rules apply retrospectively, regardless of when the scheme was entered into. This would have a significantly adverse tax impact on SMSFs that have acquired shares under an ESS at less than market value.
LCR 2021/2 does provide concessions for certain discounts offered where they are consistent with normal commercial practices, e.g., where the same discounts are provided to all employees, partners, shareholders, or office holders. If this is the case, the arrangement will still be considered at arm’s length.
However, many ESSs are only offered to a particular class of employee, e.g., senior managers, executives, or those who have completed a minimum number of years of service, so such schemes may not satisfy the ATO’s discount policy in LCR 2021/2.
Given the significant uncertainty surrounding this ruling and the potential adverse tax impact if you get it wrong, we recommend that you reach out to your adviser before entering into any employee shares schemes involving your SMSF.
If you require any assistance please reach out to the C&N team.
