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Federal Court case gives insight into sole purpose test

Katarina Taurian
30 October 2014 — 2 minute read

A recent Federal Court decision, which involved an SMSF making 80 loans to members, offers insight into the operation of the sole purpose test.

The decision in Deputy Commissioner of Taxation (Superannuation) v Graham Family Superannuation Pty Limited [2014] FCA 1101 involved an SMSF that was established in 2006, with the trustee of the fund being a company.

The directors of the trustee and members of the fund were husband and wife, Ian and Carolyn Graham.


In 2007, the trustee purchased a residential property and leased it to Ian and Carolyn’s son. However, rent was not paid and $60,762 was outstanding by 30 June 2012.

In addition, from approximately 2007 until 30 June 2012, the trustee had paid for a caravan, stud cattle, motor vehicles and associated costs for these items – items which did not generate income for the fund.

“There was also other unexplained expenditure. The various outgoings were treated as loans and by 30 June 2012, the loan account of the fund stood at $260,064. Auditor contravention reports were lodged between 2008 and 2011,” said DBA Lawyers’ David Oon.

“The fund was not declared non-complying at any point. The Court recounted that the reason for this was that Ian and Carolyn repaid the fund using other assets. The parties agreed that the Commissioner could have declared the fund to be non-complying.

“The parties also agreed that the trustee of the fund contravened the sole purpose test, the prohibition on loans to members, the in-house asset rules and the arm’s length rule.”

Mr Graham was liable to pay penalties of $30,000 and Ms Graham was liable for $10,000, Mr Oon said.

Speaking to SMSF Adviser, Mr Oon explained that this case “hints” at what is behind the sole purpose test.

He noted that in the case of the Grahams' SMSF, the judge said the sole purpose test was contravened by the provision of rental income “on non-arm’s length terms” to Mr and Ms Graham's son.

“The sole purpose doesn’t say anything about arm’s length, [it] doesn’t even use the words arm’s length,” Mr Oon said. “If we just look at all the decisions that have happened, we can see a pattern forming. That is when the SMSF is invested at arm’s length, the sole purpose test was met.”

“[The judge] actually used the words non-arm’s length, even though the words non arm’s-length don’t appear in the sole purpose test. Essentially what I’m saying is they are buried in there; they are implicitly in there.

“If an investment is at arm’s length, the natural objective conclusion is far more likely to be that it was done to provide retirement benefits, and is consistent with the sole purpose test.”

The SMSF Academy’s Aaron Dunn viewed this case as a “timely reminder” for trustees to ensure their SMSF is used for the sole purpose of retirement.

“Such circumstances can only lead to the regulator taking a heavy-handed approach to ensure that this message of non-compliance acts as a deterrent for what is a well-functioning industry,” he said.

Federal Court case gives insight into sole purpose test
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