Edited version of private advice

Authorisation Number: 1051978862024

Date of advice: 5 May 2022

Ruling

Subject: Non-arm's length income

Question

Was the capital gain made by the Fund non-arm's length income within the meaning of section 295-550 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

No.

This ruling applies for the following period:

Year ended 30 June 20XX

The scheme commences on:

18 May 20XX

Relevant facts and circumstances

A member of a self-managed superannuation fund (the Fund) was employed from as Chief Financial Officer (CFO) of the international joint venture company (the Company).

As CFO, the member reported to the Company's CEO. The member was not a director of the Company or a member of its advisory board.

The member was invited either directly or through a related entity, to subscribe for a class of shares in the Company. You have stated that the Company has a practice of inviting key employees to participate in the company's performance as holders of small parcels of shares with limited rights

The Fund, through a nominee, subscribed for the shares in the Company and paid a subscription price of xx per share.

One of the parties to the joint venture sold one of its business to the Company. The acquisition was funded by debt and involved a significant acquisition of assets.

Upon the Company acquiring the business, a new head company (the New Company) was established. The capital structure of the Company was reorganised with shareholder debt and equity now invested through the New Company rather than through the Company.

The member, along with two other individuals were directors of the New Company to facilitate its incorporation and other administrative matters associated with the reorganisation. The directors could not make decisions alone and were not in a position to control or influence the voting of the other directors.

To facilitate this reorganisation, the New Company purchased all of the shares issued in the Company, including the class of shares beneficially owned by the Fund by making payments and issuing shares to the Company's shareholders.

The New Company acquired the shares in the Company for an enterprise value. The value was determined and agreed by the parties prior to the Company acquiring the business. The valuation was also confirmed by an independent valuation conducted.

The total value of the consideration received by the Fund from the New Company on the disposal of the class of shares was more than the cost base such that it made a significant capital gain.

The directors of the New Company resigned soon after the formalities had been completed.

Relevant legislative provisions

Section 295-545 of the Income Tax Assessment Act 1997

Section 295-550 of the Income Tax Assessment Act 1997

Relevant ATO view document

Taxation Ruling TR 2006/7 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

Reasons for decision

Section 295-545 of the Income Tax Assessment Act 1997 (ITAA 1997) states:

(1)  The taxable income of a complying superannuation entity is split into non-arm's length component and a low tax component.

(2)  The non-arm's length component for an income year is the entity's non-arm's length income for that year less any deductions to the extent that they are attributable to that income.

Subsection 295-550(1) of the ITAA 1997 states:

An amount of ordinary income or statutory income is non-arm's length income of a complying superannuation entity if, as a result of a scheme the parties to which were not dealing with each other at arm's length in relation to the scheme, one or more of the following applies:

(a)  The amount of the income is more than the amount that the entity might have been expected to derive if those parties had been dealing with each other at arm's length in relation to the scheme;...

One of the essential elements of paragraph 295-550(1)(a) of the ITAA 1997 is for the parties to not have been dealing with each other at arm's length in relation to the scheme.

Subsection 995-1(1) of the ITAA 1997 when defining arm's length, states:

"...in determining whether parties deal at arm's length, consider any connection between them and any other relevant circumstance..."

Paragraphs 76-77 of Taxation Ruling TR 2006/7 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 (TR 2006/7), states:

[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.

[77] If the relationship of the parties is such that one party has the ability to influence or control the other, this will suggest that the parties may not be dealing at arm's length, but it will not be determinative.

Subsection 995-1(1) of the ITAA 1997 states that scheme means:

(a)  Any arrangement; or

(b)  Any scheme, plan, proposal, action, course of action or course of conduct, whether unilateral or otherwise.

An arrangement under subsection 995-1(1) of the ITAA 1997 means:

Any arrangement, agreement, understanding, promise or undertaking, whether express or implied, and whether or not enforceable (or intended to be enforceable) by legal proceedings.

In this matter, a director of the corporate trustee of the Fund has been involved with the Company matters since they commenced employment as CFO. From the information that has been provided to us, the arrangement for his Fund to acquire shares through a nominee company was not only restricted to the member of the Fund but to other key employees of the Company as well. In this regard, the arrangement for the Fund to acquire the shares does not, based on the information provided (that is publicly available) and considering the risks, seem to be non-arm's length in nature.

Similarly, upon disposal of the shares, while we recognise the member was a director of the New Company for a short period to facilitate the reorganisation of the Company structure and to manage administrative matters, we have been advised that the member could not make decisions alone and was not in a position to either control or influence the voting of the other directors. As such, the total value of the consideration received by the Fund does not, based on the information provided and verified against publicly available information, seem to be consistent with non-arm's length behaviour.

No formal evidence has been provided to determine whether at the time when the member was invited to participate in the share subscription, that the eventual sale of the business to the Company was a known factor.

Evidence provided also supports your claim that the Company had a practice of inviting key employees to participate in the company's performance as holders of small parcels of shares with limited rights.

Furthermore, you confirmed the following in the ruling application:

•         The qualified valuer acted independently in carrying out their valuation analysis and acted to provide their independent opinion of Market Value of the shares

•         The member had no involvement or control in respect of the allocation/subscription of the shares

•         At the time when the Fund acquired the shares, the member had no knowledge of when or if the Company would be sold or floated or of any other event that would impact on the value of the Company

•         The member had no involvement or decision-making ability in either the setting up of the joint venture or the establishment of the Company.

Accepting these statements in the context of the ruling application, means that there does not appear to be any evidence that any non-arm's length behaviour has occurred.

As such, the investment return received by the Fund from the disposal of the shares is not considered non-arm's length income.