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A broadening of the 'sole purpose test' for SMSFs

Self-managed superannuation funds (SMSFs) continue to rise in popularity in Australia. However, there are extremely strict rules that apply to the purchase, by an SMSF, of real property, one of which is the ‘sole purpose test’. This test was recently considered in Aussiegolfa Pty Ltd (Trustee) v Commissioner of Taxation [2017]1.

What is the sole purpose test?

The sole purpose test requires that a super fund is maintained solely for one or more of the prescribed core purposes, being provision of retirement benefits, provision of benefits to members aged 65 and over, or payment of death benefits.

Otherwise, the fund must be maintained solely for one or more of the prescribed ancillary purposes, being the provision of benefits on cessation of work due to ill health, or payment of death benefits.

The Aussiegolfa case

The Full Federal Court has recently held that a self-managed superannuation fund investing in property and dealing with a related party in an arm’s-length transaction does not breach the sole purpose test. It was however found to be a breach of the in-house asset rules, which limit the in-house assets of a superannuation fund to 5% of the market value of the total assets.

The SMSF in question had invested 7.83% of its assets with related entities in a structure that was intended to buy real estate, which real estate was eventually rented out by the member’s daughter at market value. The initial Federal Court judge agreed with the Australian Taxation Office (ATO) that the investment breached the in-house asset rules and the sole purpose test.

While the Full Federal Court unanimously agreed with the Federal Court judge regarding the in-house asset question, contrary to the judge at first instance, the Full Court determined that the investment did not breach the sole purpose test as the terms of the rental arrangement were the same as they would have been with arm’s-length tenants.

The key factors in this judgement were:

  • The decision to invest was made in 2015, whereas the decision to lease to the daughter was not made until 2017, meaning that there was no initial plan to lease the property to a related party;
  • The property was first leased to other tenants at arm’s-length before being leased to the daughter;
  • The daughter did not receive any benefits from this transaction;
  • The decision to lease to the daughter was made by the Custodian, not the SMSF Trustee; and
  • The SMSF continued to receive the same return from its investment due to the continued payment of market rent.

Consequences of the decision

It was held that the incidental outcomes of the investment were not the main focus of this case, rather the Court must consider the underlying reasons for the investment by the SMSF in the first place.

More notably, the decision in Aussiegolfa will change how the ATO applies the sole purpose test in the future. It is, however, important to ensure any related party transaction is at arm’s-length and on market terms, and that evidence supporting the decision as being a commercial one is maintained.

If you would like to discuss proposed or current SMSF investments or any other matter relating to the sole purpose test, please contact our office.

This article was written by Frances Kelly, Graduate, and Sharon O’Toole, Special Counsel

1 Aussiegolfa Pty Ltd (Trustee) v Commissioner of Taxation [2018] FCAFC 122

"The content of this publication is for reference purposes only. It is current at the date of publication. This content does not constitute legal advice and should not be relied upon as such. Legal advice about your specific circumstances should always be obtained before taking any action based on this publication."