Private ruling: Non-arm's length income
Published: December 2012
Ruling period: Year ending 30 June 2013
Date scheme commenced: 1 July 2012

Ruling: Q1: Is the valuation of the shares in the Company to be purchased by the Fund sufficient so the purchase can be considered an arm’s length dealing? Advice/Answers Yes.


Relevant legislative provisions: Income Tax Assessment Act 1936 Section 273 | Income Tax Assessment Act 1997 Section 295-545 | Income Tax Assessment Act 1997 Subsection 295-550(1) | Income Tax Assessment Act 1997 Subsection 995-1(1)

Reasons for decision: Detailed Reasoning - Summary of decision: The value of shares in the company is considered to have been made on a rational and reasonable basis so their purchase by the fund will be on an arm’s length basis. | Detailed Reasoning - Non-arm’s length income: In accordance with section 295-545 of the Income Tax Assessment Act 1997 (ITAA 1997) the income of a complying superannuation fund, complying approved deposit fund or pooled superannuation trust is split into a ‘non-arm’s length component’ and a ‘low tax component’. The non-arm’s length component (formerly known as special income) comprises non-arm’s length dividends received from private companies, non-fixed interest trust distributions, and any income derived from transactions where the parties are not dealing with each other at arm’s length. This component is reduced by any deductions attributable to that income and is then taxed at the highest marginal rate. ‘Derived’ in this context is applicable to both ordinary and statutory income. The remaining part of the entity’s taxable income for the income year is the low tax component which is taxed at a concessional rate (currently 15 per cent). The Commissioner has issued Taxation Ruling TR 2006/7, titled ‘ Income tax: special income derived by a complying superannuation fund, a complying approved deposit fund or a pooled superannuation trust in relation to the year of income ’ (TR 2006/7). This ruling refers to the former section 273 of the Income Tax Assessment Act 1936 (ITAA 1936) which concerned ‘special income’ and still provides useful guidance on the factors to be considered in the interpretation of section 295-550 of the ITAA 1997. Subsection 295-550(1) of the ITAA 1997 states: An amount of ordinary income or statutory income is non-arm's length income of a complying superannuation fund, a complying approved deposit fund or a pooled superannuation trust (other than an amount to which subsection (2) applies or an amount derived by the entity in the capacity of beneficiary of a trust) if: a) it is derived from a scheme the parties to which were not dealing with each other at arm's length in relation to the scheme; and b) that amount 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 in relation to the scheme. The non-arm’s length provisions require the determination of whether the parties to the scheme are dealing with each other at arm’s length in relation to the scheme. ‘Arm’s length’ is not defined, however subsection 995-1(1) of the ITAA 1997 states that: in determining whether parties deal at arm’s length, consider any connection between them and any other relevant circumstance. In relation to arm’s length TR 2006/7 states at paragraph 76 to 78: 76. The Commissioner considers that parties are dealing with each other at arm's length in relation to a transaction if the independent minds and wills of the parties are applied to the transaction and their dealing is a matter of real bargaining. If this is not the case, the Commissioner will consider that the parties are not dealing with each at arm's length in relation to the transaction. 77. If the relationship of the parties is such that one party has the ability to influence or control the other, this will suggest that the parties may not be dealing at arm's length, but it will not be determinative. 78. Parties that are not at arm's length can deal with each other at arm's length in relation to a transaction and parties that are at arm's length can deal with each other in a way that is not at arm's length. An amount of income can only be special income under subsection 273(4) if, in relation to the particular transaction, the parties are not dealing with each other at arm's length. This view is based on the decisions in Re Hains (deceased), Barnsdall v. FC of T (1988) 88 ATC 4565; (1988) 81 ALR 173; (1988) 19 ATR 1352, Re Trustee of the Estate of the late AW Furse (1990) 21 ATR 1123; (1990) 91 ATC 4007, and Granby Pty Ltd v. FC of T (1995) 129 ALR 503; (1995) 30 ATR 400; (1995) 95 ATC 4240 and the examples in the Explanatory Memorandum to the Superannuation Legislation Amendment Bill (No. 2) 1999, which, as enacted, inserted subsections 273(6) to (8) of the ITAA 1936. These cases were also relied upon in Allen (As Trustee of the Allen's Asphalt Staff Superannuation Fund) v. Federal Commissioner of Taxation 2010] FCA 1276; (2010) 2010 ATC 20-225; (2010) 80 ATR 849; [2012] ALMD 2629; [2012] ALMD 2630; [2012] ALMD 2631; [2012] ALMD 2632 case where Justice Collier said: …if conduct of parties is not consistent with conduct of independent third parties, because one party is exerting personal influence or control over the other or others, dealings between them cannot be termed ‘arm’s length’. Further, consideration must be given to whether the amount derived from the scheme is more than the amount the fund might have been expected to derive if those parties had been dealing with each other at arm’s length in relation to the scheme. In relation to the above paragraphs 79 and 80 of TR 2006/7 state: 79. The final requirement for an amount of income to be special income under subsection 273(4) is that the amount of income derived from the transaction must be greater than the amount of income that might have been expected if the parties were dealing with each other at arm's length in relation to the transaction. 80. This is a question of fact. When considering this issue, the Commissioner will take into account all relevant matters. The level of investment risk that the superannuation entity is exposed to will be a relevant matter. In Syngenta Crop Protection Pty Ltd v. Federal Commissioner of Taxation [2005] FCA 1646; (2005) 61 ATR 186; [2008] ALMD 422 Justice Gyles, discussing arm’s length consideration in the context of the transfer pricing provisions held that the test for determining excessive income was objective, stating: The question as to whether the consideration is that which might reasonably be expected to have been received or receivable as consideration in either a supply or acquisition if the property had been supplied or acquired under an agreement between independent parties dealing at arms length is an objective question. It does not depend upon anybody's opinion, save that of the court or body making that decision. It is a matter for evidence… In this case the Company was established as a retail and wholesale distribution business. The Company was sold to the members of the Fund (the Members) who are also directors and shareholders of the corporate trustee the Fund. Therefore, the relationship of the parties is such that one party has the ability to influence or control the other and both the Members are in a position to influence the decisions of the Company and the Fund. However, the transactions have been dealt with at arm’s length. The Members have engaged the services of an independent firm to value shares in the Company. A valuation report explains that as the Company has ceased as a going concern but has the ability to distribute franking dividends. On a discounted cashflow basis the valuation of the shares in the Company has been valued. It is accepted that the valuation of shares in the Company has been undertaken in good faith, results from a rational and reasoned process and results in a reasonable market value with objective and supportable evidence. Therefore the value of shares in the Company is considered to have been made on rational and reasonable basis so their purchase by the fund is on an arm’s length basis.

This notice must not be taken to imply anything about: | ● the binding nature of the private advice issued to the applicant | ● the correctness of other edited versions. | Relevant facts: Self managed superannuation fund specific advice has been provided to the Fund regarding acquisition of assets from a related party and in-house assets. | The Company was sold to members of the Fund (the Members) who are also directors and shareholders of the corporate trustee the Fund. | The Fund is a regulated self managed superannuation fund. | Since the 2011-12 income year the Company has ceased to operate as a going concern. | The trustees of the Fund intend to acquire shares in the Company as part of the members’ investment strategy. | As at 30 June 2012 the Company had cash, term deposits and undistributed franking credits. | The Company has no borrowings, no interest in another entity and it does not have any charges over company assets. | The Members have engaged the services of an independent accounting firm to value shares in the Company. | A valuation report explains that the Company has ceased as a going concern but has the ability to distribute franking dividends. Using a discounted cashflow basis shares in the Company have been valued. | The directors of the Company in conjunction with the trustees and members of the Fund intend to pay fully franked dividends over a period starting in the 2012-13 income year. | The Members have retired and see the Company as a source of funding for their retirement income needs.