The Aussiegolfa appeal (Aussiegolfa Pty Ltd (Trustee) v FC of T [2018] FCAFC 122) involved the provision of residential accommodation to a related party of a superannuation fund. Amongst the range of investment rules that apply to superannuation funds, two key issues require consideration for this kind of transaction: the in-house asset rules and the sole purpose test in s 62 and 71 of the Superannuation Industry (Supervision) Act 1993 (SISA). These issues were considered and clarified in the Aussiegolfa appeal.
Brief facts
- 31 March 2015 – SMSF invested in a DomaCom Fund (DCF), a widely held unit trust. The investment comprised less than 1% of the units in DCF.
- DCF allowed the creation of sub funds. At the time of investment, the constitution and product disclosure statements of DCF stated that a sub fund was a separate trust.
- Under the terms of DCF, the investor could nominate a property to be acquired by DCF. SMSF nominated an apartment in a student accommodation complex.
- 21 July 2015 – DCF entered into a contract to acquire the property.
- 23 July 2015 and 17 August 2015, funds held for SMSF’s were applied to the acquisition of units in the sub fund. SMSF and related parties held all of the units in the sub fund. The property was allocated to that sub fund.
- Prior to the creation of the sub fund, the constitution of DCF was amended to provide a sub fund was not a separate trust, but the product disclosure statements continued to make references to a sub fund as a separate trust.
- Investors in a sub fund did not have a direct investment in the underlying property but were entitled to 100% of the net income and proceeds of sale of the underlying property of that sub fund.
- 17 August 2015 – Exclusive management of the property was granted to Student House in Australia (SHA). The first tenancy of the property (from 8 January 2016 for a period of approximately 12 months) and the second tenancy (from 20 February 2017 for a period of approximately 12 months) were granted by SHA to persons not related to SMSF. The third tenant of the property was the daughter of the sole member of SMSF at the same rental and on the same terms as that provided to the first two tenants.
- 3 April 2017 – The sole member stated they were using the Burwood property to test “the related party use of residential property within” self-managed superannuation funds.
- Importantly, the Constitution provided that units in the sub fund had such rights as a responsible entity determines, there was no evidence of any determination of rights attaching to the units in the SMSFs sub fund.
First Instance Decision
In-house asset rules
Pagone J concluded that a sub fund was a separate trust, relying on a statement in the product disclosure statement which described a sub fund as a separate trust and various provisions of the Constitution of DCF.
Sole Purpose Test
Pagone J concluded there was a breach of the sole purpose test since the purpose was to provide residential accommodation to a related party. This was despite the property being provided to the related party on market rental terms. In reaching its decision, the court relied on a statement by the sole member and sole director of the trustee that he wished to test the ability for residential properties held by SMSFs to be used by related parties. A broad view of the decision is that providing housing to a relative would, in itself, cause a breach of the sole purpose test irrespective of the terms of the arrangement.
Concern for grandfathered trusts?
Grandfathered trusts are unit trusts established prior to 11 August 1999 where investments by superannuation funds are either made before 11 August 1999 or under transitional rules that applied until 30 June 2009.
There is no specific provision governing the transactions of grandfathered trusts (unlike ungeared trusts which are governed by Division 13.3 A of the SISA Regulations).
Some grandfathered trusts own residential property either required prior to 11 August 1999, or acquired after that date from realising other property owned prior to that date.
It is often the case that the in-house asset rules do not apply to leases of property by grandfathered trusts and the question is whether a lease of residential property to a related party would cause a breach of the sole purpose test. The view could be taken that where the property is leased on arm’s length terms at market rental, the sole purpose test may not be breached (although all circumstances of the arrangement must be considered). The same may also apply to unrelated trusts (trusts that are not controlled in any of the three ways described in s70E(2) of SISA) at least where the lease to the related party was not contemplated at the time of the investment by a superannuation fund.
The first instance decision in Aussiegolfa would have caused a change in that position on the basis of the broad view that any use of housing by a relative would in itself cause a breach of the sole purpose test.
Aussiegolfa appeal
Following the first instance decision in Aussiegolfa, we expressed the view in an earlier earlier article (see CCH Tax Week Issue 15, 20 April 2018):
- The hurdle for the Aussiegolfa was the in-house asset rules.
- The conclusion on the sole purpose test was reached notwithstanding the court referring to principles that an inquiry into purpose is not an inquiry into motive and where property is used for a permitted purpose, the purpose test is not breached merely because there is an incidental benefit.
- The nature of the property is such that the sole purpose test would not be called into question were it not for use by a related party. It is therefore the case that the property has been used for a permitted purpose, even though there may be an incidental benefit (the use by a related party).
- It is also questionable whether there can be any benefit where property that is a suitable investment for a superannuation fund is provided at market value on commercial terms. The basis for this point is, almost without exception, the cases that found a breach of the sole purpose test involved a financial benefit to a related party.
The decision of the Appeal Court is consistent with the views expressed above.
Appeal Decision
The investment by SMSF in the sub fund constituted an in-house asset because the sub fund was a separate trust. This conclusion was reached because there was an absence of evidence of the rights attaching to the particular class of units, and in the absence of that evidence reliance was placed on the statement in the product disclosure statement that a sub fund was a separate trust as secondary evidence of those rights.
In relation to the sole purpose test, the Appeal Court concluded:
- There is a fundamental distinction between purpose and motive. A motive of providing accommodation to a related party, does not cause a breach of the sole purpose test.
- There is not a breach of the sole purpose test merely because the trustee enters into a transaction with a related party.
- Whilst a tenant of property would obtain a benefit in the sense of obtaining accommodation, where market rent is payable for the accommodation there is no relevant benefit.
- In the absence of a financial or non-incidental benefit, and other facts or matters pointing to a collateral purpose, there is not a breach of the sole purpose test.
- The position would be different if the lease were not at market rent or if the property were not considered a prudent investment for the SMSF and the SMSFs investment policy had been affected by the objective to lease property to the related party.
The decision on appeal is consistent with the views we expressed in our earlier article.
Decision Impact Statement
The ATO issued a draft Decision Impact Statement in respect of the Aussiegolfa appeal on 3 December 2018. The Commissioner considers the decision is limited to certain points of the factual matrix including that the property was initially leased to unrelated parties, the relative paid market rent and there was no suggestion that leasing the property to the relative influenced the SMSF investment policy.
They note it is the purpose of making and maintaining a fund’s investments that is central to the sole purpose test. In this regard the author submits that the sole purpose test requires that a superannuation fund is maintained for the purpose of providing retirement and death benefits as well as permitted ancillary purposes, and there is a range of investments that may achieve that purpose. A superannuation fund can satisfy that purpose notwithstanding that the trustee has the motive of acquiring investments that suit the requirements of related parties. In accordance with Aussiegolfa, such an investment would not cause a breach of the sole purpose test provided any use by related parties is on market value terms, and the investment is otherwise a prudent investment for a superannuation fund.
The ATO take a contrary view. They consider that the case is not authority for the proposition that there is no breach of the sole purpose test when market value rent is charged. That is clearly correct, the charging of market rent does not overcome the sole purpose test if there are ancillary rights attached to the investment (e.g. club membership) or the investment is not prudent, for example, a beach house used by related parties during the Christmas period each year but in a location that does not attract tenants for the remainder of the year.
The ATO conclude with the position that a super fund will contravene the sole purpose test if the fund acquires residential premises for the collateral purpose of leasing to an associate, even if the associate pays rent at market value. The author considers this position is contrary to the Aussiegolfa appeal. The reference to collateral purpose is in fact the motive of the investment and is in accordance with the decision of the primary judge which was overturned on appeal. If the ATO were right, the acquisition of business premises for use in a related party’s business would contravene the sole purpose test, which is clearly not the case in the absence of other factors described in the Aussiegolfa appeal.
Conclusion
The first instance decision would have caused concerns for residential property owned by grandfathered an unrelated trusts. The simple lease of residential property to a related party, irrespective of the terms, may have caused a breach of the sole purpose test.
The appeal court, in the author’s view, brings matters back to what existed before the first instance decision – namely the focus of the sole purpose test is on whether there is the provision of a financial benefit that is not in accordance with the core or ancillary purposes.
With proper implementation of arrangements, grandfathered and unrelated trusts are not subject to the same investment restrictions as apply to superannuation funds, and transactions can be entered into with related parties without breaching the sole purpose test.
Financial Benefit cases:
Driclad Pty Limited v Commissioner of Taxation (Cth) (1968) 121 CLR 45
Raymor Contractors Pty Ltd v Federal Commissioner of Taxation (1991) 21 ATR 1410 (Davies, Wilcox and Hill JJ) and Cameron Brae Pty Ltd v Commissioner of Taxation (2007) 161 FCR 468 (Stone, Allsop a
See also iKnow: Home » Practice Areas » Superannuation » Commentary » Annotated commentary » SUPERANNUATION INDUSTRY SUPERVISION Fund Operations » Compliance with sole purpose test