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I am auditing a SMSF which has 90% of the fund investment in private company. The shareholders of the private company are the SMSF 50% and the SMSF members 25% each, with the members as the directors. Which means the SMSF has control.
The private company owns 2 properties, depreciable assets and has a mortgage in the financials. In 2021 and in 2022 the private company paid franked dividends to the shareholders. The shares in the private company were not purchased at market value. The only upside is that the shares held in the private company are at market value in the SMSF.
The SMSF Deed was amended in 2007 permits investment in private company if its in the investment strategy. The investment strategy provided was signed in 2020 and the asset allocation does not mention investing in private company.
Both members in the SMSF are in pension phase.
1. Private company dividends - does the SMSF lose the exempt pension income on the dividend and the fund pays 45%?
2. Does the SMSF lose the franking credit on the dividend?
3. If the shares were purchased at market value would that change the status of the payment of dividends from special income to dividends and taxed normal?
Contraventions - in-house asset, sole purpose and NALI?
Hi Wafaa
Thanks.
I assume the investment was made by the fund post 11 August 1999 when the in-house asset (IHA) rules were amended.
Yes if a SMSF invests in a related party (that is an in-house asset) then yes if the asset is greater than 5% of the Fund's assets there will be a breach of section 82 - 85 if SIS.
(Please note section 82 requires that if 5% limit is breached that the IHA must be reduced to below this limit by the end of the following year)
If the shares were not acquired at market value there would be a breach of section 109 of SIS (arm's length) & section 62 of SIS (sole purpose).
There would also likely be a breach of section 66 of SIS if the shares were acquired from a related party (assuming no exceptions existed eg 13.22C & 13.22D "ungeared" trust / company).
If the investment did not comply with the investment strategy there would be a breach of SIS Regulation 4.09.
If the shares were not acquired at market value then the dividends & franking credits (& any capital gains on sale) from the company would be excluded from ECPI and be taxed at 45% as non-arm's length income.
For further guidance refer:
https://www.ato.gov.au/law/view/document?DocID=TPA/TA20232/NAT/ATO/00001
The Fund should still receive the franking credits on the dividends although there is a risk that the ATO could make a determination re these.
If the shares were acquired on an arm's length basis then the dividends would not be treated as NALI. The Fund would still have the breach of the in-house asset rules.
Thanks
SMSF AAA