ATO cracks down on SMSF tax scams targeting small business owners

By Rod Myer

The Australian Taxation Office is cracking down on “pot of gold” tax schemes that use self-managed super funds (SMSFs) to milk profits out of private companies or turn normal income into superannuation.

The ATO has lost patience with the practices and set up a project called Super Scheme Smart designed to warn off errant SMSF investors with an education program.

ATO assistant commissioner Scott Parkinson told The New Daily “people are being drawn in looking for a pot of gold. But you need to tread cautiously with schemes that seem too good to be true.”

The ATO is concerned that older taxpayers are being targeted by promotors. “We’ve recently seen an increase in the number of schemes that are designed specifically to target those approaching retirement,” said ATO deputy commissioner Michael Cranston.

The cohort targeted tends be people over 50 looking to put significant amounts of money into super, usually through SMSFs. They are also likely to be small business owners, self-funded retirees or property investors.

The arrangements the ATO is gunning for are highly contrived and complex, involve lots of paper shuffling and leave the taxpayer with a major tax benefits.

They typically fall into two types: schemes avoiding income tax on normal earnings and schemes designed to claw back tax already paid on dividends.

Schemes aimed at diverting income are the simpler of the two types and they work like this.

Here’s the deal

The taxpayer provides services to a client through their trade, business or profession. The client is then billed for the services through a company or trust entity.

When the entity receives payment, it directs the money into the individual’s SMSF. The SMSF trustee treats the payment as a return on an investment in the entity made by the SMSF.

The end result is income earned in the normal course of work, instead of being taxed at the person’s marginal rate, is taxed at the concessional rate, or not at all. The SMSF trustee treats the income as subject to tax at a concessional rate of 15c in the dollar, or, if the fund is in pension phase, at zero tax.

The arrangement is a sham as the SMSF has not invested in the trust or company, which is simply being used as a vehicle to turn taxable income into super.

Washing out dividends

This rort is even more complex and involves clawing back tax already paid on company profits.

A private company that has made profits and paid tax over the years is able to pay out any undistributed profits as fully franked dividends. Those fully franked dividends are assumed to have tax already paid on them at 30c in the dollar.

So the owners can choose to move the shares in the company into their SMSF. After a 45-day waiting period the company can pay out its undistributed profits as dividends which are paid into the SMSF.

If the SMSF is in pension mode, any income it receives is tax free. That entitles it to a refund of the unused franking credit offsets from the ATO.

That would mean the SMSF and its members get the 30c in the dollar tax already paid by the company on the dividends back in cash.

In a move reminiscent of the “Bottom of the Harbour” tax schemes of the 1980s, the company is often liquidated or deregistered after the dividends are paid out as it becomes worthless.

Parkinson said these arrangements were “a new and emerging risk and we’ll enforce the law in the area.”

Rod Myer is the editor of YourSuper for The New Daily, where this article was first published.