The sole purpose test is nothing new and has existed in some form for many years. In fact the original concept of sole purpose first appeared in the Income Tax Assessment Act (1936) before the introduction of the Superannuation Industry (Supervision) Act 1993 (“SIS Act”).
The sole purpose test resides in section 62 of the SIS Act and requires a superannuation fund be maintained solely for:
- one or more core purposes, or
- for one or more of the core purposes and for one or more ancillary purposes.
The core purposes are for the provision of retirement benefits or death benefits. Whereas ancillary purposes relate to the provision of benefits on the cessation of a member’s employment, other death benefits and approved benefits not specified under the core purposes such as illness and those approved by the regulator. Importantly this test applies to all regulated superannuation funds and must be considered across all actives of the Fund throughout its life.
The Royal Commission and APRA’s statements in response to Commissioner Haynes findings last year has seen the sole purpose test receive closer attention. This emanated from concerns around non-superannuation advice fees being charged to members APRA regulated superannuation fund accounts. As a result, APRA wrote to the large superannuation funds on the issue. This in turn has resulted in a greater level of scrutiny by the larger funds.
APRA has also undertaken to complete a review of the sole purpose test and to provide further guidance to APRA fund trustees. The consultation phase is to be completed in the first half of this year, and is to be finalised in the second half of the year.
So does this mean we will start to see a greater focus being placed on the application of the sole purpose test by the ATO as regulator for SMSFs?
In an attachment to their letter to RSE licensees on 27 March 2019, APRA stated that their review “may also lead to recommendations as to whether the law could be clarified to better meet the intent of the sole purpose test.”
Given that the sole purpose test applies to all regulated superannuation funds, any updates to the legislation will likely impact SMSFs.
Interestingly the APRA circular III.A.4 providing guidance on the sole purpose test was issued some 19 years ago. Across the industry a lot has changed in that time.
The ATO of course has its own guidance for SMSFs in SMSFR 2008/2. Were any changes to the legislation to eventuate, we will no doubt see this updated or replaced depending upon the size and nature of the changes.
When reviewing arrangements that involve related parties, as practitioners we will carefully consider SIS compliance issues that can arise with regards to in-house assets and related party acquisition rules, or the non-arm’s length rules that apply under SIS or taxation legislation.
However, does our compliance review process include a running of the ruler over the sole purpose test?
Indeed the ATO does include an examination of the sole purpose test as part of their compliance activities when examining other compliance concerns.
In practice, often the challenge can be having all the relevant facts and information to be able to fully advise our clients. It is not uncommon for the client to have already entered into an arrangement before we have any knowledge of the transaction.
What the sole purpose test does highlight is the need to dig deeper and ask more detailed questions of our clients. We need to better understand the reasons that decisions have been made and ensure that documentation is in place to support this position.
A common scenario we see in practice is the SMSF acquiring the business premises for the related party business. This can be a property acquired from a related party or a new property purchased on market. We know that exemptions apply to business real property transactions under the in-house assets test and the related party acquisition rules. The remainder of our focus is then typically placed on ensuring that we have arm’s length arrangements in place to comply with both SIS and the non-arm’s length income rules in ITAA 1997 s.295-550, putting the necessary lease agreements in place, updating investment strategies and so forth.
What we also need to examine is the “why”. Why is the property is being purchased by the superannuation fund?
If we are presented with a scenario where business premises are being purchased in the SMSF because the individual or the business entity is unable to finance the purchase, sole purpose could become an issue. What were the intentions of the trustee in entering into the arrangement? Are there any other salient facts? We need to dig deeper!
The ATO states:
A strict standard of compliance is required under the sole purpose test. The test requires exclusivity of purpose, which is a higher standard than the maintenance of the SMSF for a dominant or principal purpose. (SMSFR 2008/2, para 7)
Trustees need to factor in the sole purpose test as part of their decision making process. When undertaking a compliance review of a proposed transaction or arrangement, expand your discussions with clients. Ensure that you obtain the details necessary to properly consider the application of the sole purpose test. It is much easier to document and evidence intentions and decisions at the time those decisions are made rather than when defending a decision down the track if subject to review by the ATO as regulator.
Tracey Scotchbrook is a SMSF Specialist Advisor and consultant with over 15 years industry experience. She is an active member of the SMSF Association (“SMSFA”) holding various committee positions. In June 2019 Tracey was appointed to the Board as a non-executive director. Tracey’s accreditations include: SMSF Specialist Advisor (SSA) with the SMSF Association, CA and CPA SMSF Specialist, and Charted Tax Advisor with the Tax Institute. She also holds a Masters in Taxation and Graduate Diploma in Financial Planning. Tracey is a regular presenter to industry professionals and trustees, commentator, educator, and writer. In 2009 Tracey was awarded the Premium Scholarship by the SMSFA. Connect with Tracey via LinkedIn