Broadly, the sole purpose test – found in s62 of the SIS Act – requires SMSF trustees to maintain the fund (and therefore life insurance policies on the lives of members) for the purpose of providing its members with a retirement or death benefit. Each case should be considered individually to determine if, by holding an insurance policy inside the SMSF, this will breach the sole purpose test.
Two questions you should consider are:
- What was the reason that the SMSF came to hold the insurance policy?
If the reason is solely as a consequence of a buy sell arrangement, then holding the insurance policy inside the SMSF is likely to be in breach of the sole purpose test.
- Is the purpose to receive payment for the member’s share of the business?
If so, then this is also likely to breach the sole purpose test as the purpose is to fund the transfer of the member’s business interest, not provide a retirement or death benefit to the member or beneficiaries.
Another matter to consider is whether the parties to the buy sell arrangement are related. If they are related (for example siblings, parent and child, or husband and wife) then it is likely that the SMSF will also contravene s65(1)(b) of the SIS Act, in that it is providing financial assistance to a relative of a member. Financial assistance is provided where:
- The relative is not paying premiums for the insurance policy; and
- The relative receives the member’s share of the business without paying any consideration themselves.
If you believe that your client has structured their insurance in a way that may breach the sole purpose test you should:
- Contact the client’s accountant and/or lawyer to determine whether the structure is in fact a breach of the sole purpose test; and
- Work with the accountant and/or lawyer to devise a strategy to rectify the insurance ownership.