Private company shares and superannuation funds – a timely reminder of the special income rules

The Tax Acts have long treated dividends paid from private companies to the trustees of superannuation funds as “special income”, which means they are taxed at the top marginal tax rate rather than the normal concessional rates for superannuation funds.

These special income provisions are often overlooked.

Prior to the introduction of simpler super rules, private company dividends were automatically special income unless the ATO otherwise determined the dividends were not special income (section 273).

Section 273 listed a number of factors to be taken into account (including “any other matters that the Commissioner considers relevant”).

From 1 July 2007, private company dividends are “non-arm’s length income” unless “the amount of the dividend and circumstances in which they are paid are consistent with an arm’s length dealing” (section 295-550).

An ATO determination is no longer necessary, but in determining whether the dividend satisfies the arm’s length criteria there are a number of factors to be taken into account, similar to the factors in the old section 273.

In a recent decision, the AAT upheld the ATO’s decision that dividends paid by a private company to the trustee of a self-managed superannuation fund were special income under section 273 ((FFWX and Commissioner of Taxation [2009] AATA 657)).

In the case:

• the trustee of the fund owned 4% and one member owned a further 6% of shares in a private company, which in turn owned a large majority interest in a listed public company;
• the trustee of the fund bought shares in the private company that had originally been offered to a member of the fund at what the AAT found to be only 10% of the value of the shares at that date;
• the trustee of the fund received the same dividend per share as the other shareholders, and
• the rate of the dividend was “unquestionably enormous” and more than the cost of the shares in each of the years in question.

The following factors were of particular importance to the decision:

• The size of the dividends received compared to the amount paid for the shares.
• The fact the price paid for the shares was only 10% of the market value of the shares at the time of acquisition.

The decision reinforces the need to be careful when the trustees of superannuation funds are considering investing in private companies.

If you have any queries regarding this alert, please contact a member of our team on 3231 2444.