Private ruling: Non-arm’s length income
Date of advice: 27 November 2018
Published: March 2019
Ruling period: 1 July 2016 to 30 June 2019

Ruling: Q1: Does the Trustee derive any non-arm’s length income under section 295-550 of the Income Tax Assessment Act 1997 (ITAA 1997) in relation to the acquisition and operation of the business? | A1: No. | Q2: If the answer to Question 1 is in the negative, does section 295-545 of the ITAA 1997 operate to produce a non-arm’s length component in determining the taxable income of the Trust in a relevant income year? | A2: No.

Relevant facts and circumstances: The Fund is a self-managed superannuation fund (SMSF). The Fund entered into a Purchase Contract with an unrelated party for the acquisition of a business. Pursuant to a Services Agreement, the provision of operational staff will be procured from a related Company. It has been stated that no related entities are employed by the company. Pursuant to a Management Agreement, the provision of management services for the business has been procured from a related Trust. The Trust’s management services team currently includes several employees, including the services of the member. It has been stated that the member is the only related party employed by the Trust. The Trust charges a monthly management fee to a number of other businesses it manages. This involves determining the operational wage costs of a particular business expressed as a percentage of the total operational wage costs for the total number of businesses. The operational wage cost of the Fund’s business is approximately 25% of total operational wage costs for the total number of businesses. The member is employed as a part time consultant to oversee the operations of the Trust. The member does not have any active day to day role, it is estimated he spends approximately one day a fortnight meeting with the management team. His role is purely advisory. This estimate was used to pay the member a salary equivalent on a pro rata basis for a full time Chief Operating Officer (COO).

Relevant legislative provisions: Income Tax Assessment Act 1997 section 295-545 | Income Tax Assessment Act 1997 section 295-550 | Income Tax Assessment Act 1997 section 995-1 We followed these ATO view documents | TR 2006/7 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 | Case law | Federal Commissioner of Taxation v. AXA Asia Pacific Holdings Ltd (2010)

Reasons for decision: Detailed Reasoning - Question 1: The definition of 'non-arm's length income' is given by section 295-550. Subsection 295-550(1) of the ITAA 1997 states that non-arm’s length income of a superannuation fund is income derived from a scheme in which the parties were not dealing at arm’s length and which is more than the amount that might have been expected to be derived if those parties had been dealing at arm's length. The term 'scheme' is defined in subsection 995-1(1) of the ITAA 1997 to mean: any arrangement; or any scheme, plan, proposal, action, course of action or course of conduct, whether unilateral or otherwise. The term 'arrangement' is also defined in subsection 995-1(1) of the ITAA 1997 to mean 'any arrangement, agreement, understanding, promise or undertaking, whether express or implied, and whether or not enforceable (or intended to be enforceable) by legal proceedings'. The definition of a scheme is broad enough to capture the Fund’s acquisition of the business and the Service Agreements with the Company and Trust. Parties will be dealing with each other at arm's length if the independent minds and wills of the parties are applied and their dealing is a matter of real bargaining. 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 of this conclusion. 1 The Fund has purchased the business from an unrelated party and there is no evidence to indicate that the acquisition was not at the market rate. As the Fund, the Company and the Trust are related parties they will not be in an arm’s length relationship. However, any assessment of whether parties were dealing at arm's length involves 'an assessment [of] whether in respect of that dealing they dealt with each other as arm's length parties would normally do, so that the outcome of their dealing is a matter of real bargaining’.... 2 The Fund has engaged the services of the related Company for the provision of operational staff. No related entities are employed by the Company and the annual operational fee charged is for the actual salary and wages of the staff. There is no evidence to suggest that the annual fee is not on commercial terms. The Fund has also engaged the services of the related Trust for the provision of management services for the business. The management services team currently includes several employees, including the member who is the only related party employed by the Trust. The management fee charged by the Trust will ultimately affect the business’s net profit. A fee charged at less than the market rate would result in greater income for the Fund. The Trust manages a number of businesses, including the Fund’s, and charges a monthly management fee to each business. The Trust’s operational wage cost of the Fund’s business is approximately 25% of total operational wage costs for all of the businesses. The member does not have any active day to day role in the business and it is estimated he spends approximately one day a fortnight meeting with the management team. His role is purely advisory based on years of experience in the restaurant industry. The member’s salary is pro rata for a full time COO. The salary that the member receives is for services across all businesses with approximately 25% of this amount coming from the Fund’s service fee. Although the amount he indirectly receives from the Fund is low, this is commensurate with his participation rate. Subsequently, there is no evidence to show that the member is being remunerated below the market rate for services he provides to the business. As the member’s salary (and other management staff) will resemble real commercial bargaining, the fee charged by the Trust to the Fund will not result in the Fund deriving income greater than what would be expected than if they were dealing at arm’s length. Based on the information provided, the Fund will not derive non-arm’s length income as per subsection 295-550(1) of the ITAA 1997. | Detailed Reasoning - Question 2: 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. The note to subsection 295-545(1) explains that a concessional rate of tax applies to the low tax component, while the non-arm's length component is taxed at the highest marginal rate. 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. The definition of 'non-arm's length income' is given by section 295-5503. As the Fund has not derived non-arm’s length income from its business as per section 295-550 of the ITAA 1997, it’s non-arm’s length income component under subsection 295-545(2) will be nil in relation to this income. | Detailed Reasoning - Relevant legislative provisions: Income Tax Assessment Act 1997 section 295-545 Income Tax Assessment Act 1997 section 295-550 Income Tax Assessment Act 1997 section 995-1 | Detailed Reasoning - We followed these ATO view documents: TR 2006/7 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 | Detailed Reasoning - Case law: Federal Commissioner of Taxation v. AXA Asia Pacific Holdings Ltd (2010)