'The sole purpose test is the heart of Superannuation' because this test is perhaps the most fundamental and important to the superannuation system. Because of its importance, we will spend some time here looking at what the sole purpose test is, why it is so important in keeping your SMSF compliant, and what this means for how you act when running your SMSF. Specifically we will look at the things you need to consider in terms of investment decisions and benefit payments.
The legislation states that the SMSF must be maintained for its core purpose or a limited number of ancillary purposes. What these purposes are is defined by the legislation to avoid confusion, and basically if the reason you want to make a transaction, whether it be an investment or a payment out of the fund, does not fit within one of these defined purposes, you cannot do it.
The core purposes are:
- Providing for a member's retirement – this is the main test for people who are in the accumulation phase.
- Providing benefits to members who have reached the prescribed age, which is currently 65 years of age, and
- To pay a death benefit to the member's dependents or estate where the member was less than the prescribed age at the time of their death.
The requirement that the SMSF be maintained for retirement purposes is a very broad catch all – it is a requirement that spans across all phases of a SMSFs lifecycle and affects every decision that a trustee may make. When a trustee is making a decision in relation to the fund, it is not good enough that the SMSF will still be expected to benefit from the transaction, if the decision is really made for personal reasons. It's not even good enough that the predominant purpose of a particular transaction is to provide for retirement. The benefit of the SMSF must be the sole purpose of the transaction.
This is probably the most commonly breached law within SMSFs and is of major concern for the regulators. Broadly, the breaches can be broken into two main areas and occur mostly during the accumulation phase of the SMSF.
- Investment decisions are a common source of problems particularly where 'exotic' investments are concerned. For example, if the trustee purchased some paintings because they liked them, but had no evidence that they were likely to appreciate in value, they may well have breached the sole purpose test even if they pay rent for hanging them in their house.
- Another problem where the sole purpose test in concerned is where the SMSF crosses from being a passive investor to running a business. This is usually evidenced by completion of repetitive tasks, payment of wages, lodging IAS and BAS etc. This indicates that the SMSF is perhaps acting as a bank for the member's business rather than being a genuine retirement vehicle.
- Where trustees pay out benefits to members prior to their reaching preservation age and satisfying a condition of release you also have a sole purpose test problem. Again, because the fund is not being maintained as a retirement vehicle. For example, where a member's business is having cash flow problems and the super fund cash is dipped into, you would be treating the fund as a bank, not for the provision of retirement.
In addition to the sole purpose for which a SMSF must be run, there are a number of ancillary (or secondary) purposes that the SMSF is allowed to cater for. These are:
- For the payment of benefits to the member after termination of employment from an employer who contributed to the fund.
- Payment of benefits after termination of employment due to ill health is another purpose. This type of payment is commonly called total and permanent disability or TPD.
- The SMSF is also permitted to make payments of salary continuance due to ill health
- Payment of benefits where the member is in financial hardship or on compassionate grounds are also permitted, however the terms under which these payments are permitted is generally much more restrictive than people appreciate.
- The final ancillary purpose is the payment of benefits upon death of the member after they had reached the prescribed age of 65.
The sole purpose test underlies every decision made within the SMSF. It requires that every decision made by a trustee, be made for the benefit of members upon retirement. While the core and ancillary purposes allow other actions or payments to take place, these are mostly only relevant when something goes wrong and an unexpected event occurs to the member.
So throughout the life of SMSF, no member or person or entity related to a member should derive a benefit either directly or indirectly from the fund.
