COMPLIANCE
Employee share scheme NALI doubts The introduction of the non-arm’s-length expenditure rules has now brought uncertainty over employee share schemes involving SMSFs. Dan Butler and Shaun Backhaus give their insights into the current status of the situation.
DANIEL BUTLER (pictured) is a director and SHAUN BACKHAUS a senior associate at DBA Lawyers.
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Acquiring shares under an employee share scheme (ESS) via an SMSF may appear attractive, but substantial uncertainty has arisen following the ATO’s recent Law Companion Ruling (LCR) 2021/2 on the application of the non-arm’s-length income (NALI) rules to such a transaction. This ruling focuses on NALI arising from the non-arm’s-length expenditure (NALE) changes to section 295-550 of the Income Tax Assessment Act (ITAA) 1997 that came into effect from 1 July 2018.
Typical ESS Many employers, including small, medium and large employers, seek to encourage their employees to work in the best interests of the company by offering an ESS to align their employees’ interests with the business. Research suggests companies having an ESS generally perform better than companies that do not offer such plans. Under an ESS, companies typically offer employees the opportunity to acquire shares in the organisation at a discounted price. There are also a range of tax rules that cover the taxation of ESS interests and certain employees may qualify for some tax relief, such as the ability to defer the taxing point or obtaining a more favourable tax treatment compared to ordinary income under section 83A-115 of the ITAA. Many ESS allow employees to nominate a related entity, such as a family member, a family company, a family trust or an SMSF, to acquire the shares on offer. Naturally, section 66 of the Superannuation Industry (Supervision) (SIS) Act 1993 needs to be considered if an SMSF acquires an asset from a member or related party. However, we will focus solely on the potential application of NALI in this article.
Note the tax rules generally assess the employee on any discount granted via an ESS even if the employee nominates another family member or related entity, such as an SMSF, that ends up acquiring the shares.
ESS discount treatment prior to LCR 2021/2 The ATO generally treats discounts on shares as assessable income to the employee. Where the shares are nominated to an SMSF, the ATO has also treated any discount as a contribution. This is confirmed on the ATO webpage QC 26221 where the regulator states: “A super contribution is anything of value that increases the capital of a super fund and is provided with the purpose of benefiting one or more particular members of the fund, or all of the members in general. “For example, when shares acquired under an ESS are transferred to an SMSF at less than market value, the acquisition results in a super contribution because the capital of the fund increases and the purpose of the acquisition is to benefit a member, or members, of the fund.”
The impact of LCR 2021/2 on ESS shares acquired by SMSFs The ATO states in LCR 2021/2 that: “[18] [NALE] incurred to acquire an asset (including associated financing costs) will have a sufficient nexus to all ordinary or statutory income derived by the complying superannuation fund in respect of that asset. This includes any capital gain derived on the disposal of the asset…” It therefore appears the purchase by an SMSF of an asset like a share at a discount will result in all future dividends and net capital gain on disposal of that asset being treated as NALI and
