Edited version of private ruling

Authorisation Number: 1011772250040

NOTICE

This edited version has been found to be misleading or incorrect. It does not represent the ATO’s view of the relevant law.

This notice must not be taken to imply anything about:

● the binding nature of the private advice issued to the applicant

● the correctness of other edited versions.

Ruling

Subject: Acquisition of assets from fund member and non-arm's length income

Question

1. Will the acquisition of shares in a private company (the Company) by a self managed superannuation fund (the Fund) from a member of the Fund who is a shareholder of the private company contravene subsection 66(1) of the Superannuation Industry (Supervision) Act 1993 (SIS Act)?

2. Will dividends and attached franking credits received by the Fund from the Company be non-arm’s length income of the Fund in accordance with subsection 295-550(3) of the Income Tax Assessment Act 1997 (ITAA 1997)?

3. In the event of the Company being liquidated, will distributions and attached franking credits received by the Fund from the liquidator be non-arm’s length income of the Fund in accordance with subsection 295-550(3) of the ITAA 1997?

Answer:

1. The Commissioner is unable to rule.

2. No.

3. The Commissioner declines to rule.

This ruling applies for the following period:

1 July 2010 onward

The scheme commences on:

1 July 2010

Relevant facts and circumstances

Your client, the trustee of a self managed superannuation fund (the Fund), is contemplating acquiring, on behalf of the Fund, all the ordinary shares currently held by a member of the Fund (the Member) in a private company (the Company). Instead of the Fund paying the Member cash to acquire the shares, the Member intends to make an in-specie contribution to the Fund by transferring the shares to the Fund.

As the Member will make a capital gain on transferring the shares to the Fund, it is the Member’s intention that the in-specie contribution will comprise:

(a) the amount of capital gain which the Member will choose to disregard and contribute to the Fund as a CGT exempt amount under subsection 152-305(1) of the ITAA 1997; and

(b) a specified amount being the Member’s non-concessional contribution to the Fund.

Upon transfer of the shares, the Fund will become the sole shareholder of the Company.

The Trustee of the Fund intends to rely on regulation 13.22C of the Superannuation Industry (Supervision) Regulations 1994 to exempt the Fund’s investment in the Company from being treated as an in-house asset of the Fund for the purposes of the SIS Act.

The Fund, established in 2010, consists of the Member and another member, both of whom are the directors of the Company.

The Company’s current share structure is as follows:

The Class ‘C’ shares, being discretionary dividend shares and carrying no value, will be cancelled prior to the Fund acquiring the Member’s ordinary shares in the Company.

The Company was originally registered under a different name. After selling its business in 2010 to a third party, it changed its name and has, since then, ceased paying remuneration to the directors. Prior to the sale of the business, the Member was the managing director of the Company, while the other member of the Fund, being an office employee of the Company, was also a director of the Company.

Upon sale of its business, the Company made a capital gain. It chose to disregard part or all of the capital gain made pursuant to subsection 152-305(2) of the ITAA 1997 and contributed a specified CGT exempt amount to the Fund for the Member, who is a CGT concession stakeholder of the Company and eligible for the small business retirement exemption under Subdivision 152-D of the ITAA 1997.

Currently the Company’s assets consist entirely of cash and cash equivalents. No formal valuation has been conducted. The Company also carries a franking balance.

After the transfer of the shares from the Member to the Fund:

(a) the Member will continue to be a director and corporate secretary of the Company;

(b) the other member of the Fund will also continue to be a director of the Company but will not be in receipt of director’s fees; and

(c) both directors intend to invest the Company’s assets in cash and real estate assets.

Subject to the ongoing profitability of the Company, the directors also anticipate implementing a policy of paying dividends to the Fund at a specified percentage or based on 100% of the Company’s net profit after tax, whichever is the greater.

If at some time in the future the directors decide to liquidate the Company, it is expected that the return to shareholders would be made up of a return of paid-up capital and a fully franked liquidator’s dividend.

Relevant legislative provisions

Income Tax Assessment Act 1936 Subsection 273(2).

Income Tax Assessment Act 1997 Section 152-305

Income Tax Assessment Act 1997 Subsection 152-305(1)

Income Tax Assessment Act 1997 Subsection 152-305(2)

Income Tax Assessment Act 1997 Section 152-315

Income Tax Assessment Act 1997 Section 152-325

Income Tax Assessment Act 1997 Subsection 152-325(1)

Income Tax Assessment Act 1997 Subsection 152-305(7)

Income Tax Assessment Act 1997 Subsection 152-305(8)

Income Tax Assessment Act 1997 Section 295-545.

Income Tax Assessment Act 1997 Section 295-550.

Income Tax Assessment Act 1997 Subsection 295-550(2).

Income Tax Assessment Act 1997 Subsection 295-550(3).

Income Tax Assessment Act 1997 Paragraph 295-550(3)(a).

Income Tax Assessment Act 1997 Paragraph 295-550(3)(b).

Income Tax Assessment Act 1997 Paragraph 295-550(3)(c).

Income Tax Assessment Act 1997 Paragraph 295-550(3)(d).

Income Tax Assessment Act 1997 Paragraph 295-550(3)(e).

Income Tax Assessment Act 1997 Paragraph 295-550(3)(f).

Taxation Administration Act 1953 Section 357-55

Taxation Administration Act 1953 Section 357-105

Taxation Administration Act 1953 Subsection 357-105(2)

Taxation Administration Act 1953 Section 357-105

Taxation Administration Act 1953 Section 357-110

Taxation Administration Act 1953 Paragraph 357-110(1)(a)

Taxation Administration Act 1953 Section 357-120

Taxation Administration Act 1953 Section 359-35

Taxation Administration Act 1953 Section 359-35(2)

Taxation Administration Act 1953 Section 359-35(3)

Superannuation Industry (Supervision) Act 1993 Section 66

Superannuation Industry (Supervision) Act 1993 Subsection 66(1)

Superannuation Industry (Supervision) Act 1993 Sub-paragraph 66(2A)(a)(iv)

Superannuation Industry (Supervision) Act 1993 Paragraph 66(2A)(b)

Superannuation Industry (Supervision) Act 1993 Section 71

Superannuation Industry (Supervision) Act 1993 Sub-paragraph 71(1)(j)(ii)

Superannuation Industry (Supervision) Regulations 1994 Regulation 13.22C

Summary

The Commissioner is unable to rule on question 1 as subsection 66(1) of the SIS Act is not a provision about any of the matters listed in section 357-55 of the Taxation Administration Act 1953 (TAA).

Provided the proposed acquisition of the Company shares by the Fund from a member of the Fund complies with the SIS Act, the Commissioner is of the view that the parties involved in the proposed acquisition are dealing with each other at arm’s length. Provided further that when dividends with attached franking credits are paid to the Fund, and the rate of dividends and the manner in which those dividends are paid are all consistent with an arm’s length dealing, the dividends so paid will not be non-arm’s length income of the Fund.

The Commissioner declines to rule on question 3 as the scenario provided is speculative or hypothetical in nature.

Detailed reasoning

SIS provision not relevant for rulings

Division 359 of Schedule 1 to the TAA provides that a private ruling is a written statement of the Commissioner’s opinion of how a relevant provision applies, or would apply, to a particular entity in relation to a specified scheme. Under section 357-55 of the TAA, the provisions that are relevant for rulings are those about the following:

(a) income tax

(b) Medicare levy

(c) fringe benefits tax

(d) franking tax

(e) withholding tax

(f) mining withholding tax

(g) the administration or collection of those taxes

(h) a grant or benefit mentioned in section 8 of the Product Grants and Benefits Administration Act 2000, or the administration or payment of such a grant or benefit.

As subsection 66(1) of the SIS Act is not about any of the matters listed above and is, therefore, not relevant for rulings, the Commissioner is unable to make a private ruling on question 1 of your private ruling application.

Income of a complying superannuation fund

In accordance with section 295-545 of the ITAA 1997, the taxable income of a complying superannuation fund is split into a ‘non-arm’s length component’ and a ‘low tax component’.

Any income falling within the non-arm’s length component is reduced by any deductions to the extent that the deductions are attributable to that income and is then taxed at the highest marginal rate (currently 45%).

The remaining part of the entity’s taxable income for the income year is the low tax component, which is taxed at a concessional rate (currently 15%).

The non-arm’s length component, as defined in section 295-550 of the ITAA 1997, includes dividends paid to a complying superannuation fund by a private company, or ordinary income or statutory income that is reasonably attributable to such a dividend, unless the amount is consistent with an arm’s length dealing.

The Commissioner has issued Taxation Ruling TR 2006/7 (TR 2006/7), which is concerned with special income derived by a complying superannuation fund under the now repealed section 273 of the Income Tax Assessment Act 1936 (ITAA 1936). As the wording of section 273 of the ITAA 1936 is similar to section 295-550 of the ITAA 1997, TR 2006/7 provides useful guidance on the factors to be considered in the interpretation of the current provision.

Paragraph 19 of TR 2006/7 states:

Dividends are only derived on an arm's length basis when the shares are acquired, the investment is maintained, and the dividends are paid on an arm's length basis. If the shares are acquired at market value, the private company is not involved in non-arm's length dealings and the rate of dividend is the same as the rate of dividend paid on other shares in the company or is reasonable having regard to investment risk, and there are no other matters that the Commissioner will consider relevant, the Commissioner will form the opinion that it would be reasonable not to treat the dividend as special income.

In applying subsection 295-550(3) of the ITAA 1997 to the facts of this case, the Commissioner will have regard to paragraphs 295-550(3)(a) to (f) of the ITAA 1997 in order to decide whether or not dividends are derived on an arm’s length basis. The facts of the case and all the matters contained in paragraphs 295-550(3)(a) to (f) of the ITAA 1997 cannot be considered in isolation to each other but must be considered as a whole. Subsection 295-550(3) states:

In deciding whether an amount is consistent with an arm’s length dealing under subsection (2), have regard to:

(a) (g) the value of shares in the company that are assets of the entity; and

(b) the cost to the entity of the shares on which the dividend was paid; and

(c) the rate of that dividend; and

(d) whether the company has paid a dividend on other shares in the company and, if so, the rate of that dividend; and

(e) whether the company has issued any shares to the entity in satisfaction of a dividend paid by the company (or part of it) and, if so, the circumstances of the issue; and

(f) any other relevant matters.

It is proposed to deal with each of these matters in turn.

The value and cost of the shares acquired

For the purposes of subsections 295-550(2) and (3) of the ITAA 1997, the Fund, which is a complying self managed superannuation fund as per your advice, is the entity, and the Company is the private company.

In deciding whether any dividend payable to the Fund by the Company is consistent with an arm’s length dealing, paragraphs 295-550(3)(a) and (b) of the ITAA 1997 requires regard to be given to:

● the value of shares in the Company that are assets of the Fund and

● the cost to the Fund of the shares on which any dividend was paid.

Your client has proposed to acquire all the ordinary shares in the Company at market value.

Since the Fund will be paying the market value of the ordinary shares in the Company for the acquisition, the transaction will be consistent with an arm’s length dealing. This is a favourable factor in the Commissioner’s consideration of paragraphs 295-550(3)(a) and (b) of the ITAA 1997.

Rate of dividend

In deciding whether any dividend payable to the Fund by the Company is consistent with an arm’s length dealing, paragraph 295-550(3)(c) of the ITAA 1997 requires regard to be given to the rate of dividend paid on the Fund’s shares:

At this stage, no dividend has yet to be paid to the Fund and the rate of dividend provided is anticipative only, which will be subject to the ongoing profitability of the Company. In the circumstances, the Commissioner is unable to provide a definitive view on whether the anticipative rate of dividend at which the dividend will be paid in the future is consistent with an arm’s length dealing. The Commissioner has taken it as a neutral factor in his overall consideration of whether the acquisition being contemplated will produce an arm’s length outcome.

Dividend on other shares and issue of shares in satisfaction of dividend

Paragraphs 295-550(3)(d) and (e) of the ITAA 1997 require regard to be given respectively to:

● whether the Company has paid a dividend on other shares in the Company and, if so, the rate of that dividend; and

● whether the Company has issued any shares to the Fund in satisfaction of a dividend (or part thereof) paid by the Company and, if so, the circumstances of the issue

With regard to dot point 1 above, as the Class C shares will be cancelled prior to the share transfer and as the Fund will become the sole shareholder of the Company after the share transfer, it is not necessary to consider, in this private ruling, the question raised. With regard to dot point 2 above, as no shares have yet been issued by the Company to the Fund in satisfaction of any dividend otherwise payable to the Fund, it is also not necessary to consider, in this private ruling, the question raised.

Other relevant factors

In deciding whether any dividend payable to the Fund by the Company is consistent with an arm’s length dealing, paragraph 295-550(3)(f) requires regard to be given to any other relevant matters.

Paragraph 54 of TR2006/7 states that:

The matters that the Commissioner may consider relevant include:

● the extent to which members who are at arm’s length to the private company have an interest in the superannuation fund, ADF or PST;

● the relationship between the superannuation fund, ADF or PST and the private company;

● the relationship between the superannuation fund, ADF or PST and any party with which the private company has dealings; and

● who the superannuation fund, ADF or PST acquires the shares from and the circumstances of that acquisition.

As the Member and the other member of the Fund are the directors of the Company and will continue to hold such positions after the share transfer, the relationship between the parties is not at arm’s length. However, as pointed out by Davies J of the Federal Court in Hains, Re; Barnsdall v. Commissioner of Taxation (Cth) (1988) 88 ATC 4565; (1988) 81 ALR 173; (1988) 19 ATR 1352, a non-arm’s length relationship does not necessarily mean that the parties cannot deal at arm’s length in relation to a particular transaction. From the information you provided, there is no indication of any particular transaction that may be inconsistent with an arm’s length dealing.

Conclusion

On the whole and having regard to each of the matters listed in paragraphs 295-550(3)(a) to (f) of the ITAA 1997, the Commissioner is of the view that the parties involved in the proposed transactions for the Fund to acquire the shares of the Company from the Member are dealing with each other at arm’s length. Provided that when dividends with attached franking credits are paid to the Fund, and the rate of dividend and the manner in which dividends are paid are all consistent with an arm’s length dealing, the dividends so paid will not be non-arm’s length income of the Fund.

As the Commissioner is unable to rule on the question of whether the proposed acquisition will or will not contravene the SIS Act, this private ruling is given on the basis that the proposed acquisition complies with the SIS Act.

Ruling not to prejudice or unduly restrict administration of taxation law

The Commissioner must comply with a private ruling application unless there is a basis to decline to make the ruling. The Commissioner may decline to make a private ruling under section 359-35 of Schedule 1 to the TAA where:

● making the ruling would prejudice or unduly restrict the administration of a taxation law (paragraph 359-35(2)(a));

● the matter sought to be ruled on is already being, or has been considered by the Commissioner for the taxpayer (paragraph 359-35(2)(b));

● the matter sought to be ruled on is how the Commissioner would exercise a power under a relevant provision and the Commissioner decides to (or not to) exercise the power (subsection 359-35(3));

● the Commissioner has asked for further information and the applicant has not provided that within a reasonable time (subsection 357-105(2));

● the Commissioner considers that correctly making a private or oral ruling would depend on making an assumption about a future event or other matter (paragraph 357-110(1)(a)); or

● the Commissioner proposes to use third party or other information which is material to the outcome of the ruling but cannot disclose this information to the applicant because such action would breach the tax secrecy provisions, privacy legislation or the confidentiality of the person providing the information (section 357-120).

With regard to question 3 of your private ruling application, the Commissioner declines to make a private ruling as the scenario you provided is speculative or hypothetical in nature for it to be reasonably considered as being seriously contemplated by your client at the time of your private ruling application. Making a private ruling under such circumstances would prejudice or unduly restrict the administration of a taxation law.

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