Edited version of your written advice

Authorisation Number: 1051449059368

Date of advice: 13 November 2018

Ruling

Subject: Non-arm’s length income

Question 1

Will the facts described in this application give rise to non-arm’s length income under section 295-550 of the Income Tax Assessment Act 1997 (ITAA 1997) – that is, in respect of any distributions of income to the Fund or any net capital gain resulting from a CGT event in connection with the Fund’s units in the Management Investment Scheme?

Answer

No.

Question 2

Will the facts described in this application give rise to non-arm’s length income under the proposed rewording of section 295-550 of the ITAA 1997 if the Treasury Laws Amendment (2018 Superannuation Measures No.1) Bill 2018 is enacted – that is, in respect of any distributions of income to the Fund or any net capital gain resulting from a CGT event in connection with the Fund’s units in the Management Investment Scheme?

Answer

The Commissioner will decline to rule on this matter.

Question 3

Will the facts described in this application enliven Part IVA of the Income Tax Assessment Act 1936 (ITAA 1936)?

Answer

The Commissioner will decline to rule on this matter.

This ruling applies for the following period:

1 July 20XX to 30 June 20XX

Relevant facts and circumstances

1. The Fund is a self-managed superannuation fund.

2. The Fund is proposing to invest in a related unit trust (the Trust).

3. Units will be issued at $1 per unit at inception and post inception, at a net asset value as calculated by the Trustee.

4. The trustee of the Trust will be an independent administrative company. The trustee will outsource all investment decisions to a related company of the Fund.

5. The related company will charge a management fee to the Trust on standard commercial terms.

6. The related company provides investment services to the public.

7. The Trust is proposing to invest in equities (e.g. public company shares); fixed interest (e.g. corporate bonds on the wholesale fixed interest market), derivatives (e.g. purchasing a put option on the listed market) and commercial real estate debt (e.g. purchasing secured loan notes issued by a special purpose vehicle arranged and managed by independent AFSL holders).

8. The Trust Deed states that:

● The Trustee may issue Classes of Units with such rights and obligations as it determines (including, for example, with such rights and obligations as to fee rebates, voting, transfer, distributions and rights on winding up).

● All or any of the rights and privileges attached to any Class (unless otherwise provided by the terms of issue of the Units of that Class) may be varied or cancelled, including by converting or reclassifying Units from one Class to another. Whilst the Trust is an Attributed Managed Investment Trust (AMIT), then for so long as AMIT Laws require this, any issue of Classes of Units by the Trustee must not result in the rights of any investor to the income and capital of the Trust being materially diminished or expanded.

● The rights conferred on the holders of the Units of any Class will not, unless otherwise expressly provided by the terms of issue of the Units of that Class, be deemed to be varied by the creation or issue of further Units ranking equally in respect of those rights.

● The beneficial interest in the Trust is divided into Units. Subject to the rights and obligations attaching to any Class, each Unit in a particular Class confers an equal undivided interest.

● The Trustee may in its discretion issue Units on terms that such Units:

● Participate fully in the Distributable Income of the Trust in respect of the Distribution Period in which they are issued;

● Do not entitle the holder of such Units to participate in the Distributable Income in respect of the Distribution Period in which such Units are issued; or

● Entitle the holder of such Units to receive an Income Distribution which is determined on the basis of the number of days that an Investor has held newly issued Units during that Distribution Period.

● Unit holders have a fixed entitlement to the income of the Trust. The distributable income will be paid in accordance with the percentage of units held by the investor.

9. It has been stated that all transactions involving the Fund and the Trust will be conducted on an arm’s length basis.

10. The Trust will operate a quarterly distribution cycle to the unitholders of the Trust.

11. It is expected that a number of independent third-party investors will become unitholders in the Trust within a period of less than 12 months following the establishment of the Trust. It is expected that the Fund and its related entities will hold no more than 50% of the units prior to 30 June 2019.

Assumptions

12. All transactions involving the Trust will be conducted on an arm’s length commercial basis, and all investments made by the Trust will be made on arm’s length terms.

13. All transactions involving the Trust and the Fund will be conducted on an arm’s length commercial basis and on the same terms as any other third party unitholder in the Trust.

14. The investment strategy of the Trust does not favour any particular class of unit holder.

15. No income will be derived by the Fund as a result of any discretion being exercised by the trustee of the Trust.

16. The class of units issued to the fund will not provide a benefit which is more favourable to the fund when compared to other investors.

17. Investment management fees will be paid by the Trust to the investment manager on standard commercial terms.

18. All other relevant service fees will be payable on commercial terms.

Reasons for decision

Detailed reasoning

Question 1

19. Section 295-545 of the ITAA 1997 provides that the taxable income of a complying superannuation fund is split into a non-arm's length component and a low tax rate component. The note to subsection 295-545(1) explains that a concessional rate of tax applies to the low tax component, while the non-arm's length component is taxed at the highest marginal rate.

20. Subsection 295-545(2) of the ITAA 1997 provides that 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. The definition of 'non-arm's length income' is given by section 295-550.

21. Subsection 295-550(4) of the ITAA 1997 states that ‘Income derived by the entity as a beneficiary of a trust, other than because of holding a fixed entitlement to the income, is non-arm’s length income of the entity.’

22. The Trustee of the Trust may issue Classes of Units with such rights and obligations as it determines. The beneficial interest in the Trust is divided into Units. Subject to the rights and obligations attaching to any Class, each Unit in a particular Class confers an equal undivided interest. You have stated that the Fund’s investment in the Trust will be for $1 units.

23. Where the Fund is issued units in the Trust which gives it a fixed entitlement to the income of the Trust, any income which the Fund derives in its capacity of beneficiary of the Trust will not be considered to have been derived in accordance with subsection 295-550(4) of the ITAA 1997.

24. Subsection 295-550(5) of the ITAA 1997 provides that ‘Other income derived by the entity as a beneficiary of a trust through holding a fixed entitlement to the income of the trust is non-arm's length income of the entity if:

(a) the entity acquired the entitlement 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

(b) the amount of the income is more than the amount that the entity might have expected to derive if those parties had been dealing with each other at arm's length.’

25. The term 'scheme' is defined in subsection 995-1(1) of the ITAA 1997 to mean:

(a) any arrangement; or

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

26. The term 'arrangement' is also defined in subsection 995-1(1) of the ITAA 1997 to mean 'any arrangement, agreement, understanding, promise or undertaking, whether express or implied, and whether or not enforceable (or intended to be enforceable) by legal proceedings'.

27. The definition of a scheme is broad enough to capture the Fund’s investment in the Trust, the investment activities of the Trust, as well as the derivation of income by the Fund in its capacity of beneficiary of the Trust.

28. Parties will be dealing with each other at arm's length if the independent minds and wills of the parties are applied and their dealing is a matter of real bargaining. 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 of this conclusion.

29. As the Fund and the Trust are related parties they will not be in an arm’s length relationship. However related parties may, in some circumstances, so conduct a dealing as to displace any inference based on the relationship.

30. 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’....

31. The Trustee of the Trust has the discretion to issue different Classes of Units. Where the Class of Units issued to the Fund will not result in a benefit that is more favourable when compared to other unrelated investors, then it may be considered that this will resemble real bargaining as expected in a commercial market.

32. It is proposed that the Trust will engage the services of the related company with regard to all investment decisions. The related company will charge a management fee of 1% plus a 20% performance fee above a certain hurdle rate, subject to a high water mark for performance.

33. The management fee charged by the related company will ultimately affect the amount of income available for distribution to the Fund as a beneficiary of the Trust. A fee charged at less than the market rate would result in a greater distribution to the Fund.

34. The related company provides investment services to the public and it has been stated that the fees charged to the Trust will be calculated on commercial standard terms. As these fees will be consistent with the market rate, it would be considered that the dealing between the parties will be on arm’s length terms and will not result in a greater distribution to the Fund.

35. The Fund has not yet invested in the Trust and hence has not derived any income. However , as per the assumptions made, provided any income derived by the Fund as beneficiary of the Trust is derived as a result of having a fixed entitlement to the income of the Trust, and that entitlement is acquired, and the income the Fund receives is derived, as a result of arm’s length dealings between the Fund, the Trust and any other parties, then that income will not be considered to be non-arm’s length income as per subsection 295-550(5) of the ITAA 1997.

Matters we have not ruled on

We have not ruled on all of your questions.

Question 2

36. Pursuant to section 359-35 of Schedule 1 to the Taxation Administration Act 1953 (TAA) the Commissioner has declined to rule on the basis that the proposed rewording of 295-550 of the ITAA 1997 has not yet been enacted.

Question 3

37. Part IVA of the ITAA 1936 involves a careful weighing of all the relevant facts and surrounding circumstances of each case, including financial consequences to you and persons connected with you. The Commissioner has considered the facts regarding the arrangement as submitted by you in your private ruling application. Without making a number of assumptions the Commissioner cannot determine whether Part IVA applies.

38. In order to rule that Part IVA will have no application to your arrangement, the Commissioner must be satisfied that you have not obtained, or will not obtain, a tax benefit in connection with a scheme to which Part IVA applies. In considering whether there is a scheme to which Part IVA applies the Commissioner must, having regard to the eight matters specified in subsection 177D(2) of the ITAA 1936, objectively determine whether the person, or one of the persons, who entered into or carried out the scheme, or any part of it, did so for the dominant purpose of enabling you to obtain a tax benefit in connection with the scheme.

39. In your case, you have not provided details about each of the eight matters in subsection 177D(2) of the ITAA 1936, subsequently, the Commissioner considers the correctness of your private ruling would depend on assumptions about future events or some other matters. Pursuant to paragraph 357-110(1)(a) of Schedule 1 to the TAA 1953, the Commissioner will decline to rule on this matter.

Review rights when we have declined to make a ruling

We have declined to make your private ruling on all matters, and have given you the reasons. This decision may be reviewable under the Administrative Decisions (Judicial Review) Act 1977 (ADJR).

The ADJR provides you with two main rights.

1. You can send a written notice to the Commissioner requiring him to provide a written statement of:

● the findings of material questions of fact

● the evidence these findings were based upon, and

● the reasons for his decision.

2. You can apply to the Federal Court of Australia or the Federal Circuit Court for a review of the decision.

If you decide to apply to the Federal Court or the Federal Circuit Court for a review of the decision, we suggest you seek professional advice on how to progress. In addition, the Court will be able to provide you with some direction and assistance about the process.

An application must be lodged within 28 days of the issue date on your Notice of private ruling.

You may lodge your application for review at the Federal Court or Federal Circuit Court in the State or Territory in which you ordinarily reside, or the State or Territory listed in the address for the ATO shown on your Notice of private ruling.

You can find more information on the Federal Court website fedcourt.gov.au, or the Federal Circuit Court fedcircuitcourt.gov.au

Relevant legislative provisions

Income Tax Assessment Act 1997 section 295-545

Income Tax Assessment Act 1997 section 295-550

Income Tax Assessment Act 1997 section 995-1

Income Tax Assessment Act 1936 section 177D

Taxation Administration Act 1953 section 357-110

Taxation Administration Act 1953 section 359-35

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