Income which is non-arm's length income or NALI is taxed in an SMSF at the top marginal tax rate (rather than the concessional rates that usually apply to income of SMSFs).
Under section 295-550 of the Income Tax Assessment Act 1997, circumstances where income to an SMSF is NALI include where:
- it is derived from a scheme where the parties are not dealing at arm's length, and the return to the SMSF is greater than it would have been had the parties been dealing at arm's length; or
- it is a dividend from shares in a private company, unless the dividends are consistent with an arm's length dealing, taking into account specific factors.
In a recent case, the AAT has confirmed that it is not just the direct actions of the SMSF involved that can give rise to NALI, but all aspects of the whole arrangement, even though they do not involve the SMSF.
In GYBW v FC of T (21 October 2019), an SMSF bought 200 shares (20%) in Company A for $200. A business associate of the SMSF members owned the other 800 shares or 80%. At the time, Company A had no assets other than what the shareholders paid for the shares.
A short time later, Company A bought all the shares in Company B from the other shareholder in Company A for less than market value. Company B carried on a business.
Over the next four years, Company A paid nearly $1.8 million in dividends to the SMSF (from the profits of the business carried on by Company B).
The question was whether the dividends received by the SMSF from Company A were NALI.
The AAT decided that although the SMSF bought the shares in Company A at market value, Company A had entered into a non-arm's length transaction when it bought the shares in Company B. As a result, the dividends received by the SMSF from Company A were NALI.
The AAT confirmed it is not just the direct involvement of the SMSF that is relevant, but the totality of the arrangement in determining whether NALI applies.
The decision in GYBW is not new law and is consistent with previous cases.
It is a reminder of the wide reach of the NALI rules, and that it is not just the actions of the SMSF that must be considered, but all the transactions as a whole.
Cooper Grace Ward is a leading Australian law firm based in Brisbane.
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