DIY super: Tread carefully over sole purpose test

The sole purpose test for self-managed super funds means just that – sole purpose. The consequences can be dire. By TERRY HAYES of Thomson Legal & Regulatory.

By Terry Hayes

The tax office recently released a draft ruling warning DIY super fund holders to stick to the sole purpose test in selecting investments for their fund. 

The consequences of breaching this test are dire. Your fund could lose its 15% concessional tax treatment and be taxed at 45%. So it pays to take note of the draft ruling and keep an eye out for the final word on the matter when it is delivered by the tax office later this year.

In the ruling, the tax office set out the factors it will consider in determining whether the provision of an incidental, remote or insignificant benefit by a DIY fund amounts to a breach of the sole purpose test.

Sole purpose test

The sole purpose test prohibits trustees maintaining a DIY fund, also known as self-managed super funds, for any purpose other than a core purpose or an ancilliary purpose defined by law.

A core purpose is providing retirement or death benefits for or in relation to fund members. An ancilliary purpose is providing benefits on the termination of a fund member’s employment and other death benefits.

A trustee who maintains a self-managed super fund for other purposes contravenes the law.

Incidental benefits

The draft ruling acknowledges that the provision of “incidental, remote or insignificant benefits” that fall outside the scope of those specified in the law may occur in certain circumstances.

The tax office says the trustee does not contravene the sole purpose test if the provision of such incidental benefits, when viewed objectively in the overall context of the circumstances of the self-managed super fund’s maintenance, does not displace an assessment that the self-managed super fund is being maintained solely for the purposes specified in the law.

However, the tax office considers that a strict standard of compliance is required under the sole purpose test. The test requires a sole purpose, not a dominant or principal purpose.

Relevant factors for consideration

To determine the purpose for which a self-managed super fund is being maintained, the tax office will survey the events and circumstances relating to the maintenance of the fund.

Satisfying the test

Factors that may lead the Commissioner to a conclusion that a self-managed super fund is being maintained in accordance with the sole purpose test are:

• The benefit is an inherent or unavoidable part of other activities that are consistent with the provision of benefits under the law.
• The benefit is remote or isolated, or is insignificant (whether it is provided once only or considered cumulatively with other like benefits) when assessed in light of other activities undertaken by the trustee that are consistent with the law.
• The benefit is provided by the self-managed super fund on normal commercial terms consistently with the financial interests of the fund and at no cost or financial detriment to it.
• All of the activities of the trustee are in accordance with the covenants set out in the law (for example in the best interest of the beneficiaries and exercised with the same degree of care, skill and diligence as an ordinary prudent person would exercise in dealing with property of another for whom the person felt morally obliged to provide).
• All of the self-managed super fund’s investments and activities are undertaken as part of, or are consistent with, a properly considered and formulated investment strategy.

Not satisfying the test

Factors that may lead the Commissioner to a conclusion that an SMSF is not being maintained in accordance with the sole purpose test are:

• The trustee negotiated for, or sought out, the benefit (whether or not the trustee does so in the course of undertaking other legitimate activities).
• The benefit has influenced the decision-making of the trustee to favour one course of action over another.
• The benefit is provided by the DIY fund to a member or another party at a cost or financial detriment to the fund.
• There is a pattern or preponderance of events that, when viewed in their entirety, amount to a material benefit being provided that is not specified under the law.

Examples

The draft ruling sets out nine examples demonstrating the Commissioner’s approach to determining whether the provision of an incidental benefit amounts to a breach of the sole purpose test. The examples consider a range of DIY super fund investments, including those in:

• Holiday apartments through a property syndicate involving incidental upgrade rights – OK according to the tax office.
• Shares in a golf club with assignable membership rights attached – two examples, one which is OK according to the tax office and one that is not.
• The use, lease and loaning of artwork at no cost – not OK says the tax office.
• Shareholder discount cards (which result in reduced dividend rights) – not OK.

In the case of collectables and boutique investments such as works of art, antiques, jewellery, classic cars and wine, the tax office says trustees must take care to ensure that self-managed super fund members are not granted pre-retirement use of or access to the assets in circumstances that suggest that the trustee is maintaining the fund for a purpose not specified in the law.

Likewise, the Commissioner advises trustees to ensure they do not provide a purposeful benefit to the fund members when undertaking self-managed super fund activities, even if there is no net cost to the self-managed super fund in providing the benefit.

Although the impact of an arrangement on the self-managed super fund’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 self managed super fund’s resources that determines whether the sole purpose test is contravened.

You can read the draft ruling on the tax office website.

Terry Hayes is the senior tax writer at Thomson Legal & Regulatory, a leading Australian provider of tax, accounting and legal information solutions.

For more Terry Hayes features, click here .