Taxpayer Alert TA 2008/4: Self-managed superannuation funds deriving income from certain uncommercial trusts
Date of issue: 26 March 2008
Status: Current


Description: The alert applies to arrangements which have some or all of the following features. 1. A trust is established which is controlled by an individual or a family group. 2. An SMSF is or becomes a beneficiary of the trust. Alternatively, the SMSF holds or obtains an indirect interest in the trust, through one or more interposed entities. The trust may also have other beneficiaries, who are associated with or related to the individual or family group. 3. The income derived directly or indirectly by the SMSF from the trust is disproportionate to its investment in the trust. As such, the SMSF derives more income from the trust than it might be expected to derive from an ordinary commercial arrangement. The SMSF may consider that the trust income is subject to the same concessional rate of tax as the SMSF's other income. This is not necessarily correct. The arrangement may be achieved in a number of ways. 4. The trust deed may provide for: (a) entitlements to income which appear to be fixed, but which can be defeated by the trustee exercising a discretion to distribute income and/or capital gains to the SMSF (whether directly or indirectly). For that reason, the trust may be described as a 'hybrid trust' or 'hybrid discretionary trust' (b) the issue of units or other interests to the SMSF (or to another entity in which the SMSF holds an interest) for no consideration, or for consideration which falls short of the market value of such interests at the time of issue (c) the redemption of trust interests held by the individual or other entities for below market value or at face value. As such, the SMSF may effectively obtain a disproportionate share of the trust's income which is not commensurate with its investment. 5. The trust deed may also purport to deny the individual or other family members any interest in capital gains of the trust. Alternatively, the capital gain to which the SMSF is entitled may be disproportionately large, in comparison to the amount of trust capital which the SMSF has funded. The deed may achieve this by preventing or restricting the distribution of capital gains to the individual or other family member, or by enabling the individual or family member's interest in the trust to be redeemed at face value, or face value, adjusted for inflation. 6. As beneficiaries of the SMSF, the individual or family members may ultimately benefit from the income and capital gains distributed to the SMSF. | 1. A trust is established which is controlled by an individual or a family group. 2. An SMSF is or becomes a beneficiary of the trust. Alternatively, the SMSF holds or obtains an indirect interest in the trust, through one or more interposed entities. The trust may also have other beneficiaries, who are associated with or related to the individual or family group. 3. The income derived directly or indirectly by the SMSF from the trust is disproportionate to its investment in the trust. As such, the SMSF derives more income from the trust than it might be expected to derive from an ordinary commercial arrangement. The SMSF may consider that the trust income is subject to the same concessional rate of tax as the SMSF's other income. This is not necessarily correct. The arrangement may be achieved in a number of ways. 4. The trust deed may provide for: (a) entitlements to income which appear to be fixed, but which can be defeated by the trustee exercising a discretion to distribute income and/or capital gains to the SMSF (whether directly or indirectly). For that reason, the trust may be described as a 'hybrid trust' or 'hybrid discretionary trust' (b) the issue of units or other interests to the SMSF (or to another entity in which the SMSF holds an interest) for no consideration, or for consideration which falls short of the market value of such interests at the time of issue (c) the redemption of trust interests held by the individual or other entities for below market value or at face value. As such, the SMSF may effectively obtain a disproportionate share of the trust's income which is not commensurate with its investment. 5. The trust deed may also purport to deny the individual or other family members any interest in capital gains of the trust. Alternatively, the capital gain to which the SMSF is entitled may be disproportionately large, in comparison to the amount of trust capital which the SMSF has funded. The deed may achieve this by preventing or restricting the distribution of capital gains to the individual or other family member, or by enabling the individual or family member's interest in the trust to be redeemed at face value, or face value, adjusted for inflation. 6. As beneficiaries of the SMSF, the individual or family members may ultimately benefit from the income and capital gains distributed to the SMSF. | (a) entitlements to income which appear to be fixed, but which can be defeated by the trustee exercising a discretion to distribute income and/or capital gains to the SMSF (whether directly or indirectly). For that reason, the trust may be described as a 'hybrid trust' or 'hybrid discretionary trust' (b) the issue of units or other interests to the SMSF (or to another entity in which the SMSF holds an interest) for no consideration, or for consideration which falls short of the market value of such interests at the time of issue (c) the redemption of trust interests held by the individual or other entities for below market value or at face value. As such, the SMSF may effectively obtain a disproportionate share of the trust's income which is not commensurate with its investment. | FEATURES WHICH CONCERN US | The Tax Office considers that the arrangement outlined above may give rise to taxation issues that include whether: 1. income derived by the SMSF from the trust is 'non-arm's length income' for the purposes of section 295-550 of the ITAA 1997, which is taxed at a higher rate than other income of the SMSF; 2. other taxation consequences arise for the individual or other family members as discussed in Taxpayer Alert TA 2008/3. | 1. income derived by the SMSF from the trust is 'non-arm's length income' for the purposes of section 295-550 of the ITAA 1997, which is taxed at a higher rate than other income of the SMSF; 2. other taxation consequences arise for the individual or other family members as discussed in Taxpayer Alert TA 2008/3. | Entities considering entering into the arrangement outlined above should also consider the requirements of the Superannuation Industry (Supervision) Act 1993. | The Australian Taxation Office is examining these arrangements . | Date of Issue: 26 March 2008 | Date of Effect: 26 March 2008 | Related Practice Statements: PS LA 2005/13 - Taxpayer Alerts | Subject References: hybrid trust self-managed superannuation fund unit trust trust distributions capital gains non-arm's length income | Legislative References: Income Tax Assessment Act 1997 Section 295-550 Part 3-1 Superannuation Industry (Supervision) Act 1993 | Related Taxpayer Alerts: | Contact Officer: Stuart Forsyth Business Line: Superannuation Phone: (07) 3149 5504





Related documents: TR 2006/7 | PS LA 2005/13 - Taxpayer Alerts | Section 295-550 | Part 3-1 | Superannuation Industry (Supervision) Act 1993 | TA 2008/3

The Taxation Office view on the major issue in this arrangement is set out in Taxation Ruling TR 2006/7 | This Taxpayer Alert describes a non-arm's length arrangement under which a self-managed superannuation fund (SMSF) derives income through a direct or indirect interest in a closely-held trust. The arrangement may be of the type of trust described in Taxpayer Alert TA 2008/3, where an individual or another entity borrows funds to invest in a trust and seeks a tax deduction for its interest costs. This Alert should be read in conjunction with Taxpayer Alert TA 2008/3.