The Real Purpose Behind the Sole
Purpose Test
The superannuation changes announced
in the May 2009 Federal Budget do not make superannuation less attractive.
Rather there will be more pressure to accumulate monies in superannuation
funds from the earliest possible date and to maximise the income which might
be derived by a fund.
As a result of the changes made at
the Federal Budget from the start of the next financial year there will be a
halving of the amounts which persons will be allowed to make to
superannuation funds as tax deductible contributions (from $50,000pa down to
$25,000pa whilst the transitional concessional contributions applicable to
persons aged over 50 and which applies to 30 June 2012 will be reduced from
$100, 000 pa to $50,000pa). These changes are quite hurtful to persons who
are making a late run to save for their retirement or whose superannuation
fund savings have decimated by the global financial crisis.
A major problem which will be faced
by persons wanting to start savings for superannuation at a relatively young
age is that there might be a conflict between their savings objectives and
need for cash flow to fund other objectives. The changes might also excite
superannuation funds to look for more novel ways of accumulating wealth.
Section 62 of the Superannuation
Industry (Supervision) Act 1997 says that the trustee of a regulated fund
(such as a standard self managed superannuation fund) must maintain the fund
for the “core purposes” of providing superannuation benefits for each
member, or the provision of benefits for the member after the member attains
65 years of age, or the provision of death benefits to the personal legal
representatives or beneficiaries of a deceased member.
As well as being maintained for a
“core purpose” a fund can also be maintained for an “ancillary purpose”
which is broadly for the provision of benefits for each member on the
termination of the member’s employment with an employer or the provision of
benefits on the ill-health of a member.
The word “purpose” does not mean
“motive” but the effect which is sought to be achieved; that is what the
arrangement does (Newton & Ors v FC of T, Privy Council, 7 July 1958).
Failure of The Sole Purpose Test
The consequence of failure of the
same business test is severe.
First any such failure will mean
that the fund ceases to be a complying fund. This would mean that the fund
might receive a tax bill equal to 47% of the total value of the assets of
the fund.
Second if a trustee fails to
maintain a fund for a sole purpose the trustee might be liable to a fine of
up to $220,000 and for imprisonment of up to 5 years.
What
causes a fund to fail the sole purpose test?
The answer is simple; if the trustee
fails to maintain the fund for a sole purpose. This purpose will normally
be able to be shown by the fund’s investment strategy.
The classic example of where a
trustee fails to maintain a fund for the required “sole purpose” was
illustrated by the “Swiss Chalet” case (Administrative Appeals Tribunal, 19
July 1995). That case involved a fund, the assets of which included shares
in a private company whose only assets were “playing shares” in a golf club,
units in a unit trust whose only asset was a chalet in Switzerland, and a
property in Sorrento (a Victorian beachside resort) which had been used for
the personal use of a member of the fund. The Tribunal held that the
ownership of those assets caused the fund to fail the sole purpose test. |
The
acquisition by a fund of “life style assets” such as holiday home, artwork,
or vintage cars, normally has sole purpose test implications. Purchases of
these types of assets by a fund are normally justified by expectation that
the assets’ values will be subject to capital growth. However the problem
is that members normally want to use the holiday home, or hang the artwork
at home, or drive the vintage car. Such applications of an asset will cause
there to be breaches of the sole purpose test; that test cannot normally be
over come by leasing the asset at an arm’s length rent to the member because
of the in house asset test restrictions.
Businesses
Persons quite often ask whether they
cause a fund to carry on a business or not. The Taxation Office takes the
view that a fund cannot carry on a business.
But is this logical? Why is it that
attempting to accumulate funds for a member’s retirement by carrying on a
business is prohibited, but attempting to accumulate funds for a member’s
retirement by the holding of passive investments is not. In the present
environment the holding of passive assets might have been counter
productive.
It might be because the carrying on
of a business involves more than just the accumulation of income; typically
profit (for day to day living expenses) will be required by members.
One suspects that the Taxation
Office would also be concerned that the risks associated with the carrying
on of a business indicate that it is not the type of activity that carried
on by a fund; I can imagine the Taxation Office saying that if a fund holds
an asset that has risk attached to it that this indicates that the fund is
not maintained for the sole purpose of providing retirement and other
accepted benefits to members.
An alternative to the fund carrying
on a business is for the fund to acquire shares in a private company or unit
in a unit trust which carries on a business. The Taxation Office will most
probably say that this does not assist a trustee in avoiding the sole
purpose test (and that the Swiss chalet case would indicate this), however
this would minimise a fund’s exposure to risk.
Perhaps the greatest disadvantage of
a fund holding shares in a private company is that any dividends paid on the
shares may be treated as “special income” and as a consequence taxed not at
the normal 15% rate but at a 47% rate. Distributions from unit trusts do not
suffer from this disadvantage.
This is the second problem which
funds which want to accumulate wealth face –that is if they want to
exaggerate non arms length income which may include income from private
companies and which does include income from discretionary trusts they will
be subject to a penal tax.
Disclaimer:
The material should not be relied upon. Super Matters, any
Australian Member, any related entity of those persons, or any of their
officers employees or representatives, will not be liable for any loss or
damage arising out of or in connection with the material contained in this
publication.
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