Edited version of private advice

Authorisation Number: 1012630099511

Ruling

Subject: Limited recourse borrowing arrangements

Issue 1

Regulation of superannuation funds - borrowing arrangements

Question 1

Can the Fund enter into a number of limited recourse borrowing arrangements (LRBAs) with related parties of the Fund if a zero rate of interest is charged over the term of the borrowings in accordance with the loan agreement?

Question 2

Can the Fund have a loan-to-asset ratio of up to 50% through a number of LRBAs with a zero rate of interest being charged?

Answers

1. The Commissioner cannot rule.

2. The Commissioner cannot rule.

Issue 2

Non-arm's length income

Question

If the Fund enters into a number of LRBAs with the related parties of the Fund and a zero rate of interest is charged over the term of the borrowings will this give rise to non-arm's length income of the Fund?

Answer

Yes

Issue 3

Application of Part IVA of the Income Tax Assessment Act 1936 (ITAA 1936)

Question

Will Part IVA of the ITAA 1936 apply in respect of the LRBAs with zero rate of interest?

Answer

The Commissioner has not yet ruled.

This ruling applies for the following period:

Income year ending 30 June 2014

The scheme commences on:

During the income year ending 30 June 2014

Relevant facts and circumstances

The Fund is a regulated self-managed superannuation fund (SMSF).

There are three members in the Fund and they are all related. Member 1 and Member 2 are each other's spouse and parents of Member 3.

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

Directors of the Fund Trustee are Member 1, Member 2 and Member 3.

Shareholders of the Fund Trustee are Member 1 and Member 2.

The Fund is currently paying transition-to-retirement income stream benefits to Member 1 and Member 2. Both superannuation income streams commenced in the 2012-13 income year.

The Fund has acquired units (the Property) in a number of managed investment funds through LRBAs.

Each investment fund is held in a separate bare trust (the Custodial Trust).

The trustee of all the Custodial Trusts (the Custodial Trustee) is an investment company.

Member 1 is the sole director and shareholder of the Custodial Trustee.

The Custodial Trustee was appointed to acquire the Property as trustee for the Fund by a number of separate bare trust deeds (the Custodial Trust Deeds. The terms of the Custodial Trust Deeds are identical.

The Lenders with respect to the eight LRBAs are:

• The Fund Trustee as trustee for the members' Family Trust (the Family Trust); and

• Member 1.

A separate loan agreement (the Agreement) is made with respect to each LRBA. The Agreements are identical and include the following terms:

• The Lender agrees to make available to the Borrower the Facility up to an aggregate principal amount equal to the Facility Limit.

• Facility Limit is a specific amount.

• The Borrower will apply all Advances made under the Facility to acquire an interest in the Property agreed to in the Schedule.

• The Property means each managed investment fund up to the value of a specific amount.

• The Borrower must repay the Lender on the Termination Date or as otherwise agreed in writing all Advances that remain outstanding together with other money the payment or repayment of which forms part of the Obligations.

• Termination Date means the earlier of less than 20 years from the date of the relevant Agreement (or such other date as agreed in writing between the Lender and the Borrower) and such earlier date on which the Facility is terminated or cancelled by the Lender in accordance with the relevant Agreement.

• Interest will accrue on a monthly basis at the Higher Rate. However, if interest is paid when due and there is no Event of Default or Potential Default, the Lender will accept interest calculated at the Lower Rate.

• Lower Rate means 0% per annum and the Higher Rate means Lower Rate plus 2% per annum.

Relevant legislative provisions

Reasons for decision

Issue 1

Summary

This issue relates to the provisions contained in the Superannuation Industry (Supervision) Act 1993 (SISA) and the Superannuation Industry (Supervision) Regulations 1994 (SISR). As such, it is not a relevant provision for the purposes of section 357-55 of Schedule 1 to the Taxation Administration Act 1953 (TAA). Consequently, the Commissioner cannot make a private ruling on this issue.

Detailed Reasoning

In accordance with subsection 359-5(1) of schedule 1 to the TAA, the Commissioner may, on application, make a written private ruling on the way in which the Commissioner considers a relevant provision applies, or would apply, to an entity in relation to a specified scheme.

Section 357-55 of Schedule 1 of the TAA states that provisions of Acts and regulations of which the Commissioner has the general administration are relevant for rulings if they are about any of the following:

(a) benefits tax;

(b) franking tax;

(c) withholding tax;

(d) Medicare levy;

(e) fringe tax;

(f) mining withholding tax;

(faa) MRRT

(fa) petroleum resource rent tax;

(fb) indirect tax;

(fc) excise duty;

(g) the administration or collection of those taxes, levies and duties;

(h) a grant or benefit mentioned in section 8 of the Product Grants and Benefits Administration Act 2000, or the administration or payment of such a grant or benefit; withholding;

(i) a net fuel amount, or the administration a net fuel amount;

(ia) an assessed net fuel amount, or the collection or payment of an assessed net fuel amount

(j) a net amount, or the administration, collection or payment of a net amount;

(ja) an assessed net amount, or the collection or payment of an assessed net amount

(k) a wine tax credit, or the administration or payment of a wine tax credit.

In your application for a private ruling, we have identified a number of issues on which you ask the Commissioner to make a private ruling. One of these issues is in relation to certain provisions contained in the SISA and the SISR.

However, because the Commissioner does not have the general administration of the SISA and the SISR, these issues do not relate to provisions that are the relevant provisions for the purposes of section 357-55 of Schedule 1 to the TAA. Therefore, the Commissioner cannot make a private ruling on this particular issue.

While the Commissioner cannot make a private ruling on this particular issue, the Commissioner can provide an SMSF specific advice instead.

SMSF specific advice applies to a specific transaction or arrangement that has been or might be entered into by the trustees of an SMSF. It is based on the facts of the specific transaction or arrangement defined in the trustees' application. .

Accordingly, we provide the following SMSF specific advice for Issue 1 of your application

Self-Managed Superannuation Fund specific advice

Summary

Neither the SISA nor ITAA 1997 prohibit the Fund from entering into LRBAs with related parties only because a zero rate of interest is charged over the term of the borrowings in accordance with the loan agreement.

Whether the Fund can have a loan-to-asset ratio of up to 50% through a number of LRBAs with a zero rate of interest depends on whether LRBAs are consistent with the Fund's investment strategy and the investment requirements contained in the SISA and the SISR.

Detailed reasoning

Arm's length dealing with other parties

Subsection 109(1) of the SISA imposes requirements with respect to investments made by a trustee of a superannuation fund. It provides that the trustee (or investment manager) must not invest in that capacity unless the trustee and the other party to the relevant transaction are dealing with each other at arm's length in respect of the transaction, or:

(b) both:

(i) the trustee or investment manager, as the case may be, and the other party to the relevant transaction are not dealing with each other at arm's length in respect of the transaction; and

(ii) the terms and conditions of the transaction are no more favourable to the other party than those which it is reasonable to expect would apply if the trustee or investment manager, as the case may be, were dealing with the other party at arm's length in the same circumstances.

Whether the trustee of a regulated superannuation fund contravenes section 109 of the SISA if they enter into an LRBA with a related party of the fund on terms that are more favourable to the fund than arm's length terms, has been considered in the ATO Interpretative Decision ATO ID 2010/162.

As discussed in ATO ID 2010/162, the term 'invest' is defined in subsection 10(1) of the SISA to mean:

(a) apply assets in any way; or

(b) make a contract;

for the purpose of gaining interest, income, profit or gain.

When entering into an LRBA, the trustee of a superannuation fund is entering into a contract for the purpose of gaining an interest in the property which is subject of the LRBA, together with any income, profit or capital gain in respect of that property. That is, in accordance with subsection 10(1) of the SISA, the trustee is making an investment.

In this case, the fact that LRBAs are interest free is more favourable to the Fund rather than the related party Lenders. Therefore, based on the above, the fact that the LRBAs are on interest-free terms does not cause a contravention of section 109 of the SISA as that fact does not make the terms and conditions of the borrowing more favourable to the related parties than would be reasonably expected if the parties were dealing with each other at arm's length in the same circumstances.

Further, section 67A of the SISA is an exception to the borrowing rules set out in section 67 of the SISA which prohibits trustees of regulated superannuation funds from borrowing money, or maintaining an existing borrowing of money, except in specific circumstances. The meaning of 'borrow' for the purposes of section 67 is explained in Self Managed Superannuation Fund Ruling SMSFR 2009/2 (SMSFR 2009/2) which, at paragraph 10, states:

… for the purposes of section 67, a borrowing is an arrangement that exhibits two necessary characteristics:

• a temporary transfer of an amount of money from one entity (the lender) to another (the borrower); and

• an obligation or an intention on the part of the borrower to repay that amount to the lender (which may be satisfied by the provision of an asset).

Paragraph 48 of the SMSFR 2009/2 states that, while an obligation to pay interest may evidence the existence of a borrowing of money, it is not a necessary feature of such a borrowing.

Therefore, the absence of a requirement to pay interest on money loaned to the Fund Trustee by the Lenders will not prevent the LRBAs from being a borrowing for the purposes of section 67A of the SISA.

Investment requirements

Trustees of superannuation funds are generally free to make properly considered investment decisions that are consistent with their responsibilities for the sound and productive management of assets for the benefit of members. However, in order to protect and enhance benefits by limiting exposure of benefits to unnecessary risk, the SISA imposes certain requirements on trustees

To that effect, subsection 52(6) of the SISA requires the trustee of a superannuation fund to:

(a) formulate, review regularly and give effect to an investment strategy for the whole of the entity, and for each investment option offered by the trustee in the entity, having regard to:

(i) the risk involved in making, holding and realising, and the likely return from, the investments covered by the strategy, having regard to the trustee's objectives in relation to the strategy and to the expected cash flow requirements in relation to the entity; and

(ii) the composition of the investments covered by the strategy, including the extent to which the investments are diverse or involve the entity in being exposed to risks from inadequate diversification; and

(iii) the liquidity of the investments covered by the strategy, having regard to the expected cash flow requirements in relation to the entity; and

(iv) whether reliable valuation information is available in relation to the investments covered by the strategy; and

(v) the ability of the entity to discharge its existing and prospective liabilities; and

(vi) the expected tax consequences for the entity in relation to the investments covered by the strategy; and

(vii) the costs that might be incurred by the entity in relation to the investments covered by the strategy; and

(viii) any other relevant matters;

(b) to exercise due diligence in developing, offering and reviewing regularly each investment option;

(c) to ensure the investment options offered to each beneficiary allow adequate diversification.

Also, subsection 52(8) of the SISA requires the trustee of a superannuation fund:

(a) to formulate, review regularly and give effect to a risk management strategy that relates to:

(i) the activities, or proposed activities, of the trustee, to the extent that they are relevant to the exercise of the trustee's powers, or the performance of the trustee's duties and functions, as trustee of the entity; and

(ii) the risks that arise in operating the entity;

(b) to maintain and manage in accordance with the prudential standards financial resources (whether capital of the trustee, a reserve of the entity or both) to cover the operational risk that relates to the entity.

With regard to SMSFs specifically, subregulation 4.09(2) of the SISR requires the trustee to formulate, review regularly and give effect to an investment strategy that has regard to the whole of the circumstances of the entity including, but not limited to, the following:

(a) the risk involved in making, holding and realising, and the likely return from, the entity's investments, having regard to its objectives and expected cash flow requirements;

(b) the composition of the entity's investments as a whole, including the extent to which they are diverse or involve exposure of the entity to risks from inadequate diversification;

(c) the liquidity of the entity's investments, having regard to its expected cash flow requirements;

(d) the ability of the entity to discharge its existing and prospective liabilities;

(e) whether the trustees of the fund should hold a contract of insurance that provides insurance cover for one or more members of the fund.

The intent of the above provisions is to ensure trustees make appropriate decisions to protect members' retirement benefits by identifying and managing investment risks, and to ensure investments are made in accordance with, amongst other things, the sole purpose and investment provisions of the SISA.

Therefore, when making investment decisions, trustees are required to consider, and be able to justify and document, how all investments made under an investment strategy are consistent with that strategy and the safeguards, if any, that will be used to ensure that both the objectives of the strategy and the requirements contained in the SISA and the SISR are met.

In-house asset

It can be seen from the above, that while the SISA and the SISR do not prescribe what the fund can and cannot invest in, they do however, restrict some investment practices of superannuation funds. The investment restrictions in the SISA and SISR aim to protect fund members by ensuring a fund's assets are not overly exposed to undue risk. One of these restrictions is a limitation on the percentage of a fund's assets that can be invested in 'in-house assets'.

The holding trust in most LRBAs is a related trust of the SMSF. An investment by an SMSF in a related trust is an in-house asset of the SMSF, unless an exemption applies.

Subsections 71(8) and (9) of the SISA provide an exception to ensure that an SMSF's investment in a holding trust is not an in-house asset, provided certain conditions are satisfied. These conditions are that:

• the holding trust is part of an arrangement that meets all of the requirements of the SISA in connection with a borrowing by the SMSF;

• only property of the trust under the arrangement is the acquirable asset; and

• the asset held by the holding trust would not be an in-house asset of the SMSF if the SMSF owned the asset directly.

The special rule ensures that an LRBA entered into by an SMSF which meets the other requirements of the SISA will not automatically result in an in-house asset arising from the investment made in the holding trust.

Accordingly, the Trustee must ensure that the asset satisfies all requirements under the SISA as noted above.

Please note:

While similar in form to a tax private ruling, the above SMSF specific advice is not binding on the Commissioner and does not have the same review rights as a private ruling.

Issue 2

Summary

The income to be derived by the Fund through the Custodial Trusts will be non-arm's length income of the Fund.

Detailed reasoning

Meaning of non-arm's length income

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. These rates are set out in the Income Tax Rates Act 1986.

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.

Amounts of ordinary income or statutory income of a superannuation fund that are non-arm's length income of a fund are set out in section 295-550 of the ITAA 1997. Relevantly, income that is derived by a fund as a beneficiary of a trust is dealt with in subsections 295-550(4) and (5) of the ITAA 1997.

Subsection 295-550(4) of the ITAA 1997 covers income derived by a complying superannuation fund through a trust by way of holding other than a fixed entitlement to the income of the trust. Subsection 295-550(5) of the ITAA 1997covers income derived by the fund through a trust by way of holding a fixed entitlement to the income of the trust.

Fixed entitlement to trust income

Taxation Ruling TR 2006/7 explains what amounts are considered to be 'special income' under former section 273 of the ITAA 1936 which was repealed with effect from 1 July 2007. Former section 273 has been re-written, with some modifications, in section 295-550 of the ITAA 1997. To the extent that section 295-550 of the ITAA 1997 expresses the same ideas as former section 273, TR 2006/7 is also taken to be a ruling about section 295-550 of the ITAA 1997.

In accordance with paragraph 101 of TR 2006/7, if a complying superannuation fund derives income from a trust by way of the trustee or any other person exercising a discretion, the income distributed will be non-arm's length income of the fund under subsection 295-550(4) of the ITAA 1997.

A trust distribution to a complying superannuation fund will fall within subsection 295-550(5) of the ITAA 1997 rather than subsection 295-550(4) of the ITAA 1997 only if the fund's entitlement to the distribution does not depend upon the exercise of the trustee's, or any other person's discretion, that is, if the fund holds a fixed entitlement to the income of the trust.

In all cases, the determining factor in deciding if a fixed entitlement exists is the terms of the trust instrument under which the trust is constituted. In this case, that is the Custodial Trust Deeds.

As far as relevant,the Custodial Trust Deeds state:

The Custodial Trustee acknowledges and declares that it holds the Property on trust on behalf of the Beneficiary as and from the date the Property was acquired.

The Beneficiary acknowledges and confirms that it holds the beneficial interest in the Property as and from the date of acquisition by the Custodial Trustee subject to the provisions of the Deed.

The Beneficiary is entitled to the full beneficial ownership and interest in the Property and any income, rents, profit, dividends or other rights accruing from it.

The Custodial Trustee is entitled to be indemnified from the assets of the trust being the Property against any expenses, liability or claim that is incurred by or made against the Custodial Trustee in that capacity, unless it is attributable either to the Custodial Trustee's dishonesty or to an act or omission by the Custodial Trustee which the Custodial Trustee knows is a breach of trust.

Together, these clauses of the Custodial Trust Deeds indicate that the parties intend the Fund to have a fixed entitlement to the income of the Custodial Trusts. Therefore, to determine whether income derived by the Fund through the Custodial Trusts is non-arm's length income of the Fund, consideration must be given to subsection 295-550(5) of the ITAA 1997.

If that conclusion was incorrect, income derived by the Fund as beneficiary of the Custodial Trusts would be non-arm's length income of the Fund under subsection 295-550(4) of the ITAA 1997.

Application of subsection 295-550(5) of the ITAA 1997

In accordance with subsection 295-550(5) of the ITAA 1997, income derived by a superannuation fund 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 fund 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 been expected to derive if those parties had been dealing with each other at arm's length.

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.

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 expressed or implied, and whether or not enforceable (or intended to be enforceable) by legal proceedings.

The Full Federal Court in Allen v Federal Commissioner of Taxation¹ (Allen) considered the term 'arrangement' as defined for the purposes of former subsection 273(7) of the ITAA 1936 - the immediate predecessor of subsection 295-550(5) of the ITAA 1997. That term was defined in terms almost identical to a combination of the definitions of 'scheme' and 'arrangement' in the ITAA 1997. The court held that the series of steps undertaken by the parties that resulted in the acquisition of a fixed interest in the trust estate and the relevant distribution of income from that trust estate were readily seen to be an 'arrangement' to which the various entities were parties, and those results were readily seen to be the consequence of that arrangement.

Similarly, for the purposes of applying subsection 295-550(5) of the ITAA 1997 in the present case, the scheme involves the series of steps undertaken by the parties that results in the Fund's acquisition of its fixed entitlement to the income of the Custodial Trusts and any derivation of income by the Fund through holding that entitlement. These steps include the establishment and operation of the LRBAs between the Fund and the Custodial Trustee (which includes the establishment and operation of the Custodial Trusts in favour of the Fund in respect of each of the Property acquired with the borrowed money).

Similarly, those results are readily seen to be the consequence of the above scheme. As such, it is readily concluded that, for the purposes of paragraph 295-550(5)(a) of the ITAA 1997, the Fund would acquire its fixed entitlement to the income of the Custodial Trusts under a scheme and any income derived through holding that entitlement would be derived under a scheme.

Not dealing at arm's length

Subsection 995-1(1) of the ITAA 1997 provides that in determining whether parties deal at arm's length, consideration is to be given to any connection between them and any other relevant circumstances.

In Federal Commissioner of Taxation v AXA Asia Pacific Holdings Ltd Justice Dowsett of the Full Federal Court summarised propositions which emerge from the numerous cases in which the expression 'not dealing with each other at arm's length' or similar expressions have been considered, as follows:

• in determining whether parties have dealt with each other at arm's length in a particular transaction, one may have regard to the relationship between them;

• one must also examine the circumstances of the transaction and the context in which it occurred;

• one should do so with a view to determining whether or not the parties have conducted the transaction in a way which one would expect of parties dealing at arm's length in such a transaction;

• relevant factors which may emerge include existing mutual duties, liabilities, obligations, cross-ownership of assets, or identity of interests which might enable either party to influence or control the other, or induce either party to serve a common interest and so modify the terms on which strangers would deal;

• where the parties are not in an arm's length relationship, one may infer that they did not deal with each other at arm's length, and that the resultant transaction is not at arm's length;

• however related parties may, in some circumstances, so conduct a dealing as to displace any inference based on the relationship;

• un-related 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 Justices Edmonds and Gordon further stated 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': …²

Further, the Full Federal Court in Allen held that former paragraph 273(7)(a) of the ITAA 1936 - the immediate predecessor of paragraph 295-550(5)(a) of the ITAA 1997 - does not require that the 'dealing' consist only of the actual derivation of the income in question by 'the entity', but that the evident legislative intention of the provisions is to permit regard to be had to the totality of the steps that result in the entity's acquisition of its fixed entitlement to the income of the trust and any derivation of income by the entity through holding that entitlement.³ In this case that means that regard may be had to the establishment and operation of the LRBAs between the Fund and the Lenders (which includes the establishment and operation of the Custodial Trusts in favour of the Fund in respect of the Property acquired with the borrowed money).

It is clear that the parties in this case are not in an arm's length relationship. This view is based on the fact that:

• Member 1 and Member 2 are members of the Fund and directors and shareholders of the Fund Trustee;

• Member 1 is the sole director and shareholder of the Custodial Trustee;

• Member 1 is the lender with regard to some LRBAs; and

• The Family Trust is the lender with regard to the other LRBAs

Consequently, as Dowsett J stated in AXA, it may be inferred that the dealing between the parties is not at arm's length. That being the case, it is necessary to consider whether the terms of the dealing between the parties can displace the inference based on the relationship of the parties.

Assessing the circumstances holistically, it is clear that the parties are not dealing with each other in respect of the LRBAs as arm's length parties would do. Aspects which, taken together, the Commissioner considers lead to that conclusion include:

• the Lenders are not by way of the charging of interest under the Agreements, or by any other means, compensated for the opportunity cost of lending the principal, or for the additional risk assumed in relation to recovery of the principal in the event of the borrower's (the Fund's) default under the Agreements, given the limited recourse nature of the loans and lack of other security;

• rather than regular periodic repayments of the principal sum, only a single lump sum repayment at the end of the loan term, which could be as much as 15 years, is required;

• 100% of the value of the Property to be acquired will be lent, rather than a lower loan to value ratio (LVR) given the nature of the Property to be acquired and the limited recourse nature of the loans.

• High LVR loans are generally provided where the risk of default and loss are small. Typically, to help mitigate the risk associated with high LVR, lenders will generally require additional terms such as mortgage insurance or an-upfront risk fee (approximately 1.5% of the loan's value). In this case there is no mortgage insurance or upfront risk fee paid under the Agreements; and

• no insistence by the Lenders on the giving of personal guarantees by the members of the Fund as security for the borrower's performance under the Agreements. If the Fund were to have borrowed from an independent lender, it could not reasonably have expected to borrow the entire purchase price without additional security.

Amount of income greater than might be expected if dealing at arm's length

The final requirement of subsection 295-550(5) of the ITAA 1997, which is set out in paragraph 295-550(5)(b) of the ITAA 1997, is that the amount of the income (derived by the entity as a beneficiary of a trust through holding a fixed entitlement to the income of the trust) is more than the amount that the entity might have been expected to derive if the parties had been dealing with each other at arm's length.

If the parties in this case were dealing with each other at arm's length, the amount of income the Fund might be expected to derive through the Custodial Trusts is either:

• nil - on the basis that no lending on the proposed terms by the Lenders might be expected and therefore no income might be expected to be derived by the Fund through the Custodial Trusts; or

• is less than under the proposed arrangement - on the basis that Member 1 and the Family Trust might be expected to lend on commercial terms that:

• involve lower than 100% LVR given the nature of the assets to be acquired with the borrowed money and the limited recourse nature of the loans. Therefore, the substantially lower borrowed amounts available to be invested might be expected to generate less income to be derived by the Fund through the Custodial Trusts than under the proposed arrangement;

• involve a higher rate of interest given the limited recourse nature of the loans. The income that might be expected to be derived by the Fund through the Custodial Trusts would be reduced by the amount of interest payable in respect of the loans.

Either way, the final requirement of subsection 295-550(5) of the ITAA 1997 is satisfied.

Consequently, income derived by the Fund through the Custodial Trusts would be non-arm's length income of the Fund.

Other relevant Comments

Legislative intent

This conclusion is entirely consistent with the legislative intent of section 295-550 of the ITAA 1997 and its predecessors.

The earliest predecessor of section 295-550 of the ITAA 1997 - former section 23F of the ITAA 1936 - was introduced in 1964 as a result of the Report of the Commonwealth Committee on Taxation, 1961 (the Ligertwood Report) which recommended legislative amendments to counter the numerous ways identified by the Committee in which a taxpayer could constitute a superannuation fund with income, that would have accrued to the taxpayer in the ordinary course of events, and thus be received virtually tax free.

Of particular relevance to the circumstances of this case was the second example given in the Ligertwood Report of a situation which the recommended legislation was to address:

"A director-controlled superannuation fund is set up by a private company, primarily for the benefit of those employees who are also shareholders and directors. The directors then cause the company to make interest-free loans to the fund which invests the proceeds. The income derived by the fund from its investments is exempt under Section 23(j) and when this income is eventually paid to the directors in a lump sum on their retirement, only 5 per cent thereof will be taxed in the hands of the beneficiaries or alternatively the amount may be wholly free from tax".

Further, the Full Federal Court in Darrelen Pty Ltd v Federal Commissioner of Taxation⁴ stated that the policy underlying former section 273 of the ITAA 1936, 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.

Similarly, the Explanatory Memorandum to the Superannuation Legislation Amendment Bill (No.2) 1999 which inserted former subsections 273(6) and (7) of the ITAA 1936 - the immediate predecessors of subsections 295-550(4) and (5) of the ITAA 1997 - explained at paragraph 2.13 that:

Section 273 is designed to prevent income from being unduly diverted into superannuation entities as a means of sheltering that income from the normal rates of tax applying to other entities, particularly the marginal rates applying to individual taxpayers.

The main effect of the scheme in this case, being the movement of income through a non-arm's length dealing from entities who would pay marginal or company tax rates on such income into the concessionally taxed superannuation fund is clearly intended to be addressed by section 295-550 of the ITAA 1997 and its predecessors.

Issue 3

Detailed reasoning

Part IVA of the ITAA 1936

Part IVA of the ITAA 1936 is a general anti-avoidance provision that gives the Commissioner the discretion to cancel all or part of a 'tax benefit' that has been obtained or would, but for section 177 be obtained, by a taxpayer in connection with a scheme to which Part IVA applies.

Broadly, Part IVA of the ITAA 1936 applies where:

• a taxpayer enters into a scheme

• the taxpayer obtains a tax benefit from the scheme

• the circumstances indicate that the obtaining of that tax benefit was a dominant purpose of one of the parties to the scheme.

Part IVA of the ITAA is a provision of last resort. It does not apply unless the taxpayer's claim is otherwise allowable under tax law.

In light of the ruling given in respect of non-arm's length income of the Fund, the Commissioner has not yet ruled with regard to the application of Part IVA of the ITAA 1936 in relation to the scheme the subject of the private ruling application.

Please be aware that, if contrary to our ruling in respect of non-arm's length income of the Fund, the non-arm's length income provisions do not so apply, it is our preliminary view that Part IVA of the ITAA 1936 could apply

¹ (2011) 195 FCR 416; [2011] FCAFC 118; (2011) 2011 ATC 20-277; [2012] ALMD 3059; (2011) 84 ATR 853.

² (2010) 189 FCR 204, at 231.

³ (2011) 195 FCR 416, at 434.

⁴ [2010] FCAFC 35; (2010) 2010 ATC 20-180; (2010) 183 FCR 237; [2010] ALMD 4701; (2010) 78 ATR 916.