Speaking at a recent Tax Institute conference, Colonial First State head of technical services Craig Day said it is important to be aware that the non-arm’s length income (NALI) provisions are broad enough to capture income derived from private companies or trusts where the company or trust entered into a non-arm’s length dealing and incurred a non-arm’s length expenditure (NALE).
“This [is because it results] in an SMSF deriving more income (via dividends or distributions) than it might have expected to receive had the company or trust dealt with the other party on arm’s length terms,” explained Mr Day at the Tax Institute’s NSW Tax Forum.
In SMSFRB 2020/1, Mr Day said the ATO outlines that dividends paid to an SMSF by a private company would be NALI where there are a series of non-arm’s length transactions occurring at the company level, including the company directors providing personal guarantees for loans taken out by the company.
Mr Day gave an example of two SMSFs that set up an unrelated company and invested their SMSFs into the company 50/50 each.
“They then go and borrow from a bank and buy a property and develop it. Very popular strategy over the last couple of years. Problem is that they’ve provided personal guarantees to the bank to get the loan for the company,” he said.
“What the regulator bulletin says is that provision of guarantees results in non-arm’s length expenses, because the income coming out of the company is higher than it otherwise should be because you as members of the fund went and provided a personal guarantee. Without that personal guarantee, the company wouldn’t have gotten the loan and therefore couldn’t have undertaken the investment and there would be no dividends coming out.
“Therefore, something is more than nothing which triggers non-arm’s length income, do be careful with that.”
Mr Day said this is interesting given that the provision of personal guarantees is expected by banks and is absolutely market.
“I think there’s more to come out of this. We have to wait and see. The argument that I’ve seen waged against the ATO is that no, this is a completely commercial arrangement. This is not something that is non-commercial. It is completely expected.
“However, if you are going to enter into that, go and get some advice before you go and do that, especially if it’s a large development because you don’t want that tainting all of the future income.”
I would have thought the personal Guarantees were given by the Directors of the Company as directors of the borrowing company, and not as members of the SMSF.
As structurally you would not have all the members of the SMSF as Directors of the Borrowing company, just one representative from each fund who are acting as Directors of the borrowing company, not as members