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Alert! – ATO targeting non-arm’s length trust distributions to SMSFs

The ATO has announced they will be targeting SMSFs which receive distributions of non-arm’s length income from related party trusts.

In one of our previous articles the issues and tax consequences surrounding non-arm’s length distribution were discussed in detail. To summarise briefly:

In relation to an investment in a unit trust, distributions of income to the SMSF will be non-arm’s length income if:

  • the SMSF acquired the investment under a scheme, or the income was derived under a scheme, the parties to which were not dealing with each other at arm’s length; and
  • the amount of the income is more than the amount that the SMSF might have been expected to derive if those parties had been dealing with each other at arm’s length.

The top marginal tax rate is applied to any income that is caught by section 295-550 of the Income Tax Assessment Act 1997 which deals with non-arm’s length income.

This is the case even if the income or underlying asset is being used to support a pension.

Examples of typical non-arm’s length trust distributions arrangements the ATO may be targeting:

Example 1

Two non-related parties operate a business from a commercial property that is owned 50% each by their respective family SMSFs.

The business pays a yearly lease that is three times the market rate for similar properties. This arrangement seeks to have a non-arm’s length amount of income taxed at concessional tax rates.

Example 2

Three accountants set up a new accounting practice. A unit trust is set up at the same time to own the business name, associated trademarked logo and all future IP. Each

Accountant’s SMSF is issued a one third ownership for one dollar.

The Unit Trust charges the Practice an excessive yearly licence fee for use of the business name and IP. Once again the arrangement is trying to divert income to the concessional taxed SMSFs.

What should you do?

We would recommend reviewing clients with Trust-SMSF arrangements to ensure all dealings can be demonstrated as arm’s length.

The ATO has asked for voluntary disclosures to be made if appropriate.

It should not be too difficult for the ATO to identify, via Unit Trust tax returns, situations where large distributions of income have been made to SMSFs.

I’m happy to answer your queries; just give me a call on 1300 TRISUP if you would like any further information or to discuss a specific client situation.

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