The tax office treats discretionary trust distributions to SMSFs as non-arm’s length income (NALI), which is taxed at the highest marginal rate and recorded at label U2 of the SMSF’s annual return, Mr Butler explained.

“SMSFs will receive an ATO letter asking them to contact the trustee of the distributing trust and review the trust deed and any resolutions to determine whether the amount reported in the annual return is NALI. Based on the review, either an amendment will need to be lodged or a different letter should be used in the CODE box at label 11M of the SMSF annual return,” Mr Butler said.

While many practitioners and trustees are aware of the law relating to discretionary trust distributions, Mr Butler believes problems are arising due to the incorrect completion of tax returns.

“You can know the law, but filling out the boxes to the tax return is like a real science in itself,” Mr Butler said.

Practitioners should be aware both of the law and of the ATO’s increased focus on this area to avoid severe tax implications for clients, he added.

“They also need to look at trust deeds, because a lot of unit trusts are not fixed and therefore they are at risk of being considered NALI,” Mr Butler said.

“Unless you are strictly a fixed trust, you still may technically have a risk under NALI.”