In a recent Administrative Appeals Tribunal decision, a corporate SMSF trustee successfully appealed an ATO determination that interest paid to the SMSF on private loan arrangements was non-arm's length income (NALI) and therefore not exempt current pension income of the SMSF. The ATO had imposed penalties and issued amended assessments for the relevant years.
This case shows that proving that while it is difficult to overturn an ATO determination in relation to NALI is not impossible. The SMSF's evidence from independent experts, genuine commercial explanations for the SMSF's structure and investments, and practices of having engaged accountants to act for the relevant entities were important in establishing the validity of arm's-length dealings.Georgina Adair & Jack Curran, Maddocks Lawyers
The Applicant was a corporate SMSF trustee which derived income as a unit holder in a unit trust (JJ Unit Trust) during the income years of 2015, 2016, and 2017 (Relevant Years).
The JJ Unit Trust loaned money to two related entities, ‘ABC’ and ‘DEF’ through a series of Loan Agreements: JJ Unit Trust loaned funds to ABC, which on-lent funds to DEF, and DEF in turn on-lent these funds to third parties.
The parties agreed to a written resolution (Funding Resolution) which set out:
The interest income which JJ Unit Trust derived from these loans was distributed to the SMSF as JJ Unit Trust’s sole unitholder, and the SMSF treated it as ‘exempt current pension income’ (ECPI). However, the Commissioner of Taxation as respondent (ATO) determined that this income was NALI and should not have been included as ECPI.
The primary issue was whether the relevant NALI provisions of the ITAA97 applied in respect of the distributions were made to the SMSF as the sole unitholder of JJ Unit Trust.
The ITAA97 provided that income derived by an entity 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 entity if:
The Tribunal set aside the ATO’s determination and allowed the SMSF’s objection to the ATO’s amended tax assessments for the Relevant Years. Deputy President Molloy was satisfied by the SMSF’s evidence that the scheme between the parties was consistent with the terms of arm’s length dealings.
Deputy President Molloy considered the following evidence which was provided in relation to the matter:
The ATO contended that because the same interest rate was applied to each of the loans, rather than ABC and DEF applying and keeping a margin , JJ Unit Trust derived more interest income under the scheme than it would have under a typical lending scenario.
Despite the ATO’s arguments, the Tribunal was satisfied from the Applicant’s witness testimony that the scheme established under the loan facilities did not differ from what might be expected between independent parties dealing with one another in the private lending market. Further, based on the SMSF’s submissions , Deputy President Molloy was satisfied that the income received by the Applicant during the Relevant Years was not NALI, and was no more than one might expect to derive when dealing at arm’s length.
SMSFs receiving sizeable income from related trusts should still expect scrutiny from the ATO, particularly where borrowing and lending is involved. However, this case provides guidance about what will be expected of an SMSF in attempts to evidence arms-length dealings in the context of private lending.
SMSFs can attempt to safeguard their dealings by:
More information from Maddocks
For more information or to find yourself a trusted legal advisor to engage, contact Maddocks on (03) 9288 3555 and ask to speak to a member of the Commercial Practice Group.
More Cleardocs information on related topics
You can read earlier ClearLaw articles on a range of topics including:
Order related document packages
Daniel is a Senior Associate in the Maddocks Tax & Revenue team.Daniel advises extensively in the following areas:
His advice covers both direct and indirect tax considerations.
Prior to joining Maddocks, Daniel worked at a Big Four Chartered Accounting Firm focusing on tax consulting for mergers and acquisitions.
The legal information and commentary on this site is general only. Documents ordered through Cleardocs affect the user's legal rights and liabilities. To assess their suitability for the user, legal accounting and financial advice must be obtained.