SMSF practitioners and trustees involved in property development projects should adopt simple guidelines to determine if any arrangement is on commercial terms and prevent potential compliance breaches related to non-arm’s-length income (NALI).
DBA Lawyers special counsel Bryce Figot stressed the importance of SMSF advisers conducting a straightforward test with their clients to ensure compliance following the release of ATO Taxpayer Alert (TA) 2023/2.
“Whenever someone says something is arm’s length or market value, I always ask them the following: ‘Would you sell it to me for that price or even [at a] slightly higher price?’” Figot told attendees at a recent DBA special webinar examining the implications of TA 2023/2.
“That is one handy rule of thumb because [property development cases] have to pass, on the first instance, the smell test and then you’ve got to properly document it.
“Everything has to be consistent with an arm’s-length dealing or else you could have big non-arm’s-length income problems as we know from the taxpayer alert with not just things that happen at the SMSF level, but all the way throughout the food chain.
“For ethical reasons, exercise extreme caution when contracting with a client. Don’t buy things from clients unless you are aware of the fiduciary obligation minefield that you are entering.”
As part of his guidelines, Figot also said advisers should carefully document the actual cash flows related to the project and examine them on behalf of clients in regards to NALI.
“Consider all the cash flows associated with the project – do they look consistent with an arm’s-length dealing?” he said.
He gave an example of a leading case to illustrate this point, in which a newly established company had issued shares and dividends to trustees on a non-arm’s-length basis.
“There was a brand-new company, Incorporated B Holdings, and a super fund acquired 200 shares at $200,” he said.
“A year later, it declares its first dividend, which is a bit shy of $1 million including franking credits. Another year later, it declares another dividend of $1.5 million including franking credits.
“In less than four years, a $200 investment returned over $2.5 million. Do you want to take a guess if those facts were held to give rise to NALI? Of course they were.
“So that’s another handy rule of thumb. Of course, you may not know the exact cash flows, precision is an impossibility, but say to the client: ‘Give me a rough feel [of the cash flows of the project].’
“What are the actual cash flows you’re expecting? If it’s something really dramatic [like the previous case], you can put the client on notice that they’ve probably got an issue to say the least.”