Edited version of your written advice

Authorisation Number: 1051489039720

Date of advice: 4 March 2019

Ruling

Subject: Assignment of a concurrent lease to a self-managed superannuation fund (SMSF)

Question 1

If the proposed Concurrent Lease is entered into with the Fund, will the Commissioner make a determination under section 177F of the Income Tax Assessment Act 1936 (ITAA 1936) to cancel a tax benefit obtained or would be obtained by a taxpayer in connection with a scheme that Part IVA applies?

Answer

If the proposed Concurrent Lease is entered into with the Fund, the Commissioner will make a determination under section 177F of the ITAA 1936 to cancel the tax benefit obtained by the taxpayer.

Question 2

Will the income received by the Fund, from a concurrent lease, be classed as non-arm’s length income under section 295-550 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

If the proposed Concurrent Lease is entered into, in the alternative to applying Part IVA, the Commissioner’s position is that the non-arm’s length income provisions in section 295-550 of the ITAA 1997 may apply in respect of the income of the Fund under the proposed Concurrent Lease.

This ruling applies for the following period:

1 July 2018 to 30 June 2019

The scheme commenced on:

The scheme has not yet commenced

Relevant facts and circumstances

1. The taxpayer is the sole member of the Superannuation Fund and the sole director of the Fund’s corporate trustee.

2. The taxpayer owns a property.

3. The taxpayer constructed a childcare centre building on the property.

4. Prior to commencing construction of the building, the taxpayer entered into an Agreement to Lease the Premises to non-related parties of the Fund.

5. The taxpayer wishes to transfer his rights and obligations under the head lease to the Fund via a concurrent lease.

6. Concurrent lease

The key terms of the concurrent lease are:

(a) the concurrent lessee is entitled to the rent payable and to enforce the original tenant’s covenants under the head lease;

(b) the concurrent lessee is subject to the same obligations to which the original landlord would be subject under the head lease, including the obligation to undertake repairs and maintenance and to maintain all structural features of the building and to effect any structural repairs thereto;

(c) to maintain all existing fire, building and liability insurance at a level commensurate with prudent business practice having regard to the value of the Property and any other relevant circumstances as required under the Original Lease

(d) the concurrent lessee indemnifies the landlord against any losses arising from claims made by the original tenant (or any other person) by reason of any act or omission of the concurrent lessee; rent is payable by the concurrent lessee to the landlord. The annual rent (payable monthly) is 50% of the head lease annual rent of $180,000.

(e) the concurrent lessee must pay a security deposit of $45,000 of the head lease annual rent amount

(f) the concurrent lessee must pay a GST-exclusive premium of $16,000 of the head lease annual rent amount; and

(g) the term commences when the concurrent lease is signed and ends on the earlier of the second last day of the head lease (including any renewed term(s)) and the taxpayer’s death but may be terminated by either party with three months’ notice.

7. The taxpayer’s advisor has provided an independent valuation for both the rent and lease premium payable by the concurrent lessee (the Fund).

Reasons for decision

Detailed reasoning

Question 1: Part IVA of the ITAA 1936

8. Under section 177F of the Income Tax Assessment Act 1936¹, the Commissioner may make a determination to cancel a tax benefit where that tax benefit has been obtained, or would but for section 177F be obtained, by a taxpayer in connection with a scheme to which Part IVA applies.

9. In order for Part IVA to apply, the following requirements must be satisfied:

● there must be a scheme (section 177A);

● a taxpayer must have obtained, or would but for section 177F obtain, a tax benefit in connection with the scheme (section 177C); and

● the dominant purpose of a person who entered into or carried out the scheme, or any part of the scheme, was to enable the taxpayer to obtain a tax benefit in connection with the scheme (paragraph 177D(b)).

The scheme

10. Where the proposed Concurrent Lease is entered into, there will be a ‘scheme’ for the purposes of section 177A comprising the entering into of the proposed Concurrent Lease on the terms as advised.

The counterfactual to the scheme

11. Paragraph 177C(1)(a) provides that subject to this section, a reference in Part IVA to the obtaining by a taxpayer of a tax benefit in connection with a scheme shall be read as a reference to:

…an amount not being included in the assessable income of the taxpayer of a year of income where that amount would have been included, or might reasonably be expected to have been included, in the assessable income of the taxpayer of that year of income if the scheme had not been entered into or carried out;…

12. In considering what would have been included, or might reasonably be expected to have been included if the particular scheme had not been entered into or carried out, requires more than a possibility. In Federal Commissioner of Taxation v. Peabody (1994) 181 CLR 359 at 385; 123 ALR 451 at 461; 94 ATC 4663 at 4671; 28 ATR 344 at 353:

A reasonable expectation requires more than a possibility. It involves a prediction as to events which would have taken place if the relevant scheme had not been entered into or carried out and the prediction must be sufficiently reliable for it to be regarded as reasonable.

13. The Full Federal Court per Edmonds J (Bennett and Middleton JJ agreeing) in Federal Commissioner of Taxation v. Ashwick (Qld) No. 127 Pty Ltd & ors [2011] FCAFC 49; 2011 ATC 20-255 at [153] outlines propositions concerning the application of section 177C. It requires an objective prediction based on all of the relevant evidence, ‘including inferences open on the evidence, as well as the apparent logic of events’, what alternative would, or might reasonably be expected to, have occurred if the scheme had not been entered into or carried out.

14. In considering what would have been included, or might reasonably be expected to have been included if the particular scheme had not been entered into or carried out, paragraph 109 of Law Administration Practice Statement PSLA 2005/24 Application of General Anti-Avoidance Rules, provides the following guidance:

…it may be useful to consider the following:

● the most straightforward and usual way of achieving the commercial and practical outcome of the scheme (disregarding the tax benefit);

● commercial norms, for example, standard industry behaviour;

● social norms, for example, family obligations;

● behaviour of relevant parties before/after the scheme compared with the period of operation of the scheme; and

● the actual cash flow.

15. Having regard to the facts, the Commissioner considers that it might reasonably be expected that if the scheme had not been entered into or carried out, taking into consideration the points above, the following would have happened:

● The proposed Concurrent Lease is not entered into and the taxpayer continues as lessor under the Agreement to Lease.

16. This is on the basis that Clause 13 of the Agreement to Lease prohibits the taxpayer from assigning any interest or benefit to another entity. As such, it would be difficult to have a counterfactual that involves the sale of the property to the Fund, even for fair market value.

17. The background of the Agreement to Lease states that the construction of the childcare centre building and the grant and acceptance of the Lease is subject to the terms and conditions of this Agreement.

18. The word ‘Agreement’ is defined in clause 1 to mean:

…this deed including the Schedules and all other documents annexed to this Agreement or specifically incorporated by reference.

19. The word ‘Lease’ is defined in clause 1 to mean:

…the lease in the form of a lease contained in Schedule 3

20. As such, the Commissioner’s position is that clause 13 of the Agreement to Lease prohibits the taxpayer to assign any rights or obligations under any of the terms of the Agreement to Lease.

21. Comment was sought from the taxpayer as to what basis the proposed Concurrent Lease could be entered into based on the prohibition contained in clause 13 of the Agreement to Lease. On 15 January 2019, the authorised representative responded to a query as to the ability of the taxpayer to enter into the proposed Concurrent Lease given the existence of clause 13 of the Agreement to Lease. The authorised representative advised that clause 13 only relates to the Agreement to Lease and ceased to apply after the construction of the child care facility.

22. However, the Commissioner’s position is that the wording in Clause 13 does not reflect this restricted application proposed by the authorised representative, for the reasons outlined in paragraphs 17 to 20 above.

The tax benefit and the taxpayer in relation to the scheme

23. Under paragraph 177C(1)(a), a tax benefit is obtained in connection with a scheme if an amount is not included in the assessable income of the taxpayer of a year of income where that amount would have been included, or might reasonably be expected to have been included, in the assessable income of the taxpayer of that year of income if the scheme had not been entered into or carried out.

24. Under paragraph 177C(1)(c), the amount of the tax benefit is the amount referred to in paragraph 177C(1)(a), that is, an amount is not being included in the assessable income of the taxpayer of a year of income.

25. This will be the rental income that, under the scheme, would be assigned to the Fund under the proposed Concurrent Lease.

Commissioner’s determination

26. Paragraph 177F(1)(a) provides that the Commissioner may, in the case of a tax benefit that is referrable to an amount not being included in the assessable income of a taxpayer of a year of income, determine that the whole or part of the amount shall be included in the assessable income of the taxpayer of that year of income.

27. If the proposed Concurrent Lease is entered into, then the Commissioner will consider making a determination to reflect the tax benefit received by the taxpayer. Any such determination will be consistent with the requirements of when the Commissioner can make an amended assessment under subsection 170(1).

28. If a determination is made, the Commissioner may also, if in his opinion considers it is fair and reasonable to do so, determine compensating adjustments in the relevant income years pursuant to subsection 177F(3).

29. While section 177G provides that there is nothing in section 170 that will prevent an amendment to an assessment to give effect to subsection 177F(3), where there is no amendment to an assessment, there will be no compensating adjustment.

Weighing each of the factors in applying the dominant purpose test in paragraph 177D(b) to the scheme

30. The dominant purpose test in paragraph 177D(b) is applied in respect of the tax benefit obtained by the relevant taxpayer.

31. The relevant taxpayers under section 177D in connection with the scheme is the taxpayer.

32. Having regard to all the factors in paragraph 177D(b), if the proposed Concurrent Lease is entered into, the Commissioner’s position will be that one or more of the participants entered into or carried out the scheme, or any part of the scheme, for the dominant purpose of enabling the taxpayer to obtain the tax benefit. The Commissioner’s consideration of the eight factors are detailed below:

The first, second and third factors in paragraph 177D(b) - manner in which the scheme is entered into or carried out; form and substance and timing

33. Where the proposed Concurrent Lease is entered into as part of the scheme, the Commissioner considers that the manner in which the scheme will be entered into or carried out will exhibit features that strongly points toward all parties, including the taxpayer acting in his own right and as director of the corporate trustee of the Fund, entering into or carrying out the scheme, or any part of it, for the dominant purpose of enabling himself to obtain the tax benefit in connection with the scheme.

34. Under the Agreement to Lease, clause 13 prohibits the taxpayer (as Lessor) from assigning any of his rights or obligations under the Agreement to Lease. As such, it is the Commissioner’s position that the Agreement to Lease restricts the ability of the taxpayer to enter into the proposed Concurrent Lease as the terms of the Concurrent Lease seeks to assign the taxpayer’s rights and obligations under the Agreement to Lease to the Fund. Notwithstanding this potential breach of the restriction in the Agreement to Lease, the taxpayer is seeking to assign his rights and obligations to the Fund in return for a once off $16,000 payment from the Fund and also $90,000 per annum payments (indexed).

35. The taxpayer has indicated that the rationale for entering into the Concurrent Lease includes:

● The taxpayer being aware that superannuation funds are concessionally taxed and therefore a preferred vehicle for investing and saving for retirement. He wanted to transfer the vacant land to the Fund but was advised that vacant land cannot be business real property and as such he had the childcare centre constructed on the property;

● The taxpayer sought peace of mind as he was the landlord of the property and considered himself personally liable for all of the Landlord’s obligations under the Agreement to Lease and the law of negligence, for example if a child was injured;

● The taxpayer wanted to diversify the Fund’s asset allocation and was seeking to obtain an exposure to direct real estate without selling its carefully balanced share portfolio.

36. It is advised that the Fund sought to diversify and seek ‘exposure to direct real estate’ and seeks to enter into the proposed Concurrent Lease to give effect to the investment strategy. However, the proposed Concurrent Lease is inconsistent with clause 13 of the Agreement to Lease which prohibits the taxpayer from assigning any right or interest under the Agreement to Lease. As such, the taxpayer is not able to enter into the proposed Concurrent Lease.

37. It is common under Concurrent Leases that the lessor is paid a lump sum amount taking into account the time value of money for the income stream that is assigned to the lessee under the Concurrent Lease. As such, a discount is applied and the upfront lump sum does not reflect the full income stream that is assigned. However, it is noted that the taxpayer is not paid a lump sum up front under the Concurrent Lease. Rather the taxpayer is paid $90,000 per annum after the Fund under the Concurrent Lease receives the $180,000 per annum from the childcare operator. As such, the significant discount applied under the proposed Concurrent Lease cannot be explained by any time value access to money by the taxpayer as he does not receive any monies in advance. In fact it raises significant concerns as to whether the taxpayer, if dealing with a third party, would have accepted the same significant discount that he received under the proposed Concurrent Lease.

38. That is, the taxpayer has effectively assigned his rights to the full $180,000 per annum for only $90,000 per annum plus the once off payment of $16,000. Based on the estimated cost of Outgoings of approximately $30,000 (as advised by the valuer), there could be no reasonable explanation as to why the taxpayer would assign a net rental income of $150,000 ($180,000 less $30,000 approximate expenditure) for only $90,000 plus one payment of $16,000.

39. The proposed Concurrent Lease does not bear any hallmarks of a commercial dealing in respect of a Concurrent Lease. The valuer advised that the $90,000 rental under the proposed Concurrent Lease is fair market value. However, to come to this amount, he has compared the proposed Concurrent Lease terms to investing in the shares of a company that operates child care centres and using expected dividend returns of a company to determine the rent payable. The taxpayer does not operate any childcare centres nor is he investing in shares in a company that operates a child care centre. Rather the taxpayer is renting property to a child care centre and as such, a market valuation should reflect consideration of the rental that would be received in respect of that property.

40. In addition, the valuer stated that a maximum $16,000 premium should be paid by the Fund to the taxpayer for entering into the proposed Concurrent Lease. There is no written obligation under any agreement for this payment. The $16,000 payment was determined based a percentage of what rent would be payable by a lessee during the 3 month notice period required to terminate the lease agreement, notwithstanding, that the lessee would obtain all rights during that 3 month period.

41. The Commissioner does not agree with the valuation methodology applied and does not consider that any of the business valuations undertaken determine a fair market value of the proposed Concurrent Lease terms.

42. The only reason for taking up such an arrangement on the terms proposed is due to the fact that the taxpayer is dealing with the Fund of which he is the sole member. In entering into the proposed Concurrent Lease, it maximises the income of the Fund, being concessionally taxed.

43. The taxpayer raised concerns of personal liability as the landlord of the property should a child be injured as one reason for entering into the proposed Concurrent Lease. This is notwithstanding that both he and the third party childcare operator are fully insured as required under the terms of the Agreement to Lease. This includes public liability insurance of $20m. Firstly it is not clear how any such risk is absolved by entering into the proposed Concurrent Lease as the taxpayer still remains the legal owner of the property. However, if the risk of personally liability after insurance exists, this risk has been transferred to the Fund. This raises serious questions as to whether a prudent trustee of a superannuation fund would have entered into the proposed Concurrent Lease and undertaken such risks. Based on the parties being fully insured and that the taxpayer is still potentially liable as legal owner of the property, then the significant discount in rent cannot be explained except by the tax benefit that the taxpayer would obtain if the proposed Concurrent Lease is entered into as part of the scheme.

44. The proposed Concurrent Lease has not been correctly valued, does not have the substance of a commercial transaction at fair market value and can only be explained by the tax benefit that the taxpayer would obtain if the proposed Concurrent Lease is entered into as part of the scheme.

Conclusion

45. If the proposed Concurrent Lease is entered into, it would be the Commissioner’s position that the manner, timing and the substance in which the scheme was carried out was for the Fund to acquire the rental income under the Agreement to Lease as a result of the proposed Concurrent Lease, such that no tax was payable by the Fund. While the taxpayer would have assessable income in respect of the rent of $90,000 per annum under the proposed Concurrent Lease, this is significantly less than the expected rental income of $150,000 ($180,000 less $30,000 approximate expenditure), if the taxpayer did not enter the scheme. If the proposed Concurrent Lease is entered into, these features of the scheme would be a clear indicator that the dominant purpose of entering into the scheme will be to reduce the taxation liability on the rent currently being paid to the taxpayer under the Agreement to Lease.

46. The natural order of things, as outlined in the counterfactual to the scheme, would be retaining the existing Agreement to Lease terms.

47. The entering into the proposed Concurrent Lease would disturb this natural order only to provide a tax benefit to the taxpayer.

48. If the proposed Concurrent Lease is entered into, the first, second and third factors strongly point to towards the taxpayer entering into or carrying out the scheme, or any part of it, for the dominant purpose of enabling himself to obtain the tax benefit in connection with the scheme.

The fourth factor in subparagraph 177D(b)(iv) – income tax result achieved by the scheme

49. If the proposed Concurrent Lease is entered into as part of the scheme, the income tax result achieved (but for Part IVA) as outlined above will be that the Fund and the taxpayer will not be subject to tax on the rental income received from the third party childcare operator. While the taxpayer would be subject to tax in respect of the rent of $90,000 per annum and $16,000 once off payment, these amounts are significantly less than under the Agreement to Lease.

50. In the counterfactual, the taxpayer would continue to pay income tax as the Lessor under the Agreement to Lease.

51. The only benefit to the taxpayer in entering into the proposed Concurrent Lease as part of the scheme would be the tax benefit. There would be little or no risks removed due to existing insurance coverage. However, if as contended by the taxpayer that there are significant risks and that they are to be assigned to the Fund under the proposed Concurrent lease, then the Commissioner would query why a prudent trustee would enter into the proposed Concurrent Lease and undertake such risks.

52. There would seem to be no justification for entering into the proposed Concurrent Lease, apart from achieving the tax benefit identified.

The direction the fourth factor points

53. If the proposed Concurrent Lease is entered into, then the Commissioner’s position would be that this factor would strongly point towards the taxpayer entering into or carrying out the scheme, or any part of it, for the dominant purpose of enabling himself to obtain the tax benefit in connection with the scheme.

The fifth factor in subparagraph 177D(b)(v) – change in financial position of the taxpayer resulting from the scheme

54. If the proposed Concurrent Lease is entered into then the taxpayer’s financial position would differ due to the differing taxation liabilities under the scheme and under the counterfactual.

55. In addition, there will be additional costs including costs in administering the Concurrent Lease. There would seem to be no justification for incurring these extra costs, apart from achieving the tax benefit identified.

The direction the fifth factor points

56. If the proposed Concurrent Lease is entered into, then the Commissioner’s position would be that the fifth factor strongly points towards the taxpayer entering into or carrying out the scheme, or any part of it, for the dominant purpose of enabling himself to obtain the tax benefit in connection with the scheme.

The sixth factor in subparagraph 177D(b)(vi) – change in financial position of any connected person resulting from the scheme

57. The relevant taxpayer is the taxpayer and if the proposed Concurrent Lease is entered into, then the Fund (being connected to the taxpayer) would be entitled to the rental income under the Agreement to Lease and would also be required to make the $90,000 per annum rental payment and the expense payments. As such, the financial position of the Fund will change if the proposed Concurrent Lease is entered into, noting that it is concessionally taxed.

58. As the Fund is concessionally taxed as compared with the taxpayer, the change in financial position of the Fund as a result of the proposed Concurrent Lease being entered into can only be explained by the tax benefit that would be available to the taxpayer.

The direction the sixth factor points

59. If the proposed Concurrent Lease is entered into, then the Commissioner’s position would be that the sixth factor strongly points towards the taxpayer entering into or carrying out the scheme, or any part of it, for the dominant purpose of enabling himself to obtain the tax benefit in connection with the scheme.

The seventh factor in subparagraph 177D(b)(vii) – any other consequences of the scheme for the taxpayer or any connected person

60. Subsection 84(1) of the SISA provides that each trustee must take all reasonable steps to ensure that the provisions including those listed above are complied with.

61. Given the significant regulatory breaches and consequences (outlined below) that would arise if the proposed Concurrent Lease is entered into, there are no other identifiable benefits under the scheme apart from tax benefits to the taxpayer.

The direction the seventh factor points

62. If the proposed Concurrent Lease is entered into, then the Commissioner’s position would be that the seventh factor strongly supports the conclusion that the taxpayer entered into a scheme for the dominant purpose of enabling himself to obtain the tax benefit in connection with the scheme.

The eighth factor in subparagraph 177D(b)(viii) – nature of the connection between the taxpayer and persons affected by the scheme

63. The close connection between the parties, the taxpayer in his own right and also as director of the corporate trustee of the Fund, would enable the entering into of the proposed Concurrent Lease on terms which the Commissioner considers to be non-arm’s length. As stated earlier, the terms of the proposed Concurrent Lease would have in effect resulted in the taxpayer assigning a net rental income of $150,000 ($180,000 less $30,000 approximate expenditure) for only $90,000 plus one payment of $16,000. There is no reasonable explanation for such an outcome except for the tax benefit to be obtained by the taxpayer.

The direction the eighth factor points

64. If the proposed Concurrent Lease is entered into, then the Commissioner’s position would be that the eighth factor would strongly point towards the taxpayer entering into or carrying out the scheme, or any part of it, for the dominant purpose of enabling himself to obtain the tax benefit in connection with the scheme.

Conclusion after considering the eight factors

65. If the proposed Concurrent Lease is entered into, then the Commissioner would consider that all factors point towards the conclusion that the scheme (or any part of it) would be entered into for the dominant purpose of enabling the taxpayer to obtain the tax benefit in connection with the scheme.

66. The Commissioner would then consider making determinations under section 177F to reflect the tax benefits obtained by the taxpayer.

67. The Commissioner will also consider making, if fair and reasonable to do so, determinations under paragraph 177F(1)(c) in respect of the scheme.

Question 2: non-arm’s length income

68. If the proposed Concurrent Lease is entered into, then as an alternative to applying Part IVA, the Commissioner would consider the potential application of the non-arm’s length income (NALI) provisions in section 295-550 of the ITAA 1997.

69. The issue is whether the NALI provisions will apply to the income that would be derived under the proposed Concurrent Lease derived by the Fund.

70. Subsection 42A(1) of the SISA prescribes that an SMSF will be a complying fund in relation to a year of income year provided it is a resident regulated fund which passes the test in subsection 42A(5) of the SISA.

71. In accordance with section 295-545 of the ITAA 1997, the taxable income of a complying superannuation fund is split into a ‘non-arm’s length component’ and a ‘low tax component’.

72. The note to subsection 295-545(1) of the ITAA 1997 explains that:

A concessional rate applies to the low tax component, while the non-arm’s length component is taxed at the highest marginal tax rate. The rates are set out in the Income Tax Rates Act 1986.

73. 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.

74. Subsection 295-550(1) of the ITAA 1997 defines NALI as:

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 …

75. The income of the Fund will be the rental that it receives as a result of entering into the proposed Concurrent Lease. It is advised that a premium of $16,000 will be paid by the Fund to the taxpayer for entering into the proposed Concurrent Lease. The terms of the proposed Concurrent lease requires that the Fund pay the taxpayer $90,000 per annum. As stated earlier in Question 1, the Commissioner considers that the proposed Concurrent Lease terms and the $16,000 payment is not for market value and as such does not reflect a commercial dealing at arm’s length between the parties (the taxpayer in his own right and as the sole member of the Fund and sole director of the corporate trustee). As such, paragraph 295-550(1)(a) of the ITAA 1997 is satisfied.

76. For paragraph 295-550(1)(b) of the ITAA 1997, to determine whether the income under the scheme is more than might have been expected if the parties had of been dealing at arm’s length, it is necessary to identify both the steps of the relevant scheme and the parties that deal with each other under those steps of the scheme. Having identified the steps and parties to the scheme, paragraph 295-550(1)(b) requires a determination of a hypothetical arrangement if the same parties to the scheme had been dealing with each other on an arm's length basis under each identified step of the scheme. Once the hypothetical arrangement is determined, then consideration is required as to whether or not it is objectively reasonable to expect that the Fund could have and would entered into that hypothetical arm’s length arrangement.

77. In this case, the scheme will be entering into the proposed Concurrent Lease on terms that includes the one-off $16,000 lease premium payment and where the taxpayer will assign his rights to the full $180,000 per annum ($150,000 net per annum) for a $90,000 per annum payment from the Fund. As stated earlier, the Commissioner does not consider that the $16,000 payment nor the $90,000 per annum payment by the Fund under the proposed Concurrent Lease terms reflect market value rates.

78. As to whether the Fund could have or would have entered into this arrangement even if at market rates, it is noted that the taxpayer is restricted from assigning any interest or benefit under clause 13 of the Agreement to Lease and as such is prevented from entering into the proposed Concurrent Lease. As such, it is reasonable to conclude that the Fund could not and would not be able to enter into the proposed Concurrent Lease.

79. As such, the Commissioner’s position is that subsection 295-550(1) of the ITAA 1997 could apply if the proposed Concurrent Lease is entered into to make any income of the Fund in respect of the proposed Concurrent Lease NALI.

80. It is also noted that the Treasury Laws Amendment (2018 Superannuation Measures No.1) Bill 2018 has been introduced into parliament with proposed amendments to the NALI provisions. These proposed amendments ensure that a superannuation entity’s NALI includes income where expenditure in gaining or producing it was not an arm’s length expense.

Further issues to consider – general advice

Acquisitions of assets – section 66 of the SISA

81. The issue is whether entering into the proposed Concurrent Lease by the Fund will be an acquisition from a related party under section 66 of the SISA.

82. Subsection 66(1) of the SISA states that subject to subsection (2),

…a trustee or an investment manager of a regulated superannuation fund must not intentionally acquire an asset from a related party of the fund.

83. Paragraph 66(2)(b) provides an exception

…if the fund is a superannuation fund with fewer than 5 members – the asset is business real property of the related party acquired at market value.

84. Subsection 66(5) defines business real property to include:

(i) Any freehold or leasehold interest of the entity in real property…where the real property is used wholly and exclusively in one or more businesses …

85. In this instance, the taxpayer is the sole member of the Fund. The proposed transaction is a Concurrent Lease agreement entered into between the taxpayer and the Fund. As the taxpayer is a related party of the Fund, an acquisition of an asset, in this case, a leasehold interest, cannot be made from a related party of the Fund unless an exception applies.

86. As the proposed Concurrent Lease is leasehold of property that is wholly used as a childcare centre it would meet the definition of business real property, however the issue is whether it has been acquired by the Fund at market value.

87. A valuation has been provided, however, the Commissioner does not consider that the contended premium of $16,000 and the proposed Concurrent Lease payments made by the Fund reflect true market value.

88. As such, the Commissioner considers that the exception in subsection 66(2) would not apply and that the Fund will contravene subsection 66(1) of the SISA if the proposed Concurrent Lease is entered into.

Sole purpose test - section 62 of the SISA

89. The issue is whether entering into the proposed Concurrent Lease by the Fund will breach the sole purpose test under section 62 of the SISA. While the taxpayer has not requested a ruling on the application of section 62 of the SISA, this advice is included for completeness.

90. Subsection 62(1) of the SISA discusses the purposes for which a superannuation fund is to be maintained. It states:

91. Each trustee of a regulated superannuation fund must ensure that the fund is maintained solely:

(a) for one or more of the following purposes (the core purposes):

(i) the provision of benefits for each member of the fund on or after the member’s retirement from any business, trade, profession, vocation, calling, occupation or employment in which the member was engaged…;

(ii) the provision of benefits for each member of the fund on or after the member’s attainment of an age not less than the age specified in the regulations;

(iii) the provision of benefits for each member of the fund on or after whichever is the earlier of:

(A) the member’s retirement from any business, trade, profession, vocation, calling, occupation or employment in which the member was engaged; or

(B) the member’s attainment of an age not less than the age prescribed for the purposes of subparagraph (ii)…

92. Paragraph 5 of SMSFR 2008/2 Self Managed Superannuation Funds: the application of the sole purpose test in section 62 of the SISA to the provision of benefits other than retirement, employment termination or death benefits (SMSFR 2008/2), states that:

…the purpose for which an SMSF is being maintained requires a survey of all of the events and circumstances relating to the SMSF’s maintenance. This enables an objective assessment of whether the SMSF is being maintained for any purpose other than those specified by subsection 62(1).

93. Paragraph 12 of SMSFR 2008/2 lists factors that could conclude that the Fund is not being maintained in accordance with the sole purpose test. These include:

● … the benefit has influenced the decision-making of the trustee to favour one course of action over another…

● There is a pattern or preponderance of events, that when viewed in their entirety, amount to a material benefit being provided that is not specified under subsection 62(1) …

94. Paragraph 13 of SMSFR 2008/2 lists factors that would weigh in favour of a conclusion that an SMSF is being maintained in accordance with section 62 of the SISA:

● The benefit is an inherent or unavoidable part of other activities undertaken by the trustee that are consistent with the provision of benefits specified by subsection 62(1).

● The benefit is remote or isolated, or is insignificant when assessed relative to other activities undertaken by the trustee that are consistent with the provision of benefits specified by subsection 62(1).

● The benefit is provided by the SMSF on arm's length commercial terms (for example, if the benefit is provided at market value), consistent with the financial interests of the SMSF and at no cost or financial detriment to the SMSF.

● All of the activities of the trustee are in accordance with the covenants set out in section 52 of the SISA.

● All of the SMSF’s investments and activities are undertaken as part of or are consistent with a properly considered and formulated investment strategy.

95. Paragraph 52(2)(b) of the SISA provides that the general covenants include the covenant by each trustee:

…to exercise, in relation to all matters affecting the entity, the same degree of care, skill and diligence as a prudent superannuation trustee would exercise in relation to an entity of which it is trustee and on behalf of the beneficiaries of which it makes investments

96. If the proposed Concurrent Lease is entered into, then the Commissioner would contend that a survey of all of the events and circumstances would indicate that the sole purpose test has not been satisfied.

97. This is on the basis that the transactions proposed, do not appear to be for the purpose of obtaining retirement benefits and is not consistent with the sole purpose test under section 62 of the SISA. Rather the parties, by entering into the proposed Concurrent Lease would be dealing with each other, as described in Issue 1, as part of the scheme to give effect to a tax benefit to the taxpayer for which the Commissioner considers that Part IVA of the ITAA 1936 will apply.

98. As such, the Commissioner considers that the sole purpose test would be breached upon entering into the proposed Concurrent Lease.

Relevant legislative provisions

Income Tax Assessment Act 1936 Part IVA

Income Tax Assessment Act 1936 section 177A

Income Tax Assessment Act 1936 section 177C

Income Tax Assessment Act 1936 section 177D

Income Tax Assessment Act 1936 section 177F

Income Tax Assessment Act 1936 section 177G

Superannuation Industry (Supervision) Act 1993 section 42A

Superannuation Industry (Supervision) Act 1993 section 52

Superannuation Industry (Supervision) Act 1993 section 62

Superannuation Industry (Supervision) Act 1993 section 66

Income Tax Assessment Act 1997 section 295-545

Income Tax Assessment Act 1997 section 295-550

We followed these ATO view documents

Law Administration Practice Statement PSLA 2005/24 Application of General Anti-Avoidance Rules

SMSFR 2008/2 Self Managed Superannuation Funds: the application of the sole purpose test in section 62 of the SISA to the provision of benefits other than retirement, employment termination or death benefits

Case law

Federal Commissioner of Taxation v. Peabody (1994) 181 CLR 359 at 385; 123 ALR 451 at 461; 94 ATC 4663 at 4671; 28 ATR 344 at 353

Federal Commissioner of Taxation v. Ashwick (Qld) No. 127 Pty Ltd & ors [2011] FCAFC 49; 2011 ATC 20-255 at [153]