He said the case of GYBW v FC of T (21 October 2019) illustrates how NALI taxed at the highest marginal rate can arise in an SMSF.

In this case, an SMSF bought 200 shares (20 per cent) in Company A for $200, in which a business associate of the SMSF members owned the other 800 shares. At the time, Company A had no assets other than what the shareholders paid for the shares.

As Company A had no assets, the SMSF’s acquisition was at market value. It then bought all the shares in Company B from the other shareholder in Company A for less than market value, while Company B carried on a business.

“Company B carried on a business that was so successful that, over the next four years, the SMSF received nearly $1.8 million in dividends due to its activities which is not a bad return on a $200 investment and is what caught the eye of the tax office,” Mr Busoli said.

The crux of the case centred on whether the dividends received by the SMSF from Company A were NALI.

In this instance, the AAT decided that although the SMSF bought the shares in Company A at market value, Company A had entered into a non-arm’s length transaction when it bought the shares in Company B.

As a result, the dividends received by the SMSF from Company A were NALI.

The AAT confirmed it is not just the direct involvement of the relevant SMSF, but the totality of the arrangement in determining whether NALI applies.

Mr Busoli explained that the ATO looks at the totality of the arrangement, not just the initial step when deciding on whether an arrangement breaches the NALI regulations.

“SMSFs are highly flexible entities that can take advantage of investment opportunities in speculative unlisted entities which may return unrealistic returns,” Ms Busoli said.

“It’s important to be able to justify each transaction, something which was difficult to do for GYBW whose member, previously the accountant for the business associate with the other 800 shares in Company A, retired to become the chief financial officer of Company B.”

Ultimately, this case illustrates that SMSFs should be wary of investment in private companies generally as it carries the suspicion that the investment is an opportunity to shift income from a higher-taxed entity to a concessionally taxed SMSF.

Subsequently, SMSF trustees looking to sustain concessional tax treatment need to adequately document their dealings with, and investment in, private companies so the arm’s length character of the investment can be verified and independent valuation supporting consistency with arm’s length dealing sought.