SMSFs that have invested in a unit trust in which the cost of units has remained static despite changes to the value of the underlying asset are likely to have exposed themselves to a breach of the non-arm’s-length income (NALI) provisions, DBA Lawyers director Dan Butler has noted.
Butler said there have been cases where unit trusts have been issuing units for $1 for the entirety of their existence, despite changes in market value, raising concerns about what this means under tax law.
“Let’s say there’s been an increase in the market value. Would you consider if the unit trust has been issuing units for $1 and the [value of] property underneath has increased, would that give you cause for concern? Would you consider that to be NALI?” he said during a recent presentation by his firm.
“That is likely to be the case because if people were dealing at arm’s length, they would generally look at the net tangible assets divided by number of units [to ascertain their value].
“Where units are issued below market value, the parties were not dealing at arm’s length and the market value is likely to be substituted under the market value substitution rules, as per section 112-20 for the cost base or section 116-30 for the sale proceeds of the Income Tax Assessment Act 1997.
“So while the market value substitution rule kicks in, the fact is you bought them below market value and that substitution doesn’t mean they’re not tainted with NALI.”
He noted further details may show this is not the case or may highlight other breaches of the NALI provisions.
“Obviously, you do have to read the deed as there could be other factors at play and not everything is a net tangible asset, particularly if there is a business involved and there is goodwill,” he added.
“However, if there is a business and goodwill, there is a heightened NALI risk you need to consider if members are involved in the business and whether they are being paid correctly, which may determine whether there is NALI.”
