The Sole Purpose of Your SMSF

28 November, 2012

Those who have self-managed superannuation must remember that all the members are trustees.  The trustees have the responsibility to ensure that the fund meets all the regulatory obligations and remains what is termed a “complying fund”.  This means complying with all of the standards imposed by the ATO through superannuation law.

One rule which is easily overlooked is the Sole Purpose Test.  This requires a fund to operate for the sole purpose of providing benefits for members at retirement or death.  The fund should not be used as an ATM or credit card in the event that a member may be in need of cash, however temporary.  Nor can the fund be used to fund cash flow problems in a business.  This includes making loans or investments in related parties.

Who is a related party?  A related party is defined under the Superannation Regulations as any of the following:

  1. Another member of the fund;
  2. An employer sponsor of the fund; or
  3. An associate of an entity referred to in 1 or 2.

The term “associates” is a far reaching definition.  It includes relatives of members, other members of the fund, other directors of a corporate trustee, a partner of a member including spouse and any children, a trustee controlled by a member and their associates, or a company controlled by a member and their associates.  It is designed to ensure that trustees do not use others to avoid the reach of the ATO.

An SMSF therefore cannot lend money to a company owned by a member of the fund or their family.  So if you have an SMSF and your business is short of cash to pay creditors, you cannot simply borrow the funds from your SMSF to pay your creditors – otherwise the purpose of the loan is not an investment of the fund to boost retirement savings but is being used to fund your business.  Whether that loan is necessary to save your income and, perhaps, your family home is immaterial.  This is what happened in JNVQ & Commissioner of Taxation [2009] AATA 522 (14 July 2009).

In the JNVQ case, the trustees of the fund made loans to a company which happened to be a company controlled by one of the members.  This was a contravention of the superannuation operating standards because the trustees had made a loan to an associate of the one of the members of the fund.  The AAT found that the fund was not being used for the sole purpose of building retirement savings but being used fro business purposes.  The fund was found to be non-complying.

This finding carries serious tax consequences for the trustees of the SMSF, including tax at the top marginal rate not just on the income but also on the value of investments.  Nearly 50% of the fund can be wiped out.

Being a trustee of an SMSF is a position of trust – what lawyers call a fiduciary obligation.  There can be serious consequences for your retirement savings if the rules are not observed.

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