A recent finding of the Full Federal Court has major implications for the sole purpose test.

In brief

The decision of the Full Federal Court in Aussiegolfa Pty Ltd (Trustee) v Federal Commissioner of Taxation [2018] FCAFC 122 has held that leasing a property held by a managed investment scheme sub-fund to the daughter of a SMSF member contravened the in-house asset provisions but did not breach the sole purpose test.

What you need to know

  • The sole purpose test in section 62 of the SISA was not contravened by the daughter of a member renting the property as no financial or non-incidental benefit being obtained.
  • It is of vital importance that documents are drafted correctly and reflect the parties’ intentions and what ultimately happens in practice with a ‘substance over form’ approach taken by the court.

Facts

  • The Fund trustee invested in units in a managed investment scheme called the DomaCom Fund.
  • The Trustee (along with two related parties) held 100% of the units in a sub-fund of the DomaCom Fund that held a residential property in Burwood, Victoria. The property was leased to two tenants for two consecutive periods and then at market rent to the daughter of a Fund member.
  • The Trustee sought declarations that the investment did not contravene the sole purpose test in section 62 of the SIS Act and was not an in‑house asset under section 71(1) of the SIS Act.

The Decision

Sole purpose test

  • The Court held that DomaCom leasing the property to the member’s daughter did not cause the Fund to contravene the sole purpose test.
  • The Court stated that there did not appear to be any financial or other non-incidental benefit to be obtained by the Fund or the member by the member’s daughter leasing the property rather than another tenant.
  • In the absence of a financial or non-incidental benefit being obtained, the Court held that the investment in DomaCom did not impact on the Fund being maintained for core and ancillary purposes consistent with the sole purpose test in section 62 of the SISA.
  • The Court noted this conclusion would be different if there was evidence that:
    • the rent received by the Fund was less than market value; or
    • providing accommodation to the member’s daughter had influenced the Fund’s investment policy.

In-house assets

The Court held that the Fund’s investment in the sub-fund was an investment in a related trust for the purposes of part 8 of the SIS Act. Accordingly, the investment was an in-house asset under section 71(1) of the SIS Act (and the applicable exceptions did not apply).

The arrangement effectively and in substance created a circumstance whereby a residential property indirectly owned by the Fund trustee was being leased to a related party.

The decision as to whether the investment was a related trust turned on whether the sub‑fund was a separate trust in accordance with general trust law concepts, based on the rights and obligations attaching to the units in the sub-fund under the constitution of Domacom. The Court held that the provisions of the constitution when considered as a whole facilitated the creation of a distinct trust associated with a particular class of units.

This case is also useful in providing some context as to when the Commissioner will seek to enliven his powers under section 71(4) of the SIS Act. There is some doubt, however, over the breadth and validity of the Commissioner’s power under section 71(4) of the SIS Act. This is reflected in the following comment of Justice Steward:

‘The power in section 71(4) to deem an investment to be an in-house asset that would otherwise not fit within the requisite criteria – the power to undo the application of s 71(1) is seemingly unlimited. A provision cast in such terms raises the possibility that it is an unconstitutional delegation of legislative power.’

Conclusion

The sole purpose test is not a panacea for all matters that appear to generally contravene the spirit of the superannuation legislation. A contravention of the sole purpose test generally requires a financial benefit to be provided or received, irrespective of whether the circumstances are inconsistent with any other provision of superannuation law. A contravention may be better captured under other areas of superannuation law. The Court considered several cases that have dealt with alleged breaches of the sole purpose test and noted that:

‘These decisions all exhibit one of two features: either payments were made to members otherwise than on retirement, or benefits were provided on non-arm’s length terms.’

Ultimately, interposing an unrelated party did not avoid the prohibition on leasing residential property to a related party, albeit indirectly. The terms of the constitution, and the supplementary material such as the product disclosure statement, were fundamental in the Court forming the view that the property was held on separate trust for the purpose of the in‑house asset provisions. Therefore, it is of vital importance that documents are drafted correctly and reflect the parties’ intentions and what ultimately happens in practice.