SMSF Technical Education & Strategies

What can you invest in, and the sole purpose test

The superannuation law does not prescribe exactly what a SMSF can & cannot invest in. In fact, this wide investment choice is one of the great appeals of SMSFs.

Common investments include:

· Shares
· Listed & unlisted property trusts
· Fixed interest securities
· Government and/or corporate bonds
· Managed funds
· Direct property
· Cash

Other investments that are allowed but are not so common include:

· Art (see article for specific issues)
· Precious metals (e.g. Gold, Silver)
· Derivatives (see article for specific issues)
· Forex and/or Commodities trading

While the choice is large, there are a number of restrictions that you definitely need to be aware of. These restrictions are there to protect SMSF members from undue risk, and also to ensure that decisions are being made with the primary purpose of generating retirement benefits for members, not providing current day benefits. This brings us to the sole purpose test below. Also see our other article on “Investment restrictions” for more info on restrictions.

Sole purpose test

The sole purpose test is probably the most important issue that SMSF trustees need to make sure they have addressed. The regulators have stated that this test is of high importance on their list when it comes to the continuing “complying” status of SMSFs (i.e. a complying fund is taxed at 15%, while a non-complying fund is taxed at 47%). The sole purpose test is a test used to ensure that SMSFs are maintained for the purpose of providing benefits to members upon their retirement, or their dependants in the event of the member’s death before retirement. The trustees must comply with the sole purpose test to be eligible for the taxation concessions available to a complying superannuation fund.

The sole purpose test is divided into core and ancillary purposes. A regulated fund must be maintained for at least one core purpose OR at least one core purpose and one or more ancillary purposes. However, a fund cannot be maintained for one or more ancillary purposes only.

Core purpose

An SMSF must be maintained for at least one of the following core purposes:
· paying benefits to members on or after retirement from gainful employment
· paying benefits to members when they have reached a prescribed age, or paying benefits to members on the member’s death. (This may require the benefits being passed on to a member’s dependants or legal representative).

Ancillary purpose

Ancillary purposes for maintaining a fund are for the provision of benefits to members in the following circumstances:
· termination of the member’s employment with an employer who, at any time, had made contributions to the fund for that member
· cessation of employment due to ill-health (whether physical or mental)
· death of the member after retirement where the benefits are paid to the member’s dependants or legal representative
· death of the member after attaining a prescribed age where the benefits are paid to the member’s dependants or legal representative, and· other ancillary purposes approved in writing by the Australian Prudential Regulation Authority.

This last ancillary purpose allows a fund to provide benefits in situations of financial hardship and / or on compassionate grounds.

Contravention of the sole purpose test

A key aspect of determining if a fund has contravened the sole purpose test is to look at the character and purpose of the fund’s investments. For example, investment arrangements can not be for the purpose of providing financial assistance to another party who is not a member or beneficiary of the fund itself. Another issue of a possible contravention of the sole purpose test is where a fund is ‘running a business’ as part of its investment strategy. The ATO has stated that in their experience, where a large proportion of fund assets are used to conduct a business within a self managed superannuation fund, the fund will almost inevitably contravene the sole purpose test (and/or other SISA provisions). This is because generally the purpose for which the investment is made is not to generate retirement benefits but rather to enable the trustees to operate the business. Another common example is where the SMSF owns a beach house, and the members of the SMSF go and stay in the house when on holidays. This is a direct breach of the sole purpose test, as the members are gaining a current benefit from the use of the asset.

The bottom line in all of this is that although investment choice is a great benefit of SMSFs, it can be a double edged sword. Each transaction of the fund (particularly the investments) needs to be examined properly in light of the sole purpose test to ensure that your fund remains a complying superannuation fund, and can benefit from the concessions available.