Edited version of private advice

Authorisation Number: 1052026267049

Date of advice: 12 October 2022

Ruling

Subject: Non-arm's length income

Question 1

Is the income derived from the rental property 'non-arm's length income' within the meaning of that term as set out in section 295-550 of the Income Tax Assessment Act 1997 (ITAA 1997) as the directors of the corporate trustee provide services with respect to the rental property at no cost?

Answer

No.

This ruling applies for the following period:

Year ended 30 June XXXX

Relevant facts and circumstances

The superannuation fund (the Fund) is a complying superannuation fund.

The Fund has a tenanted rental property.

The corporate trustee of the Fund is Co Pty Ltd.

There are two directors of the corporate trustee.

The members of the Fund are the two directors.

The corporate trustee of the Fund has not engaged a real estate agent and collect rent from the residential property directly. Rent is collected via bank transfer from the tenant to the Fund's bank account.

Neither director of the corporate trustee of the Fund has experience or qualifications in the real estate industry or property management.

The residential property was advertised for let on a local classified website

On a week to week, basis the directors of the corporate trustee check rent is received and ensure payment of bills such as rates and body corporate fees.

The directors of the corporate trustee spend less than 5 hours per year on management of the residential property.

The directors of the corporate trustee have not charged the Fund for managing the residential property.

Relevant legislative provisions

Income Tax Assessment Act 1997

section 8-1

section 295-550

paragraph 295-550(1)(b)

paragraph 295-550(1)(c)

section 295-545

subsection 295-545(1)

section 275-610

section 995-1

Superannuation Industry (Supervision) Act 1993

section 17A

section 17B

subsection 17B(1)

subsection 17B(1)

subsection 17B (2)

paragraphs 17A(1)(f)

paragraphs 17A(1)(g)

paragraphs 17A(2)(c)

paragraphs 17A(2)(d)

Summary

1.     The rental income derived by the Fund from the rental property will not be treated as non-arm's length income within the meaning of section 295-550 of the Income Tax Assessment Act 1997 (ITAA 1997) on the basis that directors of the corporate trustee provide their services at no cost. The non-arm's length expenditure provisions do not apply as the services are performed by the individuals in their capacity as directors of the corporate trustee.

Reasons for decision

2.     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) of the ITAA 1997 explains that a concessional rate of tax applies to the low tax component of the complying superannuation fund's taxable income, while the non-arm's length component is taxed at the highest marginal rate.

3.   Subsection 995-1(1) of the ITAA 1997, provides that the phrase 'non-arm's length component' has the meaning given by section 295-545 of the ITAA 1997. 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 (NALI) for that year less any deductions to the extent that they are attributable to that income. Subsection 995-1(1) of the ITAA 1997 provides that the phrase 'non-arm's length income' has the meaning given by section 295-550 of the ITAA 1997 and section 275-610 of the ITAA 1997.

4.   Relevantly 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:

...

(c) in gaining or producing the income, the entity does not incur a loss, outgoing or expenditure that the entity might have been expected to incur if those parties had been dealing with each other at arm ' s length in relation to the scheme.

This subsection does not apply to an amount to which subsection (2) applies or an amount derived by the entity in the capacity of beneficiary of a trust.

5.   Subsection 295-550(2) of the ITAA 1997 does not have application in this instance.

6.   The Explanatory Memorandum to the Treasury Laws Amendment (2018 Superannuation Measures No. 1) Bill 2018 explains the intended operation of paragraph 295-550(1)(c) of the ITAA 1997:

A new provision is added to ensure that a superannuation entity's non-arm's length income includes income where expenditure incurred in gaining or producing it was not an arm's length expense. This includes where no expense was incurred (but might be expected to have been incurred if the transaction were on arm's length terms). [Schedule 3, item 1, paragraphs 295-550(1)(b) and (c)]

7.   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.

and that an 'arrangement' 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.

8.     The directors have not charged the trustee of the Fund for providing property management services for the residential property. As such, we will consider whether paragraph 292-550(1)(c) of the ITAA 1997 would apply.

9.     In Law Companion Ruling LCR 2021/2 Non-arm's length income - expenditure incurred under a non-arm's length arrangement (LCR 2021/2), the Commissioner clarifies how section 295-550 of the ITAA 1997 operates in relation to a scheme where the parties do not deal with each other at arm's length and the trustee of a complying superannuation entity incurs non-arm's length expenditure (or where expenditure is not incurred) in gaining or producing ordinary or statutory income.

10. Relevantly, where a trustee or director of a corporate trustee provides services to the SMSF, paragraphs 40 to 52 of LCR 2021/2 states:

40.In the context of SMSFs, it may be necessary for an individual to ascertain whether they are performing an activity as a trustee of the superannuation fund or whether they are acting in a different capacity. An SMSF is a superannuation fund that satisfies the conditions set out in sections 17A and 17B of the SISA. The statutory scheme requires a member of a SMSF to be either a trustee of the fund or a director of a body corporate that is a trustee of the fund. The SISA also prevents a trustee, or a director of a body corporate that is a trustee, of an SMSF from receiving remuneration for any duties or services performed by the trustee or director in relation to the SMSF.

41.However, subsections 17B(1) and (2) of the SISA provides exceptions to paragraphs 17A(1)(f) and (g) and paragraphs 17A(2)(c) and (d) of the SISA, such that a trustee or director of a corporate trustee can receive remuneration for duties or services performed by them if they:

•                     perform the duties or services other than in their capacity as trustee or director of a body corporate that is a trustee, and

•                     are appropriately qualified, and hold all necessary licences, to perform the duties or services, and

•                     perform the duties or services in the ordinary course of a business, carried on by them, of performing similar duties or services for the public, and

•                     receive remuneration that is no more favourable to them than that which it is reasonable to expect would apply if they were dealing with the relevant other party at arm's length in the same circumstances.

42.Given the statutory restrictions that prevent a trustee or director of a corporate trustee from receiving remuneration, paragraphs 295-550(1)(b) and (c) will not be enlivened due to the trustee or director not charging for the services performed in relation to the fund when acting in a trustee capacity. For example, the non-arm's length expenditure provision will not apply where a trustee, acting in that capacity, performs bookkeeping or accounting services for the fund for no remuneration.

43.However, when the trustee or director of a corporate trustee operates in another capacity and either does not receive remuneration for those services or receives remuneration in accordance with the exceptions in section 17B of the SISA, paragraphs 295-550(1)(b) or (c) may apply where the fund incurs non-arm's length expenditure.

44.A trustee or director of a corporate trustee of a SMSF will be required to perform particular actions in order to satisfy obligations imposed on them, including:

•                     any conditions imposed by statute (for example, the SISA and the Corporations Act 2001)

•                     any fiduciary conditions imposed under the law, and

•                     any duties or obligations imposed under the trust deed of the SMSF.

45.The trust deed of the SMSF may also provide the trustee or director of the corporate trustee the power to perform certain actions.

46.An individual's business, profession, life experiences or employment may result in the individual having skills and knowledge that can assist the individual perform their duties in their capacity as trustee, or as a director of a corporate trustee, of a SMSF. Utilising such skills and knowledge of itself does not indicate that the individual is not acting in their capacity as trustee or as a director of a corporate trustee. For example, a financial adviser who is a trustee of a SMSF can utilise their skills and knowledge in deciding the investment strategy of the SMSF in their capacity as trustee.

47.In the context of applying paragraphs 295-550(1)(b) and (c), it is appropriate to presume that an individual is acting in their capacity as a trustee, or director of a corporate trustee, where the actions are consistent with a duty, obligation or power referred to in paragraph 44 of this Ruling, unless there are factors that suggest a contrary conclusion. Factors that indicate that the individual is performing their activities in their individual capacity and not in their capacity as a trustee, or a director of a corporate trustee, include:

•                     The individual charges the complying SMSF for performing the services. However, there can be circumstances where the individual can be acting in their individual capacity even though they do not charge the SMSF for performing the services.

•                     The individual uses the equipment and other assets of their business, or equipment and other assets used in their profession or employment in a material manner. However, minor, infrequent or irregular use of equipment or assets will not, of itself, indicate the individual is acting in their individual capacity. For example, in the absence of any other factor indicating otherwise, minor, infrequent or irregular use of a business computer at the office by an individual would not, of itself, indicate the individual is acting in their individual capacity.

•                     The individual performs the activities pursuant to a licence and/or qualification relating to their business, or their profession or employment. That is, the activity can only be performed due to the individual or business holding the relevant licence and/or qualification.

•                     The activity is covered by an insurance policy relating to their business, or their profession or employment (for example, indemnity insurance).

...

49.Where a trustee, or a director of a corporate trustee, of a complying superannuation fund performs services other than in these capacities (for example, in their individual capacity) to a complying superannuation fund for remuneration, the non-arm's length expenditure provisions will apply where the remuneration is incurred by the fund in gaining or producing ordinary or statutory income and the remuneration is non-arm's length expenditure. The non-arm's length expenditure provisions will also apply in these situations where no remuneration is provided. For example, the non-arm's length expenditure provisions will apply where a trustee (being an accountant by profession) contracts the bookkeeping or accounting services to their accounting firm, which charges non-arm's length rates.

...

51.A complying superannuation fund might enter into arrangements that result in it receiving discounted prices. Such arrangements will still be on arm's length terms where they are consistent with normal commercial practices, such as an individual acting in their capacity as trustee (or a director of a corporate trustee) being entitled to a discount under a discount policy where the same discounts are provided to all employees, partners, shareholders or office holders

52.Further, services provided to a complying superannuation fund on a pro bono basis will also still be on arm's length terms where the trustee (or director of a corporate trustee) of the fund is not able to influence the service provider's decision to supply the services on a pro bono basis.

...

11. In this case, the directors are undertaking their duties as directors of the corporate trustee of the Fund in managing its assets:

•                     The directors have not charged the Fund for performing this service,

•                     The directors do not use equipment and/or other assets of their business or equipment and other assets used in their profession in a material manner.

•                     The directors are not performing the activities pursuant to a licence and/or qualification relating to their business, or profession and/or employment - the activities do not require licensing or qualifications.

•                     The activity is not covered by an insurance policy relating to their business, or their profession or employment.

•                     Neither of the directors has experience or qualifications in the real estate industry or property management.

12. In these circumstances the directors have been acting in their capacity as directors of the corporate trustee when managing the Fund's assets.

13. Therefore, the Commissioner considers that paragraph 295 550(1)(c) of the ITAA 1997 does not apply and the rental income from the property will not be treated as 'non-arm's length income as set out in section 295-550 of the ITAA 1997 on the basis that the directors of the corporate trustee provided their services with respect to the rental property by at no cost.

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