A tax rate of 45% applies to any income that is caught by section 295-550 of the Income Tax Assessment Act 1997.

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

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.

Tax Ruling 2006/7 provides further guidance on how the ATO interprets this section.

At paragraph 76, the Commissioner considers that parties are dealing with each other at arm’s length in relation to a transaction if the independent minds and wills of the parties are applied to the transaction and their dealing is a matter of real bargaining. If this is not the case, the Commissioner will consider that the parties are not dealing with each at arm’s length in relation to the transaction. 

The Commissioner also outlines at paragraph 80 that determining whether income is excessive is a question of fact. When considering this issue, the Commissioner will take into account all relevant matters. The level of investment risk that the superannuation entity is exposed to will be a relevant matter.  An example may be where a SMSF receives a yearly ongoing income distribution that is well in excess of the initial investment.

There have also been a few taxpayer alerts issued by the ATO that are relevant:

TA 2003/1 and TA 2008/4  both outline the Commissioner’s concern that schemes are being entered into where SMSF’s are investing in unit trusts on non-commercial terms so as to derive income that is taxed at concessional rates that would otherwise be taxed in the hands of the individual members.

Please give us a call if you have any clients that may possibly be caught out by this section.