Self-Managed Super Fund - The Sole Purpose Test is Tested

One would not ordinarily choose to take on the Commissioner of Taxation without being well and truly prepared for the consequences.

Well, recently, one Mr Benson did precisely that and, to date, despite some initial setbacks, has had a win.

The Case

Without going into all the complexities, Mr Benson’s SMSF invested in a trust that owned a student accommodation complex containing a number of flats.  The investment entitled his SMSF to the income from a particular flat.  After the SMSF acquired the interest, it was decided to lease the flat to his daughter.  It seems Mr Benson may have done this intentionally to set up the contest with the Commissioner.

His reason may have been that he wanted to test the limits of, among other things, the Sole Purpose Test* in the context of the Superannuation Industry (Supervision) Act.  Mr Benson was also the Manager of the managed investment scheme, DomaCom, which owned the accommodation complex.  I suspect there was a marketing opportunity for DomaCom if he obtained the outcome he was seeking.

The Sole Purpose Test is the legislative underpinning of the Government’s overriding policy objectives for superannuation, namely ensuring retirement income for an aging population.  There are tax benefits for superannuation investment so the law is structured to ensure those investment decisions are not about providing present day benefits for members.  Rather, the sole purpose for which the funds are invested must be members’ retirement incomes.

The Commissioner carries a very big stick for non-compliance with the Test and has stipulated in guidelines issued prior to the case that investments must meet strict standards.  There must be exclusivity of purpose, not just a dominant or principal purpose.  This does not exclude, however, incidental, remote or insignificant purposes or benefits that might arise besides the sole purpose.  So the fact that your current day taxable income (and tax liability) is reduced does not of itself disqualify the investment, so long as it is an incidental, remote or insignificant effect of making a decision to produce retirement income.

The Result

Mr Benson lost his first two rounds.  A number of issues were considered in Mr Benson’s case in the Administrative Appeals Tribunal and then in the Federal Court.  The single judge in the Federal Court found that Mr Benson’s SMSF had breached the Test by providing accommodation to a relative, namely Mr Benson’s daughter.  The decision was also seemingly influenced by an email from Mr Benson that quite bluntly said that he was using the proposed lease to test the related party use of residential property within self-managed superannuation funds.

Having lost these rounds, Mr Benson stuck to his guns and appealed to the Full Court of the Federal Court of Australia.  There, the three judges unanimously held that the fact that a related party enjoys the use of an SMSF asset does not in itself mean the Sole Purpose Test has been breached.

In this case the facts established:

• The decision to lease was made two years after the asset was acquired
• The rent payable, met market expectations
• The daughter was a perfectly acceptable tenant and she didn’t receive any benefit - after all she was obliged to pay market rent
• The SMSF was in receipt of the same income it would have received had it leased it to another
• There was nothing to suggest this was an imprudent transaction
• The email, suggesting an ulterior purpose, was sent by Mr Benson in his role at DomaCom and not in his trustee role in his SMSF

Key lessons

Many consider that the outcome of this case is surprising and has pushed back the limits of the Sole Purpose Test.  It is yet to be seen whether the ATO will appeal.

But even if the Full Court decision stands, trustees of SMSFs need to be careful.  In reality, I don’t think terribly much has changed from prior to Mr Benson’s case (Aussiegolfa Pty Ltd v. Commissioner of Taxation).

The outcome for the following examples would not be affected by the case:

Example 1:

Causing your SMSF to buy a newsagency (or any business) so as to employ yourself or your child may be questionable.

Example 2:

Buying business real property and leasing it to a related entity to conduct a business has been acceptable for many years, but if the rent is a discount to the market, then it may result in a breach of the test.  The SMSF will need evidence showing:

• the rent is at market value; and
• the lease terms are those one would objectively expect in an arms-length transaction.

Example 3:

Buying a holiday apartment which is managed by independent management and rented out to third parties at market rates should meet the Sole Purpose Test.

But what is the position if the member then decides to stay at the property?  The ATO suggests that if the member pays the market rates to the management agent then there should not be any breach of the Test.  However, reserving one month a year for the family at no cost will cause significant problems.

The take home message is to ensure you are clear that the purpose for your investment decisions are for retirement purposes only.

If you are unsure to the purpose for your investment, we suggest you seek legal advice.

Hadyn Oriti is a Partner with Donovan Oates Hannaford. He has a wealth of experience in Estate Planning and Self-Managed Superannuation Funds.

If you would like to discuss any issues you may have with respect to your Self-Managed Superannuation Fund, please contact Hadyn on 02 6583 0427 or horiti@dohlaw.com.au

*This is a test that ensures a superannuation fund is maintained for the purpose of providing benefits to its members upon their retirement or for beneficiaries if a member dies.