Private ruling: Taxation of superannuation funds: non-arm’s length income
Date of advice: 5 December 2018
Published: March 2019
Ruling period: Income year ending 30 June 2019
Date scheme commenced: 1 July 2018

Ruling: Q1: Will the trust distributions received by a self-managed superannuation fund (the Fund) from a unit trust (the Unit Trust) be treated as non-arm’s length income of the Fund for the purposes of section 295-550 of the Income Tax Assessment Act 1997 (ITAA 1997)? | A1: Yes

Relevant facts and circumstances: The Fund has two members - Member 1 and Member 2. The trustee of the Fund (the Trustee) is a private company. The directors of the Fund Trustee are Member 1 and Member 2. Member 1 and Member 2 are also individual trustees and beneficiaries of a discretionary family trust (the Family Trust). The Family Trust holds a 30% interest in the Unit Trust. The other unit holders of the Unit Trust are: Private company 1 10% Private company 2 30% Private company 3 30% The trustee of the Unit Trust (the Unit Trust Trustee) is a private company. Member 1 is a director of the Unit Trust Trustee and Member 1 and Member 2 jointly are members of the Unit Trust Trustee. The Unit Trust owns and operates a leasehold interest in a business. In order to raise monies to fund leasehold improvements and increase working capital, the Unit Trust Trustee is considering the issuing of new units on a pro-rata basis to existing unit holders. As at 30 June 2017, the value of units in the Unit Trust (the Units) was determined to be a specified amount. The income distribution to unit holders for the 2017 income year was determined to be an amount which is greater than the value of the Units. All income and capital of the Unit Trust is, and always has been, distributed on the ownership of the fixed unit holdings. The terms on which the trust fund is held in the Unit Trust are set out in the Unit Trust Deed (the Deed)

Relevant legislative provisions: Income Tax Assessment Act 1936 former section 273 | Income Tax Assessment Act 1936 section | Income Tax Assessment Act 1936 subsection 295-(2) | Income Tax Assessment Act 1936 section | Income Tax Assessment Act 1936 subsection 295-550(4) | Income Tax Assessment Act 1936 subsection 295-550(5) | Income Tax Assessment Act 1936 subsection 995-1(1) | Taxation Administration Act 1953 section 357-85 of Schedule 1

Reasons for decision: Summary: Section 295-545 of the ITAA 1997 provides that the taxable income of a complying superannuation fund is split into a non-arm’s length component and a low tax rate component. According to subsection 995-1(1) of the ITAA 1997, the phrase ‘non-arm’s length component’ has the meaning given by section 295-545 of the ITAA 1997. Subsection 295-545(2) of the ITAA 1997 provides that the non-arm’s length component for an income year is the entity’s non-arm’s length income for that year less any deductions to the extent that they are attributable to that income. According to subsection 995-1(1) of the ITAA 1997, the phrase ‘non-arm’s length income’ has the meaning given by section 295-550 of the ITAA 1997. There are various subsections in section 295-550 of the ITAA 1997 under which amounts of ordinary income or statutory income of a complying superannuation fund are non-arm’s length income of that fund. Subsections 295-550(4) and (5) of the ITAA 1997 specifically apply to such amounts derived as a beneficiary of a trust. Subsection 295-550(4) of the ITAA 1997 provides that: Income *derived by the entity as a beneficiary of a trust, other than because of holding a fixed entitlement to the income, is non-arm’s length income of the entity. *To find definitions of asterisked terms, see the Dictionary, starting at section 995-1. Subsection 295-550(5) of the ITAA 1997 provides that: Other income *derived by the entity as a beneficiary of a trust through holding a fixed entitlement to the income of the trust is non-arm’s length income of the entity if: (a) the entity acquired the entitlement under a *scheme, or the income was derived under a scheme, the parties to which were not dealing with each other at *arm’s length; and (b) the amount of the income is more than the amount that the entity might have been expected to derive if those parties had been dealing with each other at arm’s length. *To find definitions of asterisked terms, see the Dictionary, starting at section 995-1. | Detailed Reasoning - Fixed entitlement to trust income: In paragraph 102 of Taxation Ruling TR 2006/7 Income tax: special income derived by a complying superannuation fund, complying approved deposit fund or pooled superannuation trust in relation to a year of income (TR 2006/7), the Commissioner sets out his view that a complying superannuation fund has a fixed entitlement to a trust distribution ‘if the entity’s entitlement to the distribution does not depend upon the exercise of the trustee's or any other person's discretion’. Although TR 2006/7 is primarily concerned with former section 273 of the Income Tax Assessment Act 1936 (ITAA 1936), it is also taken to be a ruling about section 295-550 of the ITAA 1997 to the extent that it addresses issues in section 295-550 that are the same as were in the former section 273 (see paragraphs 1A and 1C of that ruling, and section 357-85 in Schedule 1 to the Taxation Administration Act 1953 ) which provides that a ruling about a relevant provision (the ‘old’ provision) that is re-enacted or remade (the ‘new’ provision) is taken also to be a ruling about the new provision in so far as the new provision expresses the same ideas as the old provision. Indeed, the Commissioner has confirmed in his decision impact statement for The Trustee for the MH Ghali Superannuation Fund and Commissioner of Taxation [2012] AATA 527 that he will continue to apply the view expressed in paragraph 102 of TR 2006/7 for the purposes of subsections 295-550(4) and (5) of the ITAA 1997. Whether a beneficiary has a fixed entitlement in the income or capital of a trust is to be determined with reference to the established legal principals and the terms of the relevant trust instrument, in this case, the Deed. After considering the terms of the Deed, it is our view that the Fund would not hold a fixed entitlement to income of the Unit Trust. This view is based on the following factors (discretionary powers): ● The Unit Trust Trustee may determine with respect to all or any part or parts of the net income of the trust fund to do any of the following: ○ to pay apply or set aside the same [net income] for the unit holders in proportion to the number of units they hold; ○ to accumulate the same; ○ to pay apply or set aside the same for such charitable purposes as the trustee may think fit. ● The Unit Trust Trustee shall have a complete discretion as to the making of above determination and shall not be bound to assign any reason therefore. ● The Unit Trust Trustee may redeem and cancel all or any units held by a particular unit holder on such terms and conditions and in consideration for such payment or transfer of property as that unit holder and the trustee agree upon. If the trustee has a power to issue new units or to cancel or vary existing units, particularly if those powers can be exercised for something other than an arm’s length consideration, then it cannot be asserted that a beneficiary had a fixed entitlement in the income when it was earned. As the Fund will not have a fixed entitlement to the income of the Unit Trust, a distribution from the Unit Trust would be non-arms-length income of the Fund under subsection 295-550(4) of the ITAA 1997. Consequently, we are not required to consider the application of subsection 295-550(5) of the ITAA 1997 in this case.