Private ruling: Non-arm's length income
Published: February 2014
Ruling period: Year ending 30 June 2012
Date scheme commenced: 1 July 2013

Ruling: Q1: Will any dividends received by the Fund as a result of the proposed acquisition of shares in a private company be non-arm's length income of the Fund in accordance with subsection 295-55(3) of the Income Tax Assessment Act 1997 ? Advice/Answers Yes

Relevant facts and circumstances: The Member is the sole member of the Fund. The Member is over 60 years of age and retired. The Member has not made any non-concessional contributions to the Fund in the past three years. The Fund has investments in: · cash · direct property; · loans; · shares in listed companies; · stapled securities; · units in listed unit trusts; and · units in unlisted unit trusts. All assets in the Fund are in pension phase. The Member is also the sole director and sole shareholder of a company (the Company), holding all the shares. The Company owns commercial property and cash. There are no liabilities recorded. The commercial property owned by the Company is currently leased at a rate which has been independently assessed by a real estate agent. A valuation report from the commercial property has been obtained The Company ceased trading in the 2011-12 income year and will not conduct any trading activities in the future. A business valuation report provides an estimate of the value of the Company. It is proposed that the initial shares in the Company be split into a larger bundle of shares. The Member is proposing to make a non-concessional superannuation contribution by way of an in-specie transfer of part of the shares in the Company to the Fund. It is proposed that the balance of the shares in the Company will be acquired by the Fund. An initial cash payment will be made with the balance being paid under a deferred instalment arrangement through equal annual instalments over a number of years. The instalment payments will be funded by dividends paid by the Company and other investment earnings of the Fund. It is proposed that a fully franked dividend be paid from the Company to the Fund commencing in June 2013. No dividends will be paid to the other shareholders of Pivot. The Company previously paid dividends to the Member which were a small fraction of the amount of the dividends proposed to be made under the current arrangement. It is proposed that the Member will gift the proceeds from the sale of shares in the Company to a related discretionary trust (the Trust) they control. The beneficiaries of the Trust under the trust deed of the Trust are: · the Member; · the Member's relatives (by blood or marriage); · any company where the aforementioned owns at least one share; and · any trust where any of the aforementioned beneficiaries have an interest. The gift to the Trust will generate an estimated amount of taxable income a year, the majority of which is proposed to be distributed to the Member.

Relevant legislative provisions: Income Tax Assessment Act 1936 Subsection 273(2). | Income Tax Assessment Act 1997 Section 295-545. | Income Tax Assessment Act 1997 Section 295-550. | Income Tax Assessment Act 1997 Subsection 295-550(1). | Income Tax Assessment Act 1997 Subsection 295-550(2). | Income Tax Assessment Act 1997 Subsection 295-550(3). | Income Tax Assessment Act 1997 Paragraph 295-550(3)(a). | Income Tax Assessment Act 1997 Paragraph 295-550(3)(b). | Income Tax Assessment Act 1997 Paragraph 295-550(3)(c). | Income Tax Assessment Act 1997 Paragraph 295-550(3)(d). | Income Tax Assessment Act 1997 Paragraph 295-550(3)(e). | Income Tax Assessment Act 1997 Paragraph 295-550(3)(f). | Income Tax Assessment Act 1997 Subsection 295-550(4). | Income Tax Assessment Act 1997 Subsection 295-550(5). | Income Tax Assessment Act 1997 Subsection 295-550(6). Further issues for you to consider | None. | Anti-avoidance rules | The ruling is limited to the questions raised in the application.

Reasons for decision: Detailed Reasoning - Summary of decision: The Commissioner is of the opinion that the transactions involving the payment of dividends by the Company to the Fund will not produce an arm's length outcome. Therefore the dividends paid by the Company to the Fund will be considered non-arm's length income of the Fund. | Detailed Reasoning - Detailed reasoning: 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'. This ruling refers to 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(2) of the ITAA 1997 states that dividends received by a complying superannuation fund will be non-arm's length income of the fund unless the amount is consistent with an arm's length dealing. In other words, is the dividend the same for the complying superannuation fund as it would be with any other shareholder? The factors listed in subsection 295-550(3) are to be considered in deciding whether there has been an arm's length result. Consequently, the Commissioner will consider if dividends paid to the Fund by the Company produces an arm's length result. As noted in the facts, the Member is the only member of the Fund. The Fund is a complying self-managed superannuation fund. The private company in this case is the Company. The Member is the sole director and sole shareholder of the Company, holding all issued shares. | Detailed Reasoning - Dividends: In applying subsection 295-550(3) of the ITAA 1997 to the facts of this case, the Commissioner will consider the factors described in paragraphs 295-550(3)(a) to (f) that indicate whether or not the dividends are consistent with an arm's length dealing. Further, the Commissioner will consider any other matter considered to be relevant under paragraph 295-550(3)(f). The facts of the case and all the matters contained in paragraphs 295-550(3)(a) to (f) of the ITAA 1997 cannot be considered in isolation to each other but must be considered as a whole. Subsection 295-550(3) of the ITAA 1997 states: In deciding whether an amount is consistent with an arm's length dealing under subsection (2), have regard to: (a) the value of shares in the company that are assets of the entity; and (b) the cost to the entity of the shares on which the dividend was paid; and (c) the rate of that dividend; and (d) whether the company has paid a dividend on other shares in the company and, if so, the rate of that dividend; and (e) whether the company has issued any shares to the entity in satisfaction of a dividend paid by the company (or part of it) and, if so, the circumstances of the issue; and (f) any other relevant matters. It is proposed to deal with each of these matters in turn. Paragraphs 295-550(3)(a) and (b) of the ITAA 1997: The entity in this case is the Fund. The private company is the Company and its shareholding is, as noted in the facts, owned solely by the Member. The Company owns commercial property and cash only. There are no liabilities recorded. A business valuation report which was provided estimates the value of the Company. It is proposed that the initial shares in the Company be split into a larger parcel of shares. The Member is proposing to make a non-concessional superannuation contribution by way of an in-specie transfer of a number of shares in the Company at market value to the Fund. It is proposed that the balance of shares in the Company will be acquired by the Fund at market value. An initial cash payment will be made with the balance of being paid in equal annual instalments over a number of years. The instalment payments will be funded by dividends paid by the Company and other investment earnings of the Fund. It is further proposed that the Member will gift the proceeds from the sale of shares in the Company to a related discretionary trust (the Trust) they control. The beneficiaries of the Trust are: · the Member; · the Member's relatives (by blood or marriage); · any company where the aforementioned owns at least one share; and · any trust where any of the aforementioned beneficiaries have an interest. The Fund purports to own100% of the issued share capital in the Company. It is considered that the shares have been objectively valued and that the market value is reasonable. Therefore it is considered that the value of the share acquired by the Fund was determined on an arm's length basis. Overall, it is considered that these factors are favourable to the Commissioner considering that the income of the Fund is arm's length income. | Detailed Reasoning - Paragraphs 295-550(3)(c) and (d) of the ITAA 1997:: The Company previously paid dividends to the Member which were a small fraction of the amount of the dividends proposed to be made under the current arrangement. It is noted that there is a marked increase in the dividends received by the Fund as a result of the proposed acquisition of shares in the Company. Overall, in view of the above, it is considered that these factors are unfavourable in respect of the Commissioner considering the income to be arm's length income. | Detailed Reasoning - Paragraph 295-550(3)(e) of the ITAA 1997:: Pivot has not issued shares in satisfaction of a dividend. This will be a neutral factor in determining if there is an arm's length outcome. | Detailed Reasoning - Paragraph 295-550(3)(f) of the ITAA 1997:: As noted earlier, the Fund purports to own 100% of the issued share capital in the Company notwithstanding that only a part of the total shares have been acquired by both an in-specie transfer as well as by actual payment. It is contended that the value of the remaining shares will be paid over a number of years using the dividends paid on all the shares to fund the purchase. This indicates that the Member may influence, or is in a position to significantly affect, the decisions of the Company including the timing and the amount of the payment of dividends. Therefore, the state of the relationship between the Member and the Company is an unfavourable factor. The source of the funds used by the Fund to acquire the shares in the Company may have an influence on the decision made by the Commissioner. As already noted, the Member is proposing to make a non-concessional superannuation contribution by way of an in-specie transfer of shares in the Company at market value to the Fund. Further, it is proposed that the balance of the shares in the Company will be acquired by the Fund at market value. An initial cash payment will be made with the balance of being paid in equal annual instalments over a number of years. As already noted, the instalment payments will be funded by dividends paid by the Company in respect of all the shares and other investment earnings of the Fund. This is not considered a transaction which would be struck in an arm's length dealing. It is unlikely that, in an arm's length transaction, no consideration would be given by the Fund to the Member in return for the arrangement to pay by instalments. In addition, questions are raised as to the proposal that the Member gift the proceeds of from the sale of shares in the Company to the Trust, a related discretionary trust which the Member controls. | Detailed Reasoning - Conclusion:: On the whole, having regard to the matters listed paragraphs 295-550(3)(a) to (f) of the ITAA 1997, the Commissioner is of the opinion that the transactions involving the payment of dividends by Pivot to the Fund will not produce an arm's length outcome. Therefore, the dividends paid by Pivot to the Fund will not be considered non-arm's length income of the Fund as defined by section 295-550 of the ITAA 1997.