Edited version of private advice

Authorisation Number: 1052075245751

Date of advice: 13 January 2023

Ruling

Subject: Non-arm's length income

Question 1

Will a distribution of capital made by a discretionary trust (the Trust) to a self-managed superannuation fund (the Fund) be non-arm's length income under section 295-550 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer 1

Yes, if a capital gain is included in the Fund's assessable income under Subdivision 115-C of the ITAA 1997 as a result of a distribution, that statutory income will be non-arm's length income under section 295-550 of the ITAA 1997.

Question 2

Will a distribution of discretionary trust income which includes a component of dividends with franking credits attached, made by the Trust to the Fund, be non-arm's length income under section 295-550 of the ITAA 1997? Is the amount of the non-arm's length income the grossed-up amount?

Answer 2

Yes

This ruling applies for the following period:

Year ending 30 June 20XX

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

The Trust holds investments including property, listed securities and cash. The Trust is a discretionary trust.

The Trustees are contemplating making a distribution of trust income or capital to The Fund for the year ending 30 June 20XX.

As a result, it is expected that the Fund will need to include in its assessable income its share of any franked dividends (including grossing-up for franking credits) under Subdivision 207-B of the ITAA 1997; capital gains under Subdivision 115-C of the ITAA 1997 and its share of the Trust's net income (as calculated under Division 6 of Part III of the Income Tax Assessment Act 1936).

Reason for decision

Question 1

Summary

If a capital gain is included in the Fund's assessable income under Subdivision 115-C of the ITAA 1997 as a result of a trust distribution from The Trust, that statutory income will be non-arm's length income of the Fund in accordance with subsection 295-550(4).

Detailed reasoning

The phrase 'non-arm's length income' has the meaning given by section 295-550 of the ITAA 1997.

In accordance with subsection 295-550(4) of the ITAA 1997, income derived by the entity as a beneficiary of a trust, other than because of holding a fixed entitlement to the income, is non-arm's length income of the entity.

Taxation Ruling TR 2006/7 Income tax: special income derived by a complying superannuation fund, complying approved deposit fund or pooled superannuation trust in relation to a year of income (TR 2006/7) explains what amounts are considered to be 'special income' under former section 273 of the Income Tax Assessment Act 1936 (ITAA 1936).

In accordance with paragraph 10 of TR 2006/7, the word 'income' in section 273 is to be interpreted widely. It can include both income according to ordinary concepts and amounts included in assessable income under a statutory provision.

Section 273 of the ITAA 1936 was repealed with effect from 1 July 2007. Section 273 has been re-written, with some modifications in section 295-550 of the ITAA 1997. TR 2006 paragraph 1A explains that, to the extent that section 295-550 expresses the same ideas as section 273 of the ITAA 1936 this ruling is also taken to be a ruling about section 295-550.

Paragraph 1C of TR 2006/7 continues that, section 295-550 of the ITAA 1997 refers to the income covered by it as 'non-arm's length income'. To the extent that TR 2006/7 addresses issues in section 295-550 that are the same as were in section 273 the references to 'special income' should be read as 'non-arm's length income'.

This is consistent with, section 357-85 in Schedule 1 to the Taxation Administration Act 1953 (TAA) which provides that a ruling about a relevant provision (the 'old' provision) that is re-enacted or remade (the 'new' provision) is taken also to be a ruling about the new provision in so far as the new provision expresses the same idea as the old provision.

Therefore, although this ruling is primarily concerned with former section 273 of the ITAA 1936, it 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 under subsection 295-550(4) of the ITAA 1997.

Paragraphs 143 to 153 of TR 2006/7 set out the explanation supporting the Commissioner's interpretation of 'income'.

Additionally, although it does not form part of the public binding ruling, Appendix 2 paragraph 211-215 of TR 2006/7 further explains that an alternative interpretation of the word 'income' for the purposes of section 273 of the ITAA 1936 that only includes ordinary income is not supported by the Commissioner.

The Full Federal Court decision in Allen v Federal Commissioner of Taxation[1] (Allen) concerned a distribution from a related fixed trust to a superannuation fund. The related fixed trust had itself been entitled to a distribution from a hybrid trust that had made a capital gain on the sale of an asset. Thus, the distribution from the fixed trust to the superannuation fund was referrable to a capital gain made by the hybrid trust that had flowed via the fixed trust to the superannuation fund. A capital gain was properly included in the assessable income of the SMSF. The Full Federal Court considered the term 'income derived' as used in former subsection 273(7) of the ITAA 1936 which is equivalent to section 295-550(5) of the ITAA 1997. The Full Federal Courtheld that income for the purposes of former section 273(7) of the ITAA 1936 referred to assessable income, and therefore, included income according to ordinary concepts under section 6-5 and statutory income under section 6-10 of the ITAA 1997 (e.g. including capital gains). Accordingly, the capital gain that was included in the superannuation fund's assessable income due to the trust distribution was treated as special income.

The taxpayer's application for special leave to appeal to the High Court was refused. In respect of the question of whether 'income' used in the provision was confined to income according to ordinary concepts, French CJ observed that '[t]he Full Court adopted the construction which it did by reference to both purpose and context. In so doing, in our opinion, it applied correct principle.' [2012] HCA Trans 25.

Consequently, we don't agree with the alternative view of 'Income' as discussed in your ruling application. The Commissioner is of the view that 'income derived' for the purposes of subsection 295-550(4) of the ITAA 1997, includes capital gains as capital gains are considered to be statutory income under section 6-10.

Therefore, any capital derived by the Fund from the Trust will be non-arm's length income of the Fund in accordance with subsection 295-550(4) of the ITAA 1997.

Question 2

Summary

A distribution of discretionary trust income which includes a component of dividends with franking credits attached, made by the Trust to the Fund, will be non-arm's length income of the Fund in accordance with subsection 295-550(4) of the ITAA 1997. The taxable amount of non-arm's length income is the distribution grossed up by the amount of the franking credit.

Detailed reasoning

For the reasons discussed above, a distribution of discretionary trust income which includes a component of dividends with franking credits attached, made by the Trust to the Fund, will be non-arm's length income of the Fund in accordance with subsection 295-550(4) of the ITAA 1997.

The rules regarding the effect of receiving a franked distribution are in Division 207 of the ITAA 1997. Broadly, Australian resident individuals, complying superannuation funds and certain trusts that directly or indirectly (under Subdivision 207-B) receive a franked distribution must include the amount of the franking credit and distribution in their assessable income.

Therefore, the taxable amount of the non-arm's length income received from the Trust by the Fund is the distribution grossed up by the amount of the franking credit.

Relevant legislative provisions

Income Tax Assessment Act 1936 section 273

Income Tax Assessment Act 1997 Division 207

Income Tax Assessment Act 1997 Subdivision 207-B

Income Tax Assessment Act 1997 section 295-550

Income Tax Assessment Act 1997 subsection 295-550(4)

Taxation Administration Act 1953 section 357-85

ATO view documents

Taxation Ruling TR 2006/7 Income tax: special income derived by a complying superannuation fund, complying approved deposit fund or pooled superannuation trust in relation to a year of income.

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