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Self Managed Super Fund (SMSF) Article
Draft ATO Ruling on Sole Purpose Test

By Tony Negline.

This article may be out of date.

19th September 2007

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One widely acknowledged advantage of using a Self Managed Super Fund is the potential to use the fund’s assets for personal or business purposes.

Investors who use their SMSF in this way receive a material benefit, such as leasing real property.  A benefit can also be emotional, such as purchasing a favourite artist’s work and displaying it in a room.

The super rules contain the sole purpose test (SPT) which says that a super fund must at all times only exist to meet certain core purposes such as providing retirement benefits to members.  The SPT also has some ancillary purposes which super funds can also meet if they want.

Over the last 30 years various forms of the SPT have been used to control super fund activities.  The current variation of this rule has been around since 1994.  Unfortunately there is little judicial interpretation on what the SPT means at a practical level.

To help anyone involved with SMSFs understand how to apply the SPT to a fund, the Australian Tax Office issued a draft Self Managed Superannuation Fund Ruling a few weeks ago.  The draft ruling is available from the ATO’s legal database ( and is well worth a read.

The ATO’s draft ruling points out that a breach of the SPT can only be determined by looking closely at all the events and circumstances of a fund during its “life cycle”.  The ATO interprets a SMSF life cycle as covering accepting contributions, investing money, administering the fund and paying benefits.

The ATO says that compliance with the SPT can only be determined by looking at how an SMSF trustee made its decisions.  This is an interesting point because the law requires trustees to record their decisions but does not require them to say how they reached these decisions.

It is a long standing legal principle that trustees of any trust instrument do not have to reveal how they reached a particular conclusion.  Once a trustee formally records why they made a decision, their process can be tested, examined and reviewed.  Some lawyers say that trustees should never do this as it reduces the chance of the trustees decisions being overturned by a Court because the judiciary found the trustee’s decision-making process was flawed.

Each year an external auditor must examine an SMSF to check that its financial records are accurate and also to confirm that the fund has complied with all the super laws including the sole purpose test.  How is an auditor or the ATO meant to determine compliance with the SPT if they do not have any background documentation?

The SPT is a strict test which “requires exclusivity of purpose”.  This is a higher standard than a dominant or principal purpose.  Investment activities are particularly relevant when determining whether a SMSF has complied with the SPT.  The ATO believes that the superannuation fund tax concessions are not a factor in working out if a fund satisfies the SPT.

Let’s looks at some examples.  The ABC SMSF owns business premises which are leased to the members business.  How did the trustee decide to purchase these premises?  These decisions are hardly ever made in isolation.  Often the super fund is selected as the best place within a family and corporate structure to hold these types of assets even if it may not be the best investment for the super fund.  Have the trustees satisfied the sole purpose test if the fund has purchased the property from the member or from the business and the main reason for the transaction is to provide the former owner with cash flow?

The ATO’s draft ruling makes two important points.  Firstly the facts and circumstances of a particular investment or other activity will often be peculiar to a SMSF.  Just because two funds perform the same transaction does not mean both funds will be deemed to comply with the SPT.  Secondly a benefit obtained by the fund members is not incidental where “it is one of the objects or purposes of the trustee to provide that benefit.  The question of whether a benefit is incidental and not purposeful is discerned from an objective consideration of all the facts and considerations.”

Another example involves an SMSF which owns a house which is the fund’s only asset.  For many years the fund has received no rent.  There is no 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.  In all likelihood the fund members are obtaining a benefit from this fund which breaches the sole purpose test.

SMSF trustees whilst discharging their duties need to think carefully about how they might be able to demonstrate compliance with the SPT especially if their current documentation is scratchy and some of the funds assets are being used by members.  The ATO new SMSF trustees to declare that they understand it is their responsibility to ensure the fund complies with the SPT.

Some trustees will seek advice from their advisers including their fund’s auditor who should detail what they use determine fund compliance with the sole purpose test.

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