SMSF trustees may inadvertently invest in or benefit their members and relatives before retirement, which falls foul of the superannuation rules and regulation, including the sole purpose test. Some examples where ATO ruled SMSF trustees have breached the rules are:
- fund members or their families staying in a holiday home owned by the SMSF;
- hanging artwork owned by the SMSF in a fund member’s home;
- renting an investment property owned by the SMSF to a family member (see below).
On 10 August 2018, the Full Federal Court handed down its judgment on Aussiegolfa’s Case. The Court found that Aussiegolfa, a self-managed superannuation fund (SMSF), did not breach the sole purpose test on appeal, but upheld the breach of the in-house asset rules as was found by the trial judge. Neither Aussiegolfa or the Australian Taxation Office (ATO) will seek special leave to appeal to the High Court.
The case in brief
Aussiegolfa is a sole member SMSF which, together with the member’s relatives in 2015, invested in the units of a sub-fund of a managed investment scheme which acquired a student rental apartment, ran by DomaCom. The sole member of Aussiegolfa is also the state manager of DomaCom. The apartment was managed by Student Housing Australia, an agent for DomaCom, which found three student tenants in succession, with all three paying commercial rent.
The issue in this case is that the third tenant in 2018 is the daughter of the SMSF’s member. The sole member of the SMSF provided a guarantee to secure the rental property for his daughter. The ATO argued that this is a breach of the sole purpose test because the investment in the units of the sub-fund to buy the apartment was to lease it to the SMSF member’s daughter.
Sole purpose test and the in-house asset rules – a primer
a) Sole Purpose Test
The sole purpose test ensures that regulated superannuation funds are maintained for providing benefits to members upon their retirement.
The trustee of a regulated superannuation fund, including SMSFs, must comply with the sole purpose test to be eligible for the 15% tax concession available to a complying SMSF. A non-complying fund breaching the sole purpose test will be taxed at 45% instead. The trustee can also be fined up to 60 penalties units, ie, $12,600 and pay with their own funds, not their SMSFs.
b) In-house Asset Rules
In brief, excluding exceptions, SMSFs are restricted from:
- lending or leasing more than 5% of the SMSF’s total assets to a related party of the SMSF; and
- investing more than 5% of the SMSF’s assets in a related party of the SMSF.
Breach of the inhouse asset rules can attract the civil penalty provisions. Depending on the severity of the breach, the ATO can apply to the court to issue heavy monetary penalties.
The Full Federal Court upheld the decision that Aussiegolfa breached the 5% investment rule as it had 7.83% interest in the relevant sub-fund trust asset.
Sole purpose test – the ATO’s view
The sole purpose test is a principle-based regulatory measure. The legislation does not attempt to categorically prescribe every type of investment or activity that could involve a breach of the test.
Whether an investment or activity involves a breach of the sole purpose test must ultimately be determined in the light of the overall circumstances of the particular superannuation fund.
The ATO considers that a strict standard of compliance is required under the sole purpose test. According to the ATO, the test requires exclusivity of purpose, which is a higher standard than the maintenance of the SMSF for a dominant or principal purpose as stated in its Ruling SMSFR 2008/2.
The ATO notes that the sole purpose test is also particularly concerned with what motivates an SMSF to make an investment or undertake an activity. The ATO also advises trustees to ensure they do not provide a purposeful benefit to the members when undertaking SMSF activities, even if there is no net cost to the SMSF in providing the benefit. Although the impact of an arrangement on the SMSF’s resources is a relevant consideration, it is ultimately the objective 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 as per SMSFR 2008/2.
Sole purpose test – the Full Federal Court’s decision
In brief, the Court emphasised its finding that there was not a breach of the sole purpose test in Aussiegolfa was dependent on an objective assessment of the factual arrangement being considered. The main findings included:
- There was no plan from the outset in 2015 to acquire the apartment for leasing to a relative of the SMSF’s member. The daughter being the third tenant, did not rent the apartment until 2018.
- The daughter, like the two former tenants, was selected by Student Housing Australia as a suitable tenant, not by the SMSF.
- The daughter was on the same commercial arm’s length market rental as the two former tenants.
- Benefit the daughter got in the form of student accommodation is not the type of ‘financial benefit’ concerned by the sole purpose test. The test is instead concerned with whether the fund invested for the superannuation benefits of its members in the future is being protected from dissipation.
- The continued payment by the daughter of market rent did not diminish or threaten the capacity of the SMSF’s ability to provide superannuation benefits to its members in the future. It continued to receive the same return from this investment.
Is there a change with the sole purpose test after Aussiegolfa?
Based on the Full Federal Court’s decision, the use of SMSF funds, which results in the delivery of other unrelated benefits to members of an SMSF or their relatives, does not necessarily mean the sole purpose is breached. Instead it is an objective test and assessment, based on the facts and circumstances of each case. This is not (necessarily) the same as the strict standard or purposeful benefit interpretation as espoused by the ATO in its Ruling.
How to hole a birdie putt after Aussiegolfa?
SMSF trustees should seek planning advice first before embarking on investments and transactions with their members and related parties, so to ‘play’ one better than the expected standard than an “Aussiegolfa”, and to not fall foul of the sole purpose and in-house asset test rules.
This article was co-authored by Bill Leung, HLB Mann Judd Melbourne