Tuesday, June 4, 2024

SMSFs and non-arm’s length income: right here; right now**

View Legal blog - SMSFs and non-arm’s length income: right here; right now** by Matthew Burgess

One issue to remember with SMSFs is that any income derived by an SMSF as a beneficiary of a trust can be subject to penalty tax.

In particular, income earned other than through holding a fixed entitlement, is non-arm’s length income, and will be taxed according to the non-arm’s length income provisions of the Tax Act at a flat rate of 47%.

Income derived by a superannuation fund as a beneficiary of a fixed trust will also be non-arm’s length income if:
  1. the fund acquired the entitlement under a scheme, or the income was derived under a scheme, the parties to which were not dealing with each other at arm’s length; and
  2. the amount of the income is more than the amount that the fund might have been expected to derive if those parties had been dealing at arm’s length.
To avoid the impact of the non-arm’s length income rules, it is therefore vital for SMSFs to ensure that:
  1. no distributions are made to a SMSF from a discretionary trust; and
  2. where a SMSF owns units in a unit trust, the unit trust is a fixed trust for tax purposes.
From a planning perspective, given the Medicare and other surcharges, there may in fact be a saving on overall tax payable by triggering the non-arm’s length income rules by (for example) distributing from a family trust to a SMSF and capping the tax rate at 47%.

It is also relevant to note that the non-arm’s length income rules may apply where a SMSF allows its fixed entitlement to remain as an unpaid present entitlement, as this generally does not reflect an arm’s length arrangement.

When allowing unpaid present trust entitlements in favour of a SMSF, it is therefore necessary to ensure that interest on those unpaid distributions is paid by the trust at market rates as would be the case if the SMSF and trust were dealing with each other at arm’s length.

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** For the trainspotters, the title of today's post is riffed from the Fatboy Slim song 'right here, right now’.

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