Many self-managed superannuation funds utilise a Unit Trust as an investment vehicle. These may be either listed or unlisted Unit Trusts including those involving related parties. Certain Trust situations in the SMSF environment can frequently cause headaches for trustees, accountants and auditors alike, depending on the structure and date of the Trust. Make sure you get sound advice from a professional when establishing your fund and/or Trust as to whether the structure complies with the appropriate legislation.
An often overlooked issue with SMSFs and Trusts is the use of a Trust structure other than a fixed trust. To avoid income being classified as ‘non-arm’s length income’, the investment must be made via a fixed trust (provided all transactions are conducted at arm’s length and on commercial terms). ITAA 1997 Sec 295.550(4) states, “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.”
SMSF Trustees should ensure that, where their fund is a beneficiary of a trust, there is a fixed entitlement to the income from the Trust. A discretionary trust allows the Trustees to exercise their discretion on income distribution. A hybrid trust structure also provides some discretionary ability by a Trustee, and may thereby; have its distributed income classified as non arm’s length income. Taxation Ruling 2006/7 provides guidance on the Commissioner’s stance relating to amounts considered to be ‘special income’ under ITAA36 Sec 273, now ITAA97 Sec 295.550.
SMSF Trustees should be aware that the Income Tax Assessment Act also provides other areas where income is found to be non arm’s length income. This may relate to dividends from private companies where the dividend isn’t consistent with maintaining arm’s length dealings. Also be aware of any limited recourse borrowing arrangements that have been implemented with a zero interest loan in place.
As the terminology suggests, generally, where income is derived via a transaction where the parties have not acted at arm’s length or the income is more than what would have been derived had the parties been acting at arm’s length; it is non arm’s length income and taxed at the highest marginal rate of 47%. Make sure not to get caught out paying more tax than necessary because of the Trust structure and/or transactions not conducted at arm’s length.