“Since then, the ATO has issued a draft DIS on this case dated 10 April 2024 requesting feedback by 10 May 2024. The ATO confirms that it will not appeal the decision,” he said.

This DIS outlines the ATO's response to this case, which concerns whether, under subsection 295-550(5) of the Income Tax Assessment Act 1997, the income derived by an SMSF was NALI.

In this case, the applicant, BPFN, was the trustee of an SMSF at all relevant times. BPFN was the sole unit holder of JJUT, a unit trust, having a fixed entitlement to distributions under the JJUT trust deed.

Through a series of loan agreements, JJUT lent funds to entity ABC, which then lent funds to DEF and DEF then on-lent to unrelated third parties.

BPFN, JJUT, ABC and DEF were related parties. The directing mind of each entity concerning these dealings was Mr J. This structure was determined by Mr J on advice from Mr B's firm (advisor and accountant for Mr J and his associated entities since 2000), with documents drafted by Mr C's firm (solicitor for Mr J).

DEF entered into several loan agreements with unrelated third parties. It was not in dispute in the proceedings that these loan agreements were on arm's length terms.

For each advance that DEF made to unrelated third parties, JJUT, ABC and DEF executed a funding resolution. The funding resolutions detailed:

• The loan amount, which was initially drawn down by ABC from JJUT, and subsequently by DEF from ABC.
• The interest rate to be applied on the loan to the third party, and thereby the minimum interest payable under the loans between DEF and ABC, and ABC and JJUT.
• The term of the loan.
• The security provided by the third party.

The funding resolutions also set out the fees or other considerations payable to ABC and DEF.

The terms of the loan agreements, through the funding resolutions, required each of JJUT, ABC and DEF to agree to the terms of the third-party loan (including the sharing of risk, the interest rate and fees charged) before any funds were advanced to the third party under the on-lending arrangement. ABC only drew down on the loan from JJUT when DEF drew down on its loan from ABC.

The tribunal determined that JJUT, ABC and DEF were not dealing with each other at arm's length. As Mr J controlled all the parties and was involved in all decision making, it could not be said that the dealings between the related parties resulted from real bargaining.

While deciding that there was no real bargaining, the tribunal concluded that BPFN had derived no more income than it would have derived had the parties been dealing with each other at arm's length.

The tribunal determined that the evidence established that:

1. The fees ABC charged were consistent with market rate fees charged by parties dealing at arm's length.
2. The scheme established under the private lending facility did not differ from what might be expected between independent parties dealing independently with one another in the private lending market at the time of the transactions.
3. The income derived was not 'more than the amount that the entity might have been expected to derive ... when dealing at arm's length' and, accordingly, that the interest income received by BPFN in the income years ended 30 June 2015, 2016 and 2017 was not NALI.

“In an interesting, but not surprising, approach, the ATO is happy to endorse the parts of the decision in its favour namely the width of the scheme and that there was non-arm’s length dealings, but tries to read down the adverse finding that the super fund did not derive more income than an arm’s length arrangement,” Wong said.

“In particular, the ATO notes:

“While noting the Tribunal's conclusion at [95], that JJUT (and presumably BPFN as sole unit holder) did not derive more income under this particular scheme based on the evidential findings made by the Tribunal, we would question whether this decision can be extrapolated to arrangements involving private lending arrangements more broadly.”

The ATO also said: “When considering the application of subsections 295-550(1) or (5) to a scheme involving private lending arrangements, it is necessary in each case to consider whether the terms, rates of return and other remuneration of the parties dealing with each other in relation to each step of the scheme are consistent with that which arm's length parties bargaining in their own self-interest would expect”.

Wong said according to the ATO, benchmarking evidence is necessary for the arrangement. However, the decision by the Board of Taxation Public Advice and Guidance Panel indicates that benchmarking is not strictly mandatory. Nevertheless, expert evidence regarding the commercial viability of the arrangement will likely be necessary if the case progresses to a Tribunal or court.