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Edited version of your written advice

Authorisation Number: 1012851514259

Date of advice: 30 July 2015

Ruling

Subject: Non-arm's length income

Question

Will dividends paid by a private company (the Company) to a self-managed superannuation fund (the Fund) be non-arm's length income of the Fund under section 295-550 of the Income Tax Assessment Act 1997?

Answer

Yes.

This ruling applies for the following period

Income year ended 30 June 2014

The scheme commenced on

1 July 2013

Relevant facts and circumstances

The Fund is a self-managed superannuation fund which was established during the 2007-08 income year.

There are two members in the Fund - Member 1 and Member 2.

The trustee of the Fund (the Trustee) is a company.

Directors and members of the Trustee are Member 1 and Member 2.

The Trustee holds one of the four ordinary shares in the Company.

The Company was established during the 20WW-XX income year by issuing a number of shares.

The Company then borrowed, as shown in a loan agreement, an amount from a non-related trust (the Trust) to acquire a business.

The interest rate on the loan was set to a retail bank variable home loan rate.

The trust which provided the loan to the Company is a discretionary trust with a corporate beneficiary. Member 2 is the primary beneficiary, and Member 1 is also a beneficiary.

The price the Trustee paid for the Company share is $. At the time of the purchase of the share, the Company had no assets as the business value was equal to its debt.

The director of the Company is not related to the Fund or Member 1 and Member 2 in any capacity.

In the 20XX-YY income year, the Company declared a dividend and paid % of the total dividend to the Fund.

No shares were issued by the Company in satisfaction of any dividends.

The Company does not expect to pay a dividend in the 20YY-ZZ income year.

Relevant legislative provisions

Income Tax Assessment Act 1936 Former section 273

Income Tax Assessment Act 1997 Section 295-550

All legislative references are to the ITAA 1997 unless otherwise indicated.

Reasons for decision

Summary

The Commissioner is of the opinion that the transactions involving the payment of dividends by the Company to the Fund will produce a non-arm's length outcome. Therefore, the dividends paid by the Company to the Fund will not be considered to be non-arm's length income of the Fund.

The amounts of ordinary income or statutory income that are non-arm's length income of a complying superannuation fund are set out in section 295-550 of the Income Tax Assessment Act 1997 (ITAA 1997).

In particular, subsection 295-550(2) of the ITAA 1997 provides that an amount of ordinary income or statutory income is non-arm's length income of a complying superannuation fund if it is:

In accordance with subsection 295-550(3), in deciding whether an amount is consistent with an arm's length dealing for the purposes of subsection 295-550(2), regard must be given to:

The Commissioner has issued Taxation Ruling TR 2006/7 which explains what amounts are considered to be 'special income' under former section 273 of the Income Tax Assessment Act 1936 (ITAA 1936). In this regard, TR 2006/7 specifically discusses the matters contained in former paragraphs 273(2)(a) to (f) of the ITAA 1936, which were rewritten as paragraphs 295-550(3)(a) to (f) of the ITAA 1997. Accordingly, TR 2006/7 provides useful guidance on the matters to be considered in the interpretation of section 295-550 of the ITAA 1997.

At paragraphs 19 and 20 of TR 2006/7, the Commissioner states:

    19. 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.

    20. The Commissioner will consider the matters listed in paragraph 273(2)(a) to (d) in comparison with each other. In cases where the dividend paid relates to a share which has a par value, the Commissioner will compare this value with the partly paid value under paragraph 273(2)(a). The cost of the shares considered under paragraph 273(2)(b) will be compared with the market value of the shares at the time of acquisition, which is considered under paragraph 273(2)(a). The rate of dividend considered under paragraph 273(2)(c) will be compared to the rate of dividend paid on any other shares in the company, which is considered under paragraph 273(2)(d).

In applying subsection 295-550(2) to the facts of this case, the Commissioner will consider paragraphs 295-550(3)(a) to (e) that indicate whether or not the dividends are derived on an arm's length basis. The Commissioner will consider a matter to be relevant under paragraph 295-550(3) if it indicates whether or not the 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) cannot be considered in isolation to each other but must be considered as a whole.

Paragraphs 295-550(3)(a) and (b)

At the time the Company issued its shares, the Company had no assets. That being the case, the market value of the shares is nil. However, the price that the Fund and the other shareholder paid for the Company shares was $ per share.

Although, on face value, the price paid by the Fund for the Company share was above the market value of Company shares, the fact that the Fund paid the same price as the other shareholder who originally subscribed for shares indicates that the share was acquired at market value.

It is considered these circumstances would not support a finding of 'non-arm's length income'.

Paragraphs 295-550(3)(c) to (e)

There is only one class of shares and all the shares in the Company have received the same rate of dividend. The Fund (as well as the other shareholder) is entitled to dividend in proportion to its shareholding. The Company has not issued any shares in satisfaction of a dividend (or part of it).

The fact that the rate of dividend paid to the Fund in respect of the share it holds in the Company is the same as the rate of dividend paid to the other shareholder would indicate that the dividend is paid on an arm's length basis.

Paragraph 295-550(3)(f)

The Commissioner considers that a matter is relevant under paragraph 295-550(3)(f) if it indicates whether or not the dividends are derived on an arm's length basis.

The definition of 'arm's length' in subsection 995-1(1) provides that in determining whether parties deal at arm's length, consider any connection between them and any other relevant circumstances.

In Federal Commissioner of Taxation v AXA Asia Pacific Holdings Ltd, [2010] FCAFC 134; (2010) 189 FCR 204; (2010) 2010 ATC 20-224; [2011] ALMD 2345; (2010) 81 ATR 180, Justice Dowsett of the Full Federal Court summarised the cases dealing with the expression 'at arm's length' as follows:

The parties in this case can be considered to be in an arm's length relationship in regards to the dividends paid by the Company. This is because:

However, it is also necessary to consider whether the parties have dealt with each other as arm's length parties would do, so that the outcome of their dealing is a matter of real bargaining.

At paragraph 78 of TR 2006/7, the Commissioner states that parties that are at arm's length can deal with each other in a way that is not at arm's length.

As Dowsett J mentioned in AXA, unrelated parties may, on occasions, deal with each other in such a way that the resultant transaction may not properly be considered to be at arm's length. In that case Edmonds and Gordon JJ, who did not disapprove of Dowsett J's summary of those propositions, further stated at 231 that:

    Any assessment of whether parties were dealing at arm's length involves 'an assessment [of] whether in respect of that dealing they dealt with each other as arm's length parties would normally do, so that the outcome of their dealing is a matter of real bargaining' …

Assessing the circumstances holistically, the Commissioner considers that the parties, in this case, are not dealing with each other in relation to the dividend as arm's length parties would do. Aspects which, taken together, the Commissioner considers lead to that conclusion include:

If the parties in this case were dealing with each other at arm's length, the amount of ordinary or statutory income the Fund might be expected to derive as a dividend on the Company share is nil. It might be expected that an arm's length lender would not lend any capital to the Company for the acquisition of the business on the loan terms that form part of the scheme under which the dividend is derived. Without the loan it might be expected that the Company would not acquire the business and consequently, would not realise the profits from which the dividends are paid and so no ordinary or statutory income might be expected to be derived by the Fund as a shareholder of the Company.

Based on the above, the Commissioner considers that the dividend received by the Fund from the Company is non-arm's length income of the Fund.


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