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Self Managed Super Fund (SMSF) Article
Single minded about the sole purpose test
By Tony Negline.
This article may be out of date.
2nd July 2008
One widely acknowledged advantage of using a Self Managed Super Fund is the potential to use the funds assets for personal or business reasons.
Most people who use their small super fund in this way receive a material benefit, such as leasing real property from the fund. A benefit can also be emotional, such as purchasing a favourite artist’s work and displaying it in a room.
When a Self Managed Super Fund provides any benefit to members or their relatives or associates, the trustees must be careful to ensure that the fund complies with a range of regulatory matters. One of the most important rules that small super fund trustees must continually strive to comply with is the sole purpose test.
It is quite common to see this test incorrectly described as requiring that a super fund can only exist to provide members with retirement benefits. This description unfortunately misses important nuances in the sole purpose test rule.
In reality there are two distinct parts to the sole purpose test. There are core purposes and ancillary purposes.
Core purposes can be summarized as follows:
- Provide retirement benefits for members upon retirement or after age 65
- Provide death benefits, if death occurs before retirement, to a member’s legal personal representative or the member’s dependants
Ancillary purposes can be summarized as follows:
- Provide benefits on termination of employment where a member’s employer (or associate) had contributed to the fund
- Provide benefits where a member ceases gainful employment due to physical or mental ill health
- Provide death benefits to a member’s legal personal representative or dependants if death occurs after retirement
- Any other purpose that the Regulator approves in writing
Self Managed Super Funds must satisfy at least one core purpose for every member of the fund. Ancillary purposes are optional however funds can satisfy as many of these as they wish for each member. A trustee does not have to provide the same types of core or ancillary purposes for (or in respect of) all members of the fund.
This means that a Self Managed Super Fund could have slightly different purposes for each member. For example it might be possible for one member to be entitled to retirement and death benefits and another member to be entitled to death benefits only. Where different members have different benefit entitlements this should be carefully noted and will have a flow on effect to every aspect of running the fund including the assets the trustee decides to purchase.
Can a small super fund be operated in such a way that one member receives a “core purpose” benefit and another member only receives an “ancillary purpose” benefit? No. Each member of the fund must “receive” at least one core purpose from the fund.
According to Australian Prudential Regulation Authority in its circular III.A.4, you can see what a super fund is trying to achieve by looking at how it is organised. “Contravention of the sole purpose test may arise where there is no retirement purpose behind an investment. It is not the type of investment which must be considered … but rather it is the purpose(s) for which the investment is made and maintained that is relevant to the [sole purpose] test.”
The tax office said in a draft ruling issued last year that a fund might breach the sole purpose test if the benefit obtained by the fund's members influenced the decision making of the trustee to favour one course of action over another. If the benefit provided places a super fund at a financial detriment then this might also cause problems.
When a SMSF is providing members with a benefit that might be seen as unacceptable level it may still be possible for a SMSF's trustee to argue that they have not breached the sole purpose test. They might be able to do this by demonstrating that they have satisfied all the super covenants. These covenants include creating and implementing an investment strategy, acting honestly at all times, acting in the best interests of beneficiaries, allowing all fund beneficiaries access relevant information and behaving at all times in a prudent manner.
It is still common to find small fund trustees who think they can do whatever they like. One example proves this point. Some years ago we heard about a Self Managed Super Fund which owns a house that at the time was the fund's only asset. For many years the fund had received no rent and was technically not formally rented out with a written lease agreement. The members adamantly deny they live in the house. Despite this all their personal correspondence is sent to the property and it is also their residence for electoral roll purposes. It is doubtful that this would not be seen as a breach of the sole purpose test.Each year a fund's auditor has to check to see that the sole purpose test is being met. If the breach is serious the auditor is meant to report this to the ATO.
Examples of core purposes:
Please note these examples are for one member of a fund.
- Wealth Accumulator
To build sufficient wealth to pay a pension upon retirement equivalent to 60% of pre-retirement earnings, from all sources including salary, wages and fringe benefits
Pay a mix of lump sum and pension benefits to dependants in the event of the death before retirement
Pay a mix of lump sum and pension benefits in the event of the member’s disablement
- Pre-retiree who is only going to receive a lump sum from the fund at retirement – ensure that benefits are maximized
- Retired Pensioner who will only receive an account based pension from the fund – pay the pension for as long as possible
- Child Pensioner – to pay a pension whilst they remain a minor and/or a full-time student under age 25
This email is general in nature only and does not constitute or convey specific or professional advice. Legislation changes may occur quickly. Formal advice should be sought before acting in any of the areas discussed. Be aware that the information in these articles may become innaccurate with time. Responsibility is disclaimed for any inaccuracies, errors or omissions. Particular investments are neither invited nor recommended and hence this publication is not "financial product advice" as defined in Section 766B of the above legislation. All expressions of opinion by contributors are published on the basis that they are not to be regarded as expressing the official opinion of any other person or entity unless expressly stated. No responsibility for the accuracy of the opinions or information contained in the contributor's articles is accepted by any other person or entity. Copyright: This publication is copyright. If you wish to reproduce this article you require a license, which can be purchased here, to do so.