Any SMSF needs to meet the Sole Purpose Test to be eligible for the tax concessions normally available to super funds. Given the very close association between trustees and/or members – sometimes I get calls from worried accountants who administer SMSFs.
The Sole Purpose Test means your fund needs to be maintained for the sole purpose of providing retirement benefits, or to their dependants if a member dies before retirement (SIS Act Section 62).
If any members and/or related party (directly or indirectly) obtain a personal financial benefit when making investment decisions, it’s likely the fund will not meet the sole purpose test.
The most common breaches of the Sole Purpose Test are:
- Investments that offer a pre-retirement benefit to a member or associate; and/or
- Providing financial help or a pre-retirement benefit to someone, to the detriment of the fund
Breaching the sole purpose test is very serious and can lead to:
- The fund being deemed NON-COMPLYING;
- Penalty tax of nearly 50% of the fund’s assets;
- Disqualification of the Trustees; and
- A fine of up to $10,200 for each trustee
The Sole Purpose Test is now an area firmly on the radar of the ATO.
The Rental Unit Scenario
An accountant called, he had a client whose SMSF contained a small residential unit. It seemed the client’s son and daughter-in-law were returning from overseas and needed somewhere to live. There was a shortage of good units available for rent, so the client proposed getting the tenants to leave, so his son and daughter-in-law could move in.
Given the unit was an SMSF asset, the client knew to be careful, so proposed to charge the same rent as the previous tenants were charged.
Here the tenants are paying market rates of rent ….however the same tenants are related parties occupying a residential property. In this case, there is a problem with the Sole Purpose Test (despite the best intentions of those involved). If I was auditing this fund, I would encourage the trustees to prepare a definite plan of action to have the client’s son and daughter-in-law find alternate accommodation as a matter of priority. The trustees need to show that they have recognised the breach and are taking “pro-active steps” to rectify it themselves within a defined time frame.
Who is really directing the decision making of the fund?
Another accountant called and aired serious concerns regarding an SMSF where the son of the wealthy members appeared to have full control of the investment decision making of the fund. The “son” was not a member or trustee of the fund, but ran a failing business of his own. The investment activities of the fund seemed to mirror and support the failing business of the son – including related party loans and direct investments in business assets of the son. Over a period of time related party loans were not repaid (with interest) and other assets not realised.
The result was a complete collapse in the value of the fund – resulting from unrealisable investments (that appeared) to be under the direct control of the son (rather than the trustees).
Apart from Sole Purpose Test, this case also raised serious concerns about In-House Assets and Non-Arm’s Length Transactions.
Before making any Investment Decisions
Before making any investment decisions….SMSF Trustees need to ask:
WHAT IS THE PURPOSE OF THIS INVESTMENT?
If the purpose is to provide retirement benefits to members…Then Great!
If the purpose is to immediately benefit members or those related to the fund…Then Best to Skip it!! … however tempting it may be for members and/or related parties to use the assets of the SMSF.
There are some days I wish people would make it easy for their accountants and SMSF auditors. Having said that – most Trustees do invest in cash and equities and very little else. They follow my principle of keeping low on the ATO radar.
© David Saul
David was among the first professionals to be accredited through SPAA as an SMSF Specialist Advisor™. He is also a Chartered Accountant and holds a Bachelor of Financial Administration from the University of New England, Armidale NSW.