Edited version of your private ruling

Authorisation Number: 1012440983484

Ruling

Subject: Acquisition of Residential Property by a Self Managed Superannuation Fund

Question

Will the rental income derived by the self managed superannuation fund (the Fund) from the lease be non-arm's length income?

Answer

No.

This ruling applies for the following periods:

2012 - 13 income year

The scheme commences on:

1 July 2012

Relevant facts and circumstances

The Fund is the superannuation fund of two members.

The two members are the trustees of the Fund who are in receipt of a pension from the Fund.

The trustees of the Fund, acting as a separate entity formed a partnership with two other groups to redevelop a commercial property.

The trustees of the Fund have an amount of the equity of a development company (the Company) through control of a discretionary trust which owns shares in the Company. The discretionary trust is administered by a corporate trustee.

A member is a director of the Company along with other shareholders of the Company. Each shareholding group investing in the Company holds an equal amount of the equity and controls one board seat each. All shareholding groups hold less than 50% of the equity in the company.

The other shareholders within the Company have no relationship to the trustees of the Fund.

The Company owns the land that is to be redeveloped with apartments.

The Company is currently in the process of converting the building into a number of residential strata units.

The trustees acting on behalf of the self managed superannuation fund (SMSF) wish to purchase one of the residential units being developed by the Company as part of the Fund's diversified investment policy.

Any unit purchased will be at arms length at the same price as either the valuation or the price it is being offered to the general public.

The location of the residential unit that the Trustees of the Fund propose to purchase was provided.

An independent valuation has been obtained for the units within the Company's development.

The unit will be leased, however, the identity of the lessee has not been established as the unit is still under construction There will not be any relationship to the lessee business or personal, with any Fund members. The Fund has no interest or intention of leasing to related parties.

The purchase will be funded from assets of the Fund. The Fund currently has an amount in cash deposits which may be used, or a portion of the share portfolio or from investments in property syndicates which are in the process of being liquidated. A small loan secured by the property may also be used to balance the asset classes over the whole Fund.

Loans to the Company's operations are in direct proportion to shareholding.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 273

Income Tax Assessment Act 1997 Section 295-545

Income Tax Assessment Act 1997 Section 295-550

Income Tax Assessment Act 1997 Subsection 295-550(1)

Income Tax Assessment Act 1997 Subsection 995-1(1)

Reasons for decision

Summary

The rental income derived by the self managed superannuation fund (the Fund) from the lease is not non-arm's length income.

Detailed Reasoning

Non-arm's length income

In accordance with section 295-545 of the Income Tax Assessment Act 1997 (ITAA 1997) the income of a complying superannuation fund, complying approved deposit fund or pooled superannuation trust is split into a 'non-arm's length component' and a 'low tax component'.

The non-arm's length component (formerly known as special income) comprises non-arm's length dividends received from private companies, non-fixed interest trust distributions, and any income derived from transactions where the parties are not dealing with each other at arm's length. This component is reduced by any deductions attributable to that income and is then taxed at the highest marginal rate. 'Derived' in this context is applicable to both ordinary and statutory income.

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 per cent).

The Commissioner has issued Taxation Ruling TR 2006/7, titled 'Income tax: special income derived by a complying superannuation fund, a complying approved deposit fund or a pooled superannuation trust in relation to the year of income' (TR 2006/7). This ruling refers to the former section 273 of the Income Tax Assessment Act 1936 (ITAA 1936) which concerned 'special income' and still provides useful guidance on the factors to be considered in the interpretation of section 295-550 of the ITAA 1997.

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 fund, a complying approved deposit fund or a pooled superannuation trust (other than an amount to which subsection (2) applies or an amount derived by the entity in the capacity of beneficiary of a trust) if:

(a) it is derived from a scheme the parties to which were not dealing with each other at arm's length in relation to the scheme; and

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

The non-arm's length provisions require the determination of whether the parties to the scheme are dealing with each other at arm's length in relation to the scheme.

'Arm's length' is not defined, however subsection 995-1 (1) of the ITAA 1997 states that:

in determining whether parties deal at arm's length, consider any connection between them and any other relevant circumstance.

In relation to arm's length TR 2006/7 states at paragraphs 76 to 78:

76. The Commissioner considers that parties are dealing with each other at arm's length in relation to a transaction if the independent minds and wills of the parties are applied to the transaction and their dealing is a matter of real bargaining. If this is not the case, the Commissioner will consider that the parties are not dealing with each at arm's length in relation to the transaction.

77. 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.

78. Parties that are not at arm's length can deal with each other at arm's length in relation to a transaction and parties that are at arm's length can deal with each other in a way that is not at arm's length. An amount of income can only be special income under subsection 273(4) if, in relation to the particular transaction, the parties are not dealing with each other at arm's length.

These principle can be seen in the case of Allen (As Trustee of the Allen's Asphalt Staff Superannuation Fund) v. Federal Commissioner of Taxation 2010] FCA 1276; (2010) 2010 ATC 20-225; (2010) 80 ATR 849; [2012] ALMD 2629; [2012] ALMD 2630; [2012] ALMD 2631; [2012] ALMD 2632 case where Justice Collier said:

…if conduct of parties is not consistent with conduct of independent third parties, because one party is exerting personal influence or control over the other or others, dealings between them cannot be termed 'arm's length'.

Further, consideration must be given to whether the amount derived from the scheme is more than the amount the fund might have been expected to derive if those parties had been dealing with each other at arm's length in relation to the scheme.

In relation to the above paragraphs 79 and 80 of TR 2006/7 state:

79. The final requirement for an amount of income to be special income under subsection 273(4) is that the amount of income derived from the transaction must be greater than the amount of income that might have been expected if the parties were dealing with each other at arm's length in relation to the transaction.

80. This is a question of fact. When considering this issue, the Commissioner will take into account all relevant matters. The level of investment risk that the superannuation entity is exposed to will be a relevant matter.

In this case, the trustees of the Fund have equity in a development company, (the Company) through control of the a discretionary trust which owns shares in the Company.

A member is a director of the Company along with other shareholders of the Company. Each shareholding group investing in the Company holds an equal amount of the equity and controls one board seat each. The other shareholders within the Company have no relationship to the trustees of the Fund.

The relationship of the parties is such that no one party has the ability to influence or control the other and the Members are not in a position to influence the decisions of the Company as the trustees of the Fund have an equal amount of the equity in the Company, which is less than 50%, and holds one directors seat on the board.

The trustees of the Fund intend to purchase a residential unit from the Company. The units have been independently valued. The Fund intends to purchase the unit at the price of valuation or the amount being offered to the general public. The Fund will lease the unit to an unrelated party.

In these circumstances, it is accepted that the transactions will be at arm's length.

Whether parties to the scheme were not dealing with each other at arm's length

The term 'arm's length' is not defined. However, subsection 995-1 (1) of the ITAA 1997 states that:

in determining whether parties deal at arm's length, consider any connection between them and any other relevant circumstance.

The members of the Fund have equity in a development company, through control of a discretionary trust which owns shares in the Company. The Company is currently constructing a number of residential units. In addition, the members are entitled to one of the directors seats of the Company.

In view of their close relationship, the Trustee, and the Company are non-arm's length parties in relation to the proposed development of a number of residential strata units.

Although the nature of the relationship between parties is relevant in determining whether dealings between them are at arm's length, parties that are not at arm's length can still deal with each other at arm's length in relation to a particular dealing.

In this regard, paragraph 76 of TR 2006/7 states that:

The Commissioner considers that parties are dealing with each other at arm's length in relation to a transaction if the independent minds and wills of the parties are applied to the transaction and their dealing is a matter of real bargaining. If this is not the case, the Commissioner will consider that the parties are not dealing with each at arm's length in relation to the transaction.

The dealings between the Trustee and company x involve:

(a) The trustees acting on behalf of the SMSF wish to purchase one of the residential units being developed by company x, a development company as part of the Fund's diversified investment policy.

(b) The trustees wish to purchase the residential unit at the same price as either the valuation or the price it is being offered to the general public.

(c) Once purchased the unit will be leased to an unrelated party.

From the information provided, we accept that there is no indication of the parties involved in any of the aforementioned dealings are not dealing with each other at arm's length. The unit has been independently valued, and the trustees wish to purchase the residential unit at the same price as either the valuation or the price it is being offered to the general public and the unit will be leased to an unrelated party.

Amount derived is greater than what might have been derived on arm's length basis

Paragraphs 79 and 80 of TR 2006/7 state that:

79. The final requirement for an amount of income to be special income under subsection 273(4) is that the amount of income derived from the transaction must be greater than the amount of income that might have been expected if the parties were dealing with each other at arm's length in relation to the transaction.

80. This is a question of fact. When considering this issue, the Commissioner will take into account all relevant matters. The level of investment risk that the superannuation entity is exposed to will be a relevant matter.

As mentioned above the Trustees of the Fund wish to purchase a residential unit from the Company (a related party of the Fund) at the same price as either the valuation or the price being offered to the public. Once the unit is purchased, the Fund intends to lease the unit to an unrelated party.

From the facts provided it is accepted that the amount to be derived from the lease of the unit is not greater than what might have been derived on an arm's length basis.

In this case, the Commissioner considers that the relationship of the parties is such that no one party has the ability to influence or control the other and the amount derived is not greater than what might have been derived on arm's length basis

Therefore we are of the view that income to be derived by the Fund by leasing the residential property will not be non-arm's length income of the Fund under section 295-550 of the ITAA 1997.

Conclusion

The rental income derived by the Fund from the lease is not non-arm's length income.