Actions outside an SMSF but related to it can create non-arm’s-length income (NALI) problems for the fund, according to a legal firm, which has highlighted a recent case before the Administrative Appeals Tribunal (AAT).
Brisbane-based law firm Cooper Grace Ward noted the case of GYBW v Commissioner of Taxation, heard before the AAT in October last year, found that actions outside the fund that later resulted in the addition of assets into the fund could bring NALI arrangements that would be assessable within the SMSF.
On its website, Cooper Grace Ward stated that in the case an SMSF bought 200 shares (20 per cent) in Company A for $200, while a business associate of the SMSF members owned the other 800 shares or 80 per cent of the company.
At the time of purchase, Company A had no assets other than what the shareholders paid for the shares, but a short time later Company A bought all the shares in Company B from the other shareholder in Company A for less than market value, while Company B continued to carry on a business.
For the next four years, Company A paid about $1.8 million in dividends to the SMSF from the profits of the business carried on by Company B, raising the question of whether the dividends received by the SMSF from Company A were NALI.
“The AAT decided that although the SMSF bought the shares in Company A at market value, Company A had entered into a non-arm’s-length transaction when it bought the shares in Company B. As a result, the dividends received by the SMSF from Company A were NALI,” the legal firm stated.
It pointed to section 295-550 of the Income Tax Assessment Act 1997, which states circumstances where income to an SMSF is NALI include where parties are not dealing at arm’s length, and thus the return to the fund is greater than if the dealings were at arm’s length, and where the income is a dividend from shares in a private company, unless the dividends are consistent with an arm’s-length dealing.
Under these conditions, income categorised as NALI is taxed at the top marginal tax rate rather than the concessional superannuation rates.
“The AAT confirmed it is not just the direct involvement of the SMSF that is relevant, but the totality of the arrangement in determining whether NALI applies,” Cooper Grace Ward said.
“The decision in GYBW is not new law and is consistent with previous cases. It is a reminder of the wide reach of the NALI rules and that it is not just the actions of the SMSF that must be considered, but all the transactions as a whole.”