Avoid your self-managed superannuation fund being taxed at the top tax rate

It is easy to forget that income of a superannuation fund can be taxed at the top tax rate, even if the fund is in pension phase.

Beware the non-arm’s length income rules!

Income earned by the trustee of a superannuation fund will be non-arm’s length income (formerly special income) if it is:

(a) a trust distribution and the superannuation fund does not have a ‘fixed entitlement’ to the income and capital of the trust; or

(b) as a result of a non-arm’s length dealing and the income is higher than what the income would have been had the arrangement been at arm’s length.

These rules have recently been considered by the Full Court of the Federal Court in the case of Allen (Trustee), in the matter of Allen’s Asphalt Staff Superannuation Fund v Commissioner of Taxation [2011] FCAFC 118, in which the ATO’s assessment of income as special income was upheld.

In this case, a distribution of $2,500,000 was made:

(a) firstly from a hybrid trust to a fixed trust; and then

(b) from the fixed trust to the self-managed superannuation fund (which had a “fixed entitlement” to the income and capital of the fixed trust).

The Full Court of the Federal Court confirmed that the steps undertaken by the trustee (Allen) in directing the trustee of the hybrid trust, the trustee of the fixed trust and the trustee of the superannuation fund resulted in the fund receiving the distribution in question. The Full Court determined that this could be ‘readily seen to be the consequence of an “arrangement” to which the various trustees were parties’. That arrangement led to a non-arm’s length dealing.

The Full Court found this was the case even though the trustee of the fund:

(a) may be a passive participant in the arrangement or dealing;

(b) had no direct involvement in the non-arm’s length dealing.

As a result of the arrangement being non-arm’s length, the Full Court upheld the ATO’s decision to tax the distribution to the superannuation fund at top tax rates instead of 15%. The Full Court did accept the taxpayer’s argument was reasonably arguable, so allowed their appeal on penalties.

The decision reinforces the need to take care when structuring dealings involving a self-managed superannuation fund and particularly ensuring all arrangements can be justified on arm’s length terms, even where the fund obtains only an indirect benefit.

For further information regarding superannuation please contact Scott Hay-Bartlem via 3231 2458 or email [email protected] or contact Kylie Wilson via 3231 2945 or email [email protected].