Sole Purpose Test
The purpose of an SMSF is to provide retirement benefits or retirement related benefits (e.g. Disability benefit, death benefit, reversionary benefit) for its members or dependants. If the purchase of an asset by a SMSF is perceived as providing personal or immediate benefit to its members or relatives, it will contravene the sole purpose test provided under s.62 of the SISA.
The strict Superannuation Rules relating to the purchase of assets by a SMSF provide that the assets:
- Must not be leased to a related party of the SMSF;
- Must not be stored in a private residence of a related party;
- Must have a documented decision on the storage of the item and the document must be kept for ten (10) years;
- Must be insured in the SMSF’s name within seven (7) days of being acquired;
- Must not be used by a related party of the SMSF; and
- Must have an independent valuation if transferred to a related party
The definition of a “Related Party” under s.10 of the SISA includes:
- Members of the SMSF;
- Relatives of members of the SMSF;
- A partner in a partnership business in which the SMSF member is a partner;
- An associate of a partner in a partnership business;
- Any companies where the members and/or their relatives in relation to the company hold more than 50% of the shares and voting rights in the company;
- Any trusts where the members and/or their relatives in relation to the trust control the trust or have a fixed entitlement to more than 50% of the capital or income of the trust.
Arm’s Length Transactions
All SMSF investments must be made and maintained on a commercial basis. The purchase and sale price of all assets should always reflect the true market value regardless of who the buyers and sellers are. It is recommended that Trustees use a qualified independent valuer to value the assets.
SMSF Trustee’s duties and obligations are outlined in s.52B of the SISA. These duties are referred to as “Trustee’s Covenants” and are deemed to be in all SMSF Trust Deeds regardless of whether they actually appear in it. The covenants relevant to investments are:
- To keep assets of the SMSF separate from assets held personally by Trustees; and
- To formulate and develop an investment strategy that has regard to the SMSF’s circumstances.
Effective from 1 July 2012 requires Trustees:
- To provide evidence that demonstrates assets are kept separate; and
- To ensure that all investment decisions are made in accordance with the SMSF’s investment strategy and that the investment strategy is regularly reviewed.
Paying Cash or using Borrowed Money to acquire an Asset
If there is enough money in the SMSF to pay for the asset in “cash”, then it is a straightforward transaction. As long as the money comes directly from the SMSF bank account, it is proof that it has been acquired by the SMSF. Nevertheless, it is recommended that the purchase of the asset by the SMSF be minuted.
If an SMSF needs to borrow to acquire the asset, then it will not be a straightforward transaction. The subject of borrowings by an SMSF to acquire an asset, which is referred to under the Superannuation Law as “Limited Recourse Borrowing Arrangement” (LRBA), which is a complex area of the law that needs careful planning and attention.
Briefly, under a LRBA, it is necessary:
- To establish a separate trust (holding trust/bare trust);
- The Trustee of the holding trust cannot be the same Trustee as the SMSF;
- The asset acquired can only be a single acquirable asset;
- The money borrowed can only be used for repairs and maintenance and not for improvement; and
- Once the loan is fully repaid, the asset will need to be transferred from the holding Trustee to the SMSF Trustee.
Briefly, an SMSF may acquire any type of asset from an unrelated party so long as:
- The purpose of the investment does not conflict with the sole purpose test and complies with the Rules in relation to the acquisition of collectable and personal use assets;
- The purchase price paid on the asset is at market value and the transaction is conducted at arm’s length;
- The asset is in accordance with the SMSF’s investment strategy and is clearly kept separate from the member’s personal assets; and
- If an SMSF requires borrowings to acquire the asset, the transaction loan is structured correctly.