Edited version of private ruling

Authorisation Number: 1011721300888

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Ruling

Subject: Special income

Question

Will the distribution of capital gains from a discretionary unit trust to a self managed superannuation fund (SMSF) in the 2005-06 income year be special income under subsection 273(7) of the Income Tax Assessment Act 1936 (ITAA 1936)?

Advice/Answer

Yes.

This ruling applies for the following period

Year ending 30 June 2006

The scheme commenced on

1 July 2005

Relevant facts

The Fund is a self managed superannuation fund.

The members of the Fund, Taxpayer A and Taxpayer B, are also the trustee of the Fund. Both members are gainfully employed and over preservation age.

Personal and employer contributions were made to the Fund.

The Fund's investment strategy is to achieve long term growth while limiting variability in returns.

The Fund acquired an interest in a unit trust (the Trust) in the 2001-02 income year in the form of Ordinary Units.

The Fund became aware of the opportunity to invest in the Trust through advice from a third party (the Third Party).

The Third Party is engaged by the Trust to provide services.

The Fund relied on advice from the Third Party in making the decision to invest in the Trust.

Roll-over benefits were used to purchase the units in the Trust.

The Funds other investments include cash, stapled securities and units in listed unit trusts.

Company C (the Company) was appointed to act solely as the trustee of the Trust in the 2001-02 income year.

No trustee fees have been paid to the Company.

The Members are the directors of the Company.

The beneficiaries and sole unit holders of the Trust are:

§ the Fund, who holds Ordinary Units; and

§ the Members, who hold an unknown number of units of another class (non-Ordinary Units).

The Trust's assets at the time it was established and at the time of the Fund's acquisition of units in the Trust consisted of cash.

The Trust invests in listed securities and managed funds.

The Trust's unit valuation is based on the market value of the Trust's investments which include listed shares and managed funds.

You provided a Register of Unit holders of the Trust which shows:

§ the allocation of an initial number of Ordinary Units in the third quarter of the 2001-02 income year.

§ the allocation of an unknown number of other non-Ordinary Units in 2002.

§ the allocation of additional Ordinary Units from reinvested profits during the 2002-03, 2003-04 and 2004-05 income years.

§ the allocation of additional Ordinary Units from additional investment during the 2003-04 income year.

§ the cancellation of an unknown number of other non-Ordinary Units early in the 2007-08 income year at the same value as they were acquired.

§ no unit certificates appear to have been issued, other than in respect of the initial Ordinary Units.

No income was distributed to the non-Ordinary Unit holders in the 2004-05 or 2005-06 income years.

In relation to the non-Ordinary Units, you advise that they were redeemed prior to 30 June 2007 and the proceeds repaid to the unit holders.

The Trust made taxable distributions from 2003 to 2007.

The Trust's trust deed states that Ordinary Units shall entitle the holders to receive such part of the income and capital gains of the Trust for any accounting period as the Trustee does not appoint or allocate to any other class of unit and in proportion to the number of units held by the unit holders. Similarly, Ordinary Units shall entitle the holders to the whole of any distribution of the Trust Fund not arising from income or capital gains other than any part which the Trustee appoints or allocates to any other class of unit and in proportion to the number of units held by the unit holders. The holders of Ordinary Units shall have the right to vote at meetings of unit holders generally and of Ordinary Unit holders only.

The Trust's trust deed states that non-Ordinary Units shall entitle the holders to receive in proportion to the number of units held by each of them such part of the Trust Fund not arising from income or capital gains on the vesting date or any earlier distribution of the capital of the Trust Fund as the Trustee appoints or allocates for the benefit of the class of unit in the exercise of any power or discretion vested in the Trustee. The Units shall not carry the right to vote at meetings of the class only. The Units shall not entitle the holders to any distribution of net income or net capital gains.

Other relevant comments

In a request for further information the following question was raised:

Did the purchase of the units in the Trust cause the Fund, at any time, to breach the in-house assets rules of the Superannuation Industry (Supervision) Act 1993? If no, please provide reasons why.

In response you stated that as the Trust invested in shares and managed funds, the Fund was breached under section 13.22D of the Superannuation Industry (Supervision) Regulation 1994 (SISR). The investment in the Trust now represented an in-house asset which exceeded the 5% limit.

The private ruling request related to the operation of former subsection 273(2) of the ITAA 1936. In addition, a private ruling cannot be given in respect of a provision that is not a relevant provision for the purposes of Division 359 of Schedule 1 to the Taxation Administration Act 1953. Accordingly, in making our decision we have not considered the matter of the potential breach of the in-house asset rules under the SISR.

Relevant legislative provisions

Income Tax Assessment Act 1936 Section 273.

Income Tax Assessment Act 1936 Subsection 273(2).

Income Tax Assessment Act 1936 Paragraph 273(2)(a).

Income Tax Assessment Act 1936 Paragraph 273(2)(b).

Income Tax Assessment Act 1936 Paragraph 273(2)(c).

Income Tax Assessment Act 1936 Paragraph 273(2)(d).

Income Tax Assessment Act 1936 Paragraph 273(2)(e).

Income Tax Assessment Act 1936 Paragraph 273(2)(f).

Income Tax Assessment Act 1936 Subsection 273(7).

Superannuation Industry Supervision Regulations 1994 Subsection 45(1)

Reasons for decision

Summary

On the whole, having regard to the matters listed, the Commissioner is of the opinion that the transactions and the payment of the entitlements by the Trust appear to be non-arms length transactions.

Therefore, the Commissioner is of the opinion that the entitlements paid by the Trust to the Fund for the 2006-07 income year are special income of the Fund.

Detailed reasoning

Subsection 273(2) of the ITAA 1936 applies to transactions carried out prior to 1 July 2007 and has the effect that all private company dividends paid to a superannuation entity are special income unless the Commissioner forms the opinion that it would be reasonable not to treat dividends or other entitlements as special income of the entity as the dividends are derived on an arms length basis, having regard to:

(a) the paid up value of the shares held by the fund in the private company;

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

(c) the rate of the dividend paid to the fund on the shares held by the fund;

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

(e) whether any shares have been issued by the company to the fund in satisfaction of the dividend paid by the company and, if so, the circumstances of the issue of those shares; and

(f) any other matters the Commissioner considers relevant.

In applying subsection 273(2) of the ITAA 1936 to the facts of a case, the Commissioner will consider paragraphs 273(2)(a) to (e) as matters that indicate whether or not the dividends or other entitlements are derived on an arms length basis. The Commissioner will consider a matter to be relevant under paragraph 273(2)(f) if it indicates whether or not entitlements are derived on an arms length basis. The facts of the case and all of the matters contained in paragraphs 273(2)(a) to (f) cannot be considered in isolation to each other but must be considered as a whole.

The Full Federal Court in Darrelen Pty Ltd v. Federal Commissioner of Taxation [2010] FCAFC 35; (2010) 2010 ATC 20-180; (2010) 183 FCR 237; [2010] ALMD 4701, observed (at paragraph 33, [2010] FCAFC 35) that:

… It is clear, and the appellant seems to accept, that the policy underlying s 273, and its predecessors, is to enable the Commissioner to deny the concessional taxation of income which has been diverted from taxpayers not enjoying that status. …

The Commissioner has issued Taxation Ruling TR 2006/7, titled Income tax: special income derived by a complying superannuation fund, a complying ADF or a PST in relation to the year of income, (TR 2006/7). The Taxation Ruling provides useful guidance on the factors to be considered in the interpretation of section 273 of the ITAA 1936.

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

Paragraphs 273(2)(a) and (b) of the ITAA 1936:

The Fund acquired an interest in the Trust in the 2001-02 income year in the form of Ordinary Units.

The Fund became aware of the opportunity to invest in the Trust through advice from a third party (the Third Party). The Third Party is engaged by the Trust to provide services.

The Fund relied on advice from the Third Party in making the decision to invest in the Trust.

The Fund and the Fund members are the sole unit holders of the Trust.

You provided a Register of Unitholders of the Trust which shows:

§ the allocation of an initial number of Ordinary Units in the third quarter of the 2001-02 income year.

§ the allocation of an unknown number of units of another class (non-Ordinary Units) in 2002.

§ the allocation of additional Ordinary Units from reinvested profits during the 2002-03, 2003-04 and 2004-05 income years.

§ the allocation of additional Ordinary Units from additional investment during the 2003-04 income year.

§ the cancellation of an unknown number of other non-Ordinary Units early in the 2007-08 income year at the same value as they were acquired.

It is noted that no unit certificates appear to have been issued, other than in respect of the initial Ordinary Units.

The initial price paid for each Ordinary Unit reflected the fact that these units were purchased shortly upon incorporation of the Trust.

On the basis of the matters discussed above, the Commissioner accepts that the value of the units and the value of the Trust is reasonable. The Commissioner considers there are no matters relevant to paragraphs 273(2)(a) and 273(2)(b) of the ITAA 1936 that would cause him to treat the entitlements as special income.

Paragraphs 273(2)(c) and (d) of the ITAA 1936:

From the Register of Unitholders of the Trust there are two classes of units on issue, that being Ordinary Units and non-Ordinary Units.

As already stated, the shareholdings of the Fund and the Members represent all of the Trust's issued units.

In view of this, the Fund and the Members are in a position to significantly influence the operations of the Trust by weight of their unitholding.

On the basis of the matters discussed above, the Commissioner considers these are the matters relevant to paragraphs 273(2)(c) and 273(2)(d) of the ITAA 1936 that would cause him to treat the entitlement as special income.

Paragraph 273(2)(e) of the ITAA 1936:

There were no units issued by the Trust in satisfaction of dividends. This is a neutral factor in considering the exercise of the Commissioners discretion under subsection 273(2) of the ITAA 1936.

Paragraph 273(2)(f) of the ITAA 1936:

This paragraph recognises that in assessing whether entitlements from trusts are to be considered special income, there may be other relevant matters in addition to the matters specified in paragraphs 273(a) to (e) of the ITAA 1936.

The matters that the Commissioner will consider relevant under paragraph 273(2)(f) of the ITAA 1936 are set out at paragraphs 53 and 54 of TR 2006/7. At paragraph 54 of TR 2006/7, the Commissioner states the view that the matters that the Commissioner may consider relevant under paragraph 273(2)(f) include the relationship between the superannuation fund and the private company.

One of the items listed at paragraph 54 of TR 2006/7 as relevant is the relationship between the superannuation fund and any party with which the trust has dealings.

In this case it is noted that the members and trustees of the Fund are the Members. In addition the Fund and the Members are the sole unit holders of the Trust. Further, the Company was appointed to act solely as the trustee of the Trust in the 2001-02 income year and the Members are the directors of the Company.

It is considered that, in this instance, the Members are in a position to solely influence the decisions of the Trust, including the timing and amount of the payment of entitlements. Therefore the state of the relationship between the Members of the Fund and the Trust is not a favourable factor to the exercise of the Commissioner discretion.

The Fund holds a large percentage of the issued units of the Trust and, therefore, holds a majority interest in the Trust.

Taking into account all of the above it is considered that the Fund and the Members had both scope and special powers or rights to influence the Trust in relation to payments or issuing of units.

Complying Fund

Section 273 of the ITAA 1936 applies only to complying superannuation funds, that is, funds which satisfy the requirements of the SIS Act and the Superannuation Industry Supervision Regulations 1994. In particular, subsection 45(1) of the SISA states that a fund is a complying fund if and only if:

(a) the Regulator has given a notice to a trustee of the fund under section 40 stating that the fund is a complying superannuation fund in relation to the current year of income; or

(b) the Regulator has given a notice to a trustee of the fund under section 40 stating that the fund is a complying superannuation fund in relation to a previous year of income and has not given a notice to a trustee of the fund under that section stating that the fund was not a complying superannuation fund in relation to:

(i) the current year of income; or

(ii) a year of income that is:

(A) later than that previous year of income; and

(B) earlier than the current year of income.

In this case is accepted that the Fund is a complying superannuation fund as there is no evidence that the Regulator has given a notice to the fund trustee under section 40 of the SISA stating that the fund was not a complying superannuation fund for the income year in question.

Conclusion:

On the whole, having regard to the matters listed in paragraphs (a) to (f) of subsection 273(2) of the ITAA 1936, the Commissioner is of the opinion that the transactions and the payment of the entitlements by the Trust appear to be non-arms length transactions.

Therefore, the Commissioner is of the opinion that entitlements paid by the Trust to the Fund for the 2006-07 income year are special income of the Fund.

Please note that the Ruling will have no effect for the 2004-05 income year as the time limit for amending income tax return has expired.

The law imposes time limits within which the Commissioner can amend both an original and an amended assessment.

Commencing from the 2004-05 year of income, for individuals and small business entities, the time limit for reviewing an assessment is generally two years from the day that the Commissioner gives notice of the assessment. For other taxpayers, the period is four years.

Where the Commissioner refuses to amend the assessment, the taxpayer has no statutory right of review of that decision under section 170 of the ITAA 1936 or any other income tax law.