Trust fund distributions to SMSFs - ATO on the prowl

It seems that the ATO is currently undertaking a review of SMSFs who have received trust distributions.  

From the perspective of super funds, trusts are either fixed entitlement trusts or non-fixed entitlement trusts.  

Trust fund distributions from the former type of trusts will prima facie be taxed as NALI income (ie 47% and irrespective of whether the super fund is in pension or accumulation phase).  However, there is an exception.  If the interest in the trust of the super fund was acquired on an arm’s length basis or the amount of the distribution is not greater than would have been the case if the super fund and the trust were dealing on an arm’s length basis, the trust distribution will be taxed as normal income of the super fund.  Typically this exception will apply to listed trusts and large commercial trusts (eg cash management trusts).  

Trust distributions from the latter type of trusts will always be taxed as NALI income.  The typical example of a non-fixed entitlement trust is a discretionary trust.

Where a super fund receives a distribution from a trust which is either listed or a large unlisted unit trust (ie where the super fund has no control over the trust and the super fund is treated as any other investor in the trust) then the exception will apply and that trust distributions will be treated as normal income in the hands of the super fund.

The problem is that most unit trusts (apart from listed trusts or large commercial unlisted trusts – where the issue does not arise) will fall within the category of “non-fixed entitlement trusts” because the trust instruction contains provisions permitting the trustee to accumulate income, to issue units on special terms and with different rights.  While listed trusts and large commercial unlisted trusts may, strictly speaking not be fixed entitlement trusts, this does not matter as such trusts will fall within the exception.

Super fund trustees must correctly report their income on the Annual Fund Return.   Where income has been incorrectly reported in previous financial years, amended fund returns should be lodged.

Going forward, super funds which have investments in unit trusts (other than listed or large commercial trusts) should review the terms of the unit trusts and, if necessary, to amend the terms to convert the unit trust into a fixed entitlement trust.  Additionally, the circumstances surrounding and relating to the acquisition of the trust interest by the super fund must also be reviewed to determine whether the “arm’s length requirement” has been or can be satisfied.