What is the Sole Purpose Test?
17 Nov 2021
Investment decisions made by a super fund must pass the sole purpose test. So what is the sole purpose test and how does it work?
The sole purpose test applies to all regulated superannuation funds, including Self Managed Super Funds (SMSF), and exists to make sure fund managers make decisions in the best interests of their fund’s members.
The Australian Taxation Office (ATO) says a SMSF must meet the sole purpose test to be eligible for the tax concessions normally available to super funds.
This means your fund needs to be maintained for the sole purpose of providing retirement benefits to members, or to their dependants if a member dies before retirement. Failure to do so could lead to penalties.
“Your fund fails the sole purpose test if it provides a pre-retirement benefit to someone – for example, personal use of a fund asset,” the ATO says.
How to tell if your fund passes the sole purpose test
When it comes to examining whether a fund is being run for the sole purpose of providing benefit to members, the test looks at what are called ‘core’ and ‘ancillary’ purposes, as specified in the superannuation legislation.
A fund must, at the very least, be run for one of the three core purposes and can add on one or more ancillary purposes. A fund cannot be run solely for ancillary purposes.
What are the core purposes?
The core purposes include paying benefits in one or more of the following situations:
- to members on or after they retire from gainful employment
- to members once they reach a certain age
- to dependents (or the member’s legal personal representative) if the member dies.
What are the ancillary purposes?
Ancillary purposes also provide benefits to members, but in more specific and less likely situations, and they include:
- termination of a member’s employment where the employee had made contributions to the fund on behalf of the member
- cessation of work due to ill-health (whether physical or mental)
- the member dying after retirement, and their benefits being paid to their dependent(s) or legal representative
- the member dying after reaching their preservation age, and their benefits being paid to their dependent(s) or legal representative
- anything else approved in writing by the regulator (usually Australian Prudential Regulation Authority for most superannuation funds or the ATO in the case of SMSFs)
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How can a super fund breach the sole purpose test?
There are many ways a super fund can breach the sole purpose test. The ATO has listed several example cases (to be used only as a guide).
One concerns a painting, bought by two trustees of a SMSF inline with the fund’s investment strategy. But rather than keep the painting in storage, or lease it out to anyone for a fee, they display the painting in their workplace. They regularly display other paintings that they lease, but they pay no lease money to their SMSF to display their own painting.
The ATO says this fails the sole purpose test as the painting is being used for benefit now, not for the benefit of the SMSF.
Read more: Should your SMSF invest in a collection? The pros and cons of collectables
What if the trustees offer the painting to a local gallery as part of a special exhibition, again at no charge, under the belief that its public exhibition could potentially increase the value of the artwork?
The ATO says this is okay, given the potential to increase the value of the painting, which ultimately was the reason it was bought by the trustees of the SMSF.
What these, and other examples, highlight though is the complex way the sole purpose test can be interpreted by the ATO.
Julie Dolan, Head of SMSFs and Estate Planning and a partner at KPMG Australia, told Canstar that too often trustees fall foul of the sole purpose test because they don’t know what they’re doing.
“They go in head first without seeking advice, thinking everything’s okay,” Ms Dolan said.
“You need to get some good advice, from someone who knows what they are talking about.”
That could include trying to ask the ATO for guidance, she said, or getting advice from an independent financial advisor who specialises in SMSFs.
What are the penalties for breaching the sole purpose test?
There are a number of penalties the ATO can impose on a fund and/or its trustee if it finds they have breached the sole purpose test. The main penalties include stripping a fund of its compliance status, an end to any concessional tax treatment and disqualifying and/or fining the trustee.
The ATO says it will consider the severity of any non-compliance before deciding whether to take any civil action or criminal prosecution
Ms Dolan said anyone worried they have SMSF investments that might not meet the sole purpose test should seek advice. Any breach suspected or found should be highlighted as soon as possible with a fund auditor and the ATO.
“They like proactivity,” she said. “What they hate is when you sit on it and do nothing.”
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Cover image source: Atstock Productions/Shutterstock.com
This article was reviewed by our Digital Editor Amanda Horswill before it was updated, as part of our fact-checking process.
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