The SMSF sole purpose test (SPT) is a principle central to the operation of a self-managed superannuation fund and must govern trustee decisions and actions. 

Deliberately or repeatedly ignoring the SPT could lead to civil and criminal penalties and the SMSF losing concessional tax treatment.

Trustees wanting to pass the sole purpose test would be wise to seek personal financial advice before making investment decisions.

The Sole Purpose of an SMSF

An SMSF can have only one purpose – providing retirement benefits to members (or their dependants after their death). 

The test requires “exclusivity of purpose”. Providing retirement benefits is not just the dominant or principal purpose of the SMSF. It is the only or sole purpose.

It follows then that if benefits go to anyone or anything else, the fund fails the sole purpose test.

The two main ways for trustees to fail the SPT are by providing

• Pre-retirement benefits to members
• Benefits to related parties

Providing Retirement Benefits to Members Before Retirement

Section 62 of the Superannuation Industry (Supervision) Act 1993 (SIS Act) spells out the rules of when and to whom the SMSF can make payments.  

Core and Ancillary Purposes

The core purposes of an SMSF are to

• Pay members when they have retired or reached the age specified in the regulations. (Ages are given in the ATO’s conditions of release.)
• Pay dependants and/or personal legal representatives (e.g., the executor of their will) if a member dies before that.

The ancillary purposes deal with payments to be made in circumstances that may happen:

• To pay members
  • If their employer terminates their employment, or 
  • For physical or mental health issues
• To pay dependants or personal legal representatives if
  • The  member dies after retirement or reaching the specified age
• To pay according to any other provision approved by the regulator (the ATO)

The SMSF’s trust deed may also contain conditions to be met before funds can be released. 

Granting a pre-retirement benefit to members can lead to the fund losing tax concessions.

Benefits To Related Parties

There are some exceptions, but the general rule is that the fund fails the SPT if a related party uses a fund asset or profits from an investment decision.

All SMSF members and trustees are related parties. So, too, are people, companies, and trusts closely related or associated with them. Even the employer of a member can be a related party.

How To Meet the Sole Purpose Test (SPT)

The sole purpose test is not like a one-off exam that needs to be passed. It is an all-encompassing tenet that must be part of every decision and action taken by SMSF trustees. 

The questions to be considered are

• Why an investment decision was made
• Whether SMSF funds were used for personal objectives or for the sole purpose of providing retirement benefits to SMSF members

It is not always easy to decide whether trustees meet the sole purpose requirements. 

• The ATO has provided guidelines and examples of what to look for in SMSFR 2008/2.  
• SMSF auditors are looking for signs that
  • Investment decisions were subjective, or the trustee negotiated and was swayed by potential personal gain or gain for a related party.
  • A benefit provided to a member or related party was at a cost to the fund.  
  • A pattern of events or activities leads to the conclusion that material benefit is being provided outside of the ancillary or core purposes.

There will be a breach if there is a collateral purpose – for example, acquiring a property with the purposeful intention to provide accommodation to a member, even if the property itself is a sound investment. 

Essential to the ATO guidelines is that there must be “objective consideration of all the facts and circumstances.” When two self-managed super funds seem to be taking the same action, specific circumstances may make one compliant and the other breach the sole purpose test.

Complementary Regulations to the SMSF Sole Purpose Test

There are rules in the SIS Act that complement the sole purpose test. 

They include:

• Not lending money or providing financial assistance to a member or related party, except as an in-house asset. In-house assets are
  • Loans to, or investment in, a related party
  • An investment in a related trust
  • An asset that is leased to a related party.

• Not acquiring assets from related parties, except if they are listed securities, business property, or in-house assets. 

• The value of in-house assets not exceeding 5% of the value of the fund.  

• Only borrowing through the limited recourse borrowing arrangement.

• Ensuring that financial transactions are at arm’s length, and prices reflect true market value.
  • This means no preferential treatment to a related party that would not apply to an independent third party. 
  • There should be no financial detriment to the fund from non-arm’s-length (NALI) dealings.

• Allowing members to use a binding death benefit nomination to nominate the beneficiaries of their death benefits.

The SMSF Sole Purpose Test in Practice

The following examples highlight some practical considerations of the SPT.

Lessons from the Aussiegolfa Case

The Aussiegolfa case arose from an SMSF investing in a company that provided housing units for student accommodation. After two non-related students had leased a unit, it was rented by a member’s daughter. 

A court found that this was a breach of the SPT. 

After a series of appeals, the full Federal Court ruled that it wasn’t, based on the findings that

• Providing accommodation to a related party had not been the intention at the time of the investment – and non-related tenants had leased it first.
• The daughter was paying the market-related price for the lease, so there was no financial benefit to the member or daughter and no financial detriment to the fund.
• The investment itself was prudent.

This case demonstrated the need to take an objective view of all the facts and circumstances.

Unfortunately for Aussiegolfa, the court also found that the deal was with a related trust, and the investment was an in-house asset. And it was worth more than 5% of the value of the fund. 

So Aussigolfa had to bring this value down within the next year or lose its concessional tax benefit.

Collectables and Personal-Asset Items

Super law allows SMSFs to invest in collectables and personal-asset items such as art, classic cars, wine, or antiques, subject to valuation, storage, and insurance regulations. 

However, 

• It would be a pre-retirement benefit if members used or had access to them. 
• Trustees must show that acquiring these assets was a reasonable investment decision, not unduly swayed by personal objectives.

SMSFR 2008/2 gives an example of a trustee selling listed securities (included in the SMSF’s investment strategy) to buy a work of art (not listed in the strategy and not recommended by an independent financial adviser). The trustee would be hard-pressed to explain why this was not a breach of the SMSF sole purpose test.

SPT and Property

Real property is included in some SMSF investment strategies. While other super funds can also invest in direct property, only SMSFs can decide to own a specific property or invest predominantly in property. 

There are some rules to take into account:

• An SMSF may not buy a residential property from a related party or lease it to them.
• This rule does not apply to commercial properties. 
• So, with some provisos, an SMSF can buy a member’s personal business property. The member then leases it and pays a market-related rental to the SMSF. 

This is all legal but, from a sole purpose point of view, trustees may have to justify how investing in that specific property contributed to the retirement benefit of all members. SMSF auditors might ask why the member did not, or could not, buy the property.

Incidental, Remote, or Insignificant Benefits

SMSFR 2008/2 acknowledges that benefits to members and related parties can be incidental, remote, or insignificant, arising out of legitimate activities and decisions of trustees. However, all the facts and circumstances must be considered, as shown in the SMSFR 2008/2 examples.

Example 1

An SMSF invests in a non-related company that owns holiday units at a resort where members regularly holiday and have a holiday home. The trustees negotiate to have free accommodation for members. In return, the company will pay lower dividends to the SMSF. Immediately after the investment, the members sell the holiday home.

Here the facts and circumstances show that the SMSF sole purpose test has been breached:

• The negotiation was deliberately for personal financial benefit, as demonstrated by the pattern of activities.  
• The benefits were not standard conditions for the units and therefore were not incidental. 
• The deal led to the fund losing investment returns.

Example 2

The SMSF has shares in holiday units managed by a third party. Fund members book accommodation at these units from time to time, but there is no preferential booking or price for them. They are treated as any other guests. 

This is not seen as a breach of the sole purpose test, especially as the investment was in line with the SMSF’s investment strategy – which by definition is aimed at the best ways to provide retirement benefits to members – and was undertaken following independent financial advice. 

How SMSF Engine Can Help You with the SMSF Sole Purpose Test

Many SMSF trustees do not have the time or financial and legal experience to navigate the very choppy sole purpose waters. They may need professional advice from specialised accountants and financial advisers.

SMSF Engine provides comprehensive SMSF administration services to those accountants and financial advisers, leaving them free to give strategic and investment advice to their clients.

We also provide services directly to trustees.

We have a friendly, experienced team, service packages that we can customise to your needs, and sophisticated cloud-based technology solutions to help you track and manage your self-managed superannuation funds and maintain your tax concessions.

Key Takeaways

The SMSF sole purpose test lies at the centre of trustees’ thinking about and managing their SMSFs.

Providing retirement benefits to members (and their dependants after their death) is the sole purpose of maintaining an SMSF. 

Ensuring that trustees comply with this requirement, together with all the complementary regulations around it, can be tricky. 

Trustees should tread carefully and take legal and financial advice to ensure the sole purpose test does not trip them up.

If you would like to learn more about how SMSF Engine can help you meet the SMSF Sole Purpose Test requirements, make an appointment to speak with one of our specialists.

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