The ATO has recently issued Taxpayer Alert, TA 2016/6 that highlights their concerns with individuals looking to divert personal services income (PSI) to a self-managed super fund. The taxpayer alert describes the following type of arrangement below where individuals, who are also members of a SMSF purport to divert income from their personal services to a SMSF to either minimise or avoid tax on their income.
Let take a look at the diagram using the following example…
Example – TA 2016/6
Nigel (64) currently derives 90% of his income through a contract to utilise his labour and expertise as an engineer. This income is typically paid to his company and is classified as PSI.
Nigel performs the services for X Co (client), however he does not directly receive any (or adequate) consideration for the services he has provided. X Co does not pay or remit any payment to Nigel directly or his company. Rather, the client remits the consideration for Nigel’s services to another entity.
This entity then makes a distribution of that income to his SMSF, purportedly as investment income (return on investment). As a result, the income derived by the super fund is concessionally taxed at 15% or where the member is in receipt of an income stream, as exempt current pension income (taxed at 0%).
The taxpayer alert highlights the ATO’s concern with the arrangement, in particular the intention of Nigel to avoid paying tax at his marginal tax rate. It appears only to be entered into in an attempt to divert the personal services income to the SMSF, where it will be concessionally taxed or exempt from tax.
The ATO considers that:
- the arrangement may be ineffective at alienating income and would remain assessable to Nigel under section 6-5 of the ITAA 1997;
- the income may be included in his assessable income as PSI under Part 2-42 of the ITAA 1997;
- the amounts received by the SMSF may constitute non-arm’s length income of the fund under s.295-550 of the ITAA 1997, such that the income is not eligible to be concessionally taxed and is not exempt current pension income;
- the general anti-avoidance rules in Part IVA may apply to cancel tax benefits obtained by the individual
It has also be highlighted that several other compliance issues may be impacted by such an arrangement, including:
- the amounts received by the SMSF may be deemed as a contribution and subject to the contribution caps which may result in excess contributions; and/or
- whether the SMSF is being maintains for purposes other than those set out in s.62 of the SIS Act (Sole purpose test). Such a breach may lead to the fund being made non-complying or disqualification of one or more trustees.
The ATO is currently reviewing a number of cases involving arrangements similar to those outlined above (including some variations where the income is distributed via written or oral agreement, rather than as a return on investment and where the income may come through more than one entity or distributed to more than one SMSF).
It is important to remember than penalties may apply to participants and promoters of this type of arrangement, including serious penalties under Division 290 of Schedule 1 to the Taxation Administration Act 1953 for promoters. Registered tax agents involved in the promotion of this type of arrangement may be referred to the Tax Practitioners Board to consider whether there has been a breach of the Tax Agent Services Act 2009.
For further information, see Taxpayer Alert TA 2016/6.
Join Aaron for his upcoming webinar on how the Commissioner applies the non-arm’s length income (NALI) provisions to various SMSF arrangements and meeting the requirements of arm’s length dealings.