Investments in related unit trusts are a popular investment vehicle for many SMSFs. Often the focus of these investments is ensuring that the unit trust investment complies with a host of legislative requirements in the SIS Act such as: the in-house asset rules, sole purpose test and ensuring all investments are made and maintained on an arm’s length basis. Often overlooked by SMSFs is the need to also consider non-arms’s length income (NALI), when the fund has invested in a related trust.
Income that is considered to be NALI by the ATO will be taxed at a rate of 47%, compared to the superannuation concessional rate of 15%. NALI is likely to become an issue when:
– The fund acquires an investment not on an arm’s length basis; – The fund receives a disproportionate trust distribution or dividend in relation to other unitholders/shares; – There is disproportionate dividends between different classes of shares.
From an audit perspective, there is a possibility some sections of the SIS Act may have been contravened if the fund receives NALI. These sections include: section 62 (sole purpose test) and section 109 (investments to be made or maintained on an arm’s length basis). This could result in a Part B audit qualification and an auditor contravention report being lodged to the ATO.
An auditor may qualify Part A of the audit opinion if there is a material misstatement in the tax expense (due to NALI) and possibly notify the ATO of the matter, via the additional information question in the auditor contravention report. As it can be seen the implications for not conducting all transactions on an arm’s length basis can be severe.