ATO warns investors about illegal SMSF rental property scheme

The ATO is warning investors about a tax avoidance scheme where they are encouraged to borrow funds to invest in a trust that buys a rental property and are then told they can claim the borrowings as a tax deduction.

In such a scheme a self-managed superannuation fund (SMSF) derives income through a direct or indirect interest in the trust.

“In this arrangement a promoter encourages you to borrow funds to invest in a trust which has, as one of its beneficiaries, an SMSF. The trust uses the funds to buy a rental property.

“You then claim all of the borrowing costs as income tax deductions. However, some of the income from the investment is distributed to the SMSF.

“This arrangement is considered to be a scheme because you are claiming deductions for all of the interest expenses on the borrowing but the borrowing has also been used to derive income for other beneficiaries of the trust such as an SMSF which is ordinarily taxed at the concessional rate.

“However, as the income distribution from the trust to the SMSF may be considered non arm's-length income, it may in fact be taxable at a higher rate,” says the ATO.

The ATO provides a more detailed explanation of this scheme in a 2008 taxpayer alert.

The warning is part of a new guide issued by the ATO called Investigating tax-effective arrangements, which aims to help borrowers “recognise some of the common types of tax avoidance schemes so you can reject them and avoid the negative consequences associated with them”.

The ATO is also warning on two home loan tax avoidance schemes.

The guide can be viewed online or downloaded as a PDF document.