Non-arms length income (special income)

The taxation benefits of having money in super are numerous. As a result, the laws governing superannuation are many and sometimes complex. In addition to the overriding sole purpose test, that being superannuation must only be used for retirement benefits, there is a part of the tax legislation aimed at those who try to divert regular taxable income into a superannuation fund.

Under Section 273 of the Income Tax Assessment Act, income diverted into a super fund is classed as non-arm's length income or special income and is taxed at 47 per cent in the fund, and not at the regular 15 per cent super fund rate. The four types of income caught by this section are:

• dividends paid by a private company
• income received from a non-fixed trust as a beneficiary
• income from transactions not at arm's length
• non-arm's length income from a unit trust.

Non-arm's length income is income that has not been earned at commercial rates. For example, where a super fund owns an investment such as a business property leased to a member of the fund, if the income received by the super fund is non-commercial and excessive it will be classed as special income.

Once income is classed as non-arm's length or special, the total amount received is special and not just the excess that was not commercial. For example, a super fund owns an office that is rented to the husband and wife members of the fund. If the commercial rent for an office in that area is $20,000 a year, and the rent received by the super fund is $35,000 a year, the whole of the $35,000 in rent would be taxed at 47 per cent and not just the excess $15,000.

Under Section 273, a super fund is effectively banned from receiving income from a non-fixed trust such as a family discretionary trust. But under certain circumstances the ATO can class private company dividends as not being non-arm's length or special income.

The sorts of factors taken into account to not class private company dividends as non-arm's length special income include:

• if the super fund does not have a controlling interest and the other shares are owned by unrelated parties
• the investments in the company had been purchased at market value
• the investment or income earned by the company was at market rates
• the dividends are paid at a market rate.

Another exemption to having income classed as non-arm's length or special is when the investment is within the 5 per cent in-house exemption limit. Under this exemption a super fund can hold up to 5 per cent of its total value as in-house assets.

In-house assets include loans to members, leases provided to businesses operated by members and works of art displayed in the business or private premises of the members.

Thus where a super fund derives non-arm's length or special income from a private company, where the value of those shares makes up less than 5 per cent of the total value of the fund, the income would be taxed at 15 per cent and not 45 per cent. The value used for all assets in the fund is the market value and not the cost value.