There is plenty for trustees of super funds to keep track of, including administrative details, compliance measures, and more. But a court case from earlier this year again brought the ‘sole purpose test’ into the spotlight as something for SMSF trustees in particular to remain mindful of when making investment decisions for their fund, lest they end up in legal hot water.
What is the sole purpose test?
The ‘sole purpose test’ applies to all superannuation funds and exists to make sure fund managers make decisions in the best interests of their fund’s members.
The sole purpose test is not a formal test or process that a trustee must go through, but more a rule of thumb they need to keep in mind when making decisions that guide their fund’s investments. The Australian Taxation Office (ATO) says a trustee must maintain a fund “for the sole purpose of providing retirement benefits to your members, or to their dependants if a member dies before retirement”.
According to the ATO, the sole purpose test is essentially a key rule that a trustee needs to check against every decision they make regarding their fund – if an investment or management decision is made which provides financial benefit (direct or indirect) to a fund trustee, member, or relative of a trustee or member before retirement, then there’s a chance the fund in question has breached the sole purpose test. It’s important to note, according to the ATO, this financial benefit must be more than incidental/insignificant, and that decisions made as good-faith attempts to try to improve investment earnings for members are seen as acceptable for the purposes of the sole purpose test.
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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. According to the ATO, 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, at least one of which a fund must be maintained for, are paying benefits:
- to members on or after retirement 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 are purposes which also provide benefits to members, but in more specific and less likely situations. They are:
- 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 incapacity (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
- other ancillary purposes approved in writing by the regulator (usually Australian Prudential Regulation Authority for most superannuation funds or the ATO in the case of SMSFs)
What are some ways that super funds breach the sole purpose test?
While most larger superannuation fund trustees are familiar with the compliance rules such as the sole purpose test, there are examples where trustees, especially within an SMSF, have breached the rules. Some examples of breaches reported by the ATO are:
- fund members or their families staying in a holiday home owned by the SMSF
- renting an investment property owned by the SMSF to a family member
- hanging artwork owned by the SMSF in a fund member’s home
What are the penalties for breaching the sole purpose test?
There are a number of penalties that the ATO can impose on a fund and/or its trustee if they find them to have breached the sole purpose test. Two of the main penalties imposed are stripping the fund of its compliance status and disqualifying and/or fining the trustee.
Stripping the fund of its compliance status
The ATO could decide to deem the fund in question ‘non-complying’, meaning it could then be taxed at the highest marginal rate (47%) rather than the concessional rate usually afforded to compliant super funds (15%). This not only applies to any investment return generated by the fund; the tax penalty can be applied to the entire superannuation fund balance.
In deciding whether to issue a notice of non-compliance, the ATO will consider:
- the tax consequences that would arise if the fund were to be treated as non-complying
- the seriousness of the beach
- and any other relevant circumstances
Disqualifying and/or fining the trustee
The ATO can choose to disqualify the trustee, meaning they could never operate a SMSF again. The ATO could also choose to fine the trustee up to A$10,200 – and any fine imposed must be paid by the trustee with their own money, not the fund’s.
Whether it’s a huge retail fund or a single-member SMSF, all super funds must comply with the sole purpose test – but that doesn’t mean all super funds are created equal. You can compare funds and find the right one for you with Canstar.