The sole purpose test is one the fundamental requirements for a Self Managed Super Fund (SMSF) to obtain tax concessions. It requires that the SMSF be maintained for the sole purpose of providing retirement benefits to its members or their dependents if a member dies before retirement.
Broadly, the test can be contravened when a member or a related party, directly or indirectly obtains a financial benefit when making an investment decision. Trustees need to be careful of this area as the ATO has a very high standard in relation to the compliance required under this test.
To be eligible for tax concessions available to super funds, SMSFs need to meet the sole purpose test. Essentially, this means that the SMSF needs to be maintained for the sole purpose of providing retirement benefits to its members or their dependents if a member dies before retirement.
Although the question of whether the sole purpose test has been contravened is usually determined on the facts of each case. Broadly, the sole purpose test can be contravened when a member or a related party, directly or indirectly obtains a financial benefit when making an investment decision, other than increasing the return of the SMSF.
High standard of compliance required
The ATO, which administer the relevant super laws in relation to SMSFs, has a very high standard in relation to the compliance required under the sole purpose test. It requires “exclusivity of purpose” but does accept that the provision of incidental, remote or insignificant benefits that fall outside of the scope of those specified in legislation may occur in certain circumstances.
According to the ATO, the sole purpose test is particularly concerned with how an SMSF came to make an investment or undertake an activity.
Therefore, trustees need to ensure that they do not provide a purposeful benefit to members when undertaking SMSF activities, this is the case even if there is no net cost to the SMSF in providing the benefit. Ultimately, it is the object purpose of providing the benefit rather than the net financial impact of the arrangement on the SMSF’s resources that determines whether the sole purpose test is contravened.
Factors that indicate the sole purpose test being contravened include:
- trustee negotiated or sought out addition benefit, even if the additional benefit was sought out in the course of undertaking other activities consistent with the sole purpose test;
- the benefit influenced the decision-making of the trustee;
- the benefit is provided by the SMSF to a member or another party at a cost or financial detriment to the SMSF; and
- there is a pattern of events that, when viewed in their entirety, amount to a material benefit being provided that is not consistent with the sole purpose test.
On that other hand, factors that weigh in favour of the ATO reaching a conclusion that an SMSF is being maintained in accordance with the sole purpose test include:
- the benefit is inherent or unavoidable part of other activities consistent with the sole purpose test;
- the benefit is remote, isolate, or insignificant when considered in light of other activities;
- benefit was provided on arm’s length commercial terms consistent with the financial interests of the SMSF;
- all activities of the trustee are in accordance with covenants specified in the legislation; and
- all investment and activities are undertaken as part of or are consistent with a properly considered and formulated investment strategy.
New investment opportunity?
Determining whether an investment in an SMSF meets the sole purpose test is a complex area. This is especially true for any new or planned investments in the areas of property, club memberships/licences, artwork, discount cards, and instalment warrant arrangements. Before you decide to invest, come and see us first to make sure the investment won’t contravene the sole purpose test and leave your SMSF in the lurch.