Home

 

Welcome:

Welcome

Site Map:

Site Map

Adviser Updates:

Adviser Updates

Publications and Documents:

Publications and Documents

 

Business Succession Planning:

Business Succession Planning

Need for Succession Plan

Need for Asset or Buy/Sell Strategy

Need for Liability or Key Person Strategy

Negotiating a Succession Plan

 

Simple Succession Plan:

Simple Succession Plan

 

Complete Succession Plan:

Complete Succession Plan

Strategy

Financial Needs

Insurance Funding

Retirement Funding

 

One Page Strategy:

One Page Strategy

Asset Needs

Liability Needs

Personal Needs

Who Pays the Premiums?

Valuing the Business

Simplifying the Valuation Issue

Equity vs. Loan Capital

 

One Policy Strategy:

One Policy Strategy

Flexibility

Dual Role of Personal Cover

Dual Role of Debt Red'n Cover

Security & Tax-Effectiveness

Cost Savings

Pre-Agreed Purchase Price

Apportionment of Premiums

Methods of Aggregation

 

Multiple Policy Approach:

Multiple Policy Approach

Super Fund Ownership

Tax Disadvantages

Cost Disadvantages

Other Disadvantages

Geared Premium Funding

Super Buy/Sell

 

One Page, Two Policy Strategy:

One Page, Two Policy Strategy

 

Other Issues:

Tax Deductibility

Inadequate Insurance Proceeds

Vendor Finance

Changing Needs

Future Growth of Equity

Trauma Buy/Sell Strategy

 

Sole Proprietors and Families:

Sole Proprietors and Families

Overview

Family Ownership

Sale Strategies

Third Party Buy/Sell Strategies

Estate Equalisation Strategies

Family Buy/Sell Strategies

Second Generation Strategies

Debt Reduction Strategies

 

 

 

Who Pays the Premiums?

 

One Policy Strategy

The One Policy Strategy aggregates Cover for multiple Needs onto One Policy.

As a result, instead of having multiple Premiums for multiple Policies, there will be one Premium for the One Policy.

However, this does not mean that the Business should pay the whole Premium.

In particular, it does not mean that the Business is responsible for payment of the Life Insured's Personal Premiums.

Apportionment Between Needs

The apportionment of the Premium between the different Needs is a simple mathematical process.

The Premium payable with respect to each component of the total Sum Insured will be a part of the Premium proportionate to the part of the total Sum Insured.

Example

For example, if the Personal Cover is 50% of the total Sum Insured, the Personal Premium will be 50% of the total Premium.

It is then necessary to determine who pays what part of the Premium.

 

Recommended Apportionment Between Parties

It is recommended that the total Premium cost of the Policies be split in the following manner:

  • the Business pays the total of the Premiums with respect to the Liability Needs of the different Lives Insured;

  • the Proprietors pay the total of the Premiums with respect to the Asset Needs of the different Lives Insured in proportion to their equity in the Business; and

  • each Life Insured pay the Premium with respect to their own Personal Cover.

In cases where a Superannuation Fund is the Legal Owner, Beneficial Owner or Recipient of any of the Cover, it will be responsible for its proportionate share of the Premium otherwise payable by the Life Insured.

 

Buy/Sell Premiums (Asset Needs)

The Premiums attributable to the Purchase Price represent the cost to each Proprietor of ensuring that they will be able to fund the Purchase Price of another Proprietor's Equity.

There are five alternative methods of apportioning the Premiums attributable to the Purchase Price between the Proprietors:

(a) Each Proprietor could pay the whole of the Premium with respect to their own Policy;

(b) Each Proprietor could pay an equal share of the Premiums with respect to the other Proprietors’ Policies;

(c) Each Proprietor could pay a proportionate share (i.e., proportionate to his equity) of the Premiums with respect to the other Proprietors’ Policies;

(d) Each Proprietor could pay an equal share of the total amount of the Premiums payable with respect to all of the Policies; or

(e) Each Proprietor could pay a proportionate share of the total amount of the Premiums payable with respect to all of the Policies.

Alternative (e) is the most commonly used.

If the Premiums are paid by the Business, the result is the same as alternative (e), because each Proprietor has a proportionate share of the Business.

IGS recommends alternative (e) on the basis that, while the Premiums are not necessarily a cost of business, they are "a cost of being in business together".

Therefore, it makes sense to pay them proportionately.

The Vendor might receive the Insurance Proceeds, but the Purchasers will benefit from them, because they will acquire the Proprietor's Equity, without having to fund the Purchase Price.

Thus, both Vendors and Purchasers derive a benefit from the Policy and the Premiums.

 

Complete Succession Plan

Click here to see a summary of the apportionment and deductibility of the Premiums payable with respect to a Complete Succession Plan.

 

One Page, Two Policy Strategy

If the Business is concerned about the administrative burden of working out the split, the One Page, Two Policy Strategy provides two alternative strategies.

Two Policies, Same Ownership, Different Payers

The Business could split the Cover into two Policies, both of which could be owned by the Business as Trustee.

The Life Insured could be identified as the Payer of the Premium with respect to the Personal Policy, so that the Insurance Company deducted the Personal Premium from the Life Insured directly (rather than indirectly through the Business).

Two Policies, Different Ownership, Different Payers

Alternatively, if the Business required the Buy/Sell and Personal Cover to be Self-Owned, the Policy Owner and Payer could be the Life Insured.

Apportionment of Insurance Proceeds

In both cases, the Agreement would still pool the total of the Insurance Proceeds and determine how they would be split.

 

FBT Implications with respect to Buy/Sell Premiums

The potential application of Fringe Benefits Tax ("FBT") must be taken into account when determining the responsibility for payment of Buy/Sell Premiums.

Expenses Paid on Behalf of an Employee Generally

If a Business pays an expense (such as an Insurance Premium) on behalf of an Employee, there is a risk that the payment will be subject to Fringe Benefits Tax ("FBT").

Commercial Purpose of Buy/Sell Premiums Paid on Behalf of the Proprietors

The commercial purpose of Buy/Sell Premiums is to fund the Purchase Price of an Outgoing Proprietor's Equity that would otherwise have been payable by the Continuing Proprietors (and their Related Parties).

Thus, the Insurance Proceeds benefit the Purchasers.

Collectively, the Premiums benefit the Business Owners, i.e., the Proprietors (and their Related Parties).

Reimbursement of Premiums Paid on Behalf of the Proprietors

As a result, IGS' normal view is that the Buy/Sell Premiums are an expense of the Proprietors (and their Related Parties), not the Business.

Therefore, IGS' standard advice and drafting specifies that:

  • The Business will physically pay the Buy/Sell Premiums to the Insurance Company; and

  • The Business may recover the Premium from the Proprietors (and their Related Parties) by way of reimbursement.

Once the share of each Proprietor was determined, it would pay the required amount to the Business.

Alternatively, where there are Credit Loan Accounts owing by the Business to the Proprietors, the Premium could be set-off against the Loan Accounts.

Thus, the amount owing by the Business to the Proprietors would be reduced by the amount that the Proprietors had to reimburse the Business.

Both methods of payment would avoid any FBT liability with respect to the Premiums.

Premiums Paid by the Business for the Benefit of Other Parties

If the Business does not seek any reimbursement or set the Premiums off against any Loan Accounts, then the issue of FBT must be addressed.

There are two different situations:

  • the Business Owners are the Lives Insured or Proprietors (who are Employees); or

  • the Business Owners are Related Parties of the Lives Insured or Proprietors (e.g., Spouses, Family Companies or Family Trusts).

Premiums Paid on Behalf of Business Owners Who Are Employees

If the Premium was paid on behalf of a party in their capacity as an Employee, it is clear that there would be an FBT liability.

If the Lives Insured or Proprietors owned the Equity in the Business, the ATO might argue that the Premiums have been paid on behalf of people who happen to be Employees.

Therefore, there is a risk that an FBT Liability will be incurred.

Premiums Paid on Behalf of Business Owners Who Are Related Parties of Employees

If the Equity in the Business is owned by parties other than the Lives Insured or Proprietors (e.g., Related Parties such as Spouses, Family Companies or Family Trusts), then the argument that the payments are made for the benefit of the Employee is slightly weaker.

However, it is possible that the ATO might argue that the Employee nevertheless received an indirect benefit from the payment of the Premiums.

An indirect benefit could arise where the Life Insured or Proprietor held an Equity in the Family Company or was a Trustee, Director of a Trustee Company or Beneficiary of a Family Trust.

It could also arise where a payment was made on behalf of a Spouse of the Life Insured.

Therefore, the ATO might still attempt to impose an FBT Liability.

The Need for a Nexus with the Employment of the Life Insured

The above views are conservative views based on the breadth of the FBT Legislation.

An alternative view is that there will only be an FBT Liability, if the nexus between the Payer (the Business) and the Beneficiaries (the parties for whose benefit the Premium has been paid) is an employment relationship.

On this view, there is an argument that, if the Premium is paid on behalf of a Proprietor (in its capacity as a Proprietor or Business Owner, not an Employee), then it is not subject to FBT.

Personally, IGS believes that this argument has merit.

Benefit to Business Itself

The view that there should be no FBT Liability is strengthened by the argument that the Business itself derives a benefit from an orderly Business Succession Plan and the smooth transition in the ownership of the Business (regardless of any benefit to the Proprietors).

Therefore, it is arguable that the Business is paying the Premiums, at least in part, for its own benefit.

ATO Views

The ATO has not published any relevant rulings or determinations with respect to this issue.

However, IGS suspects that, if the parties applied for a Private Ruling to this effect, the ATO would:

  • reject it; or

  • decline to rule in favour of the parties.

Thus, despite IGS' personal views, it is not safe to assume that FBT would be inapplicable.

Risk of FBT Liability

If so instructed, IGS will draft Agreements on the basis that the Business will be commercially responsible for payment of the Buy/Sell Premiums.

However, Businesses should recognise that, if they attempt to make the Business responsible for the Buy/Sell Premiums, there is a risk that an FBT Liability will be incurred.

It would therefore be prudent for a Business to obtain specific advice with respect to this issue from its Taxation Accountants.

Companies

The above discussion applies to Companies and their Shareholders.

The Shareholders are separate Tax Enities from the Company for tax purposes.

Partnerships and Unit Trusts

The situation might be slightly different in the case of Partnerships and Unit Trusts.

A Partnership is a collective of the Partners.

Any expense of the Partnership is payable on behalf of the collective of Partners in proportion to their Equity in the Partnership.

Similarly, the Trustee of a Unit Trust holds the Trust Assets on behalf of the Beneficiaries or Unit Holders in proportion to their Equity or Unit Holdings in the Unit Trust.

Any expense of the Unit Trust is payable on behalf of the collective of Beneficiaries or Unit Holders in proportion to their Equity or Unit Holdings in the Unit Trust.

In a way, every expense of these types of Business Entity is a direct expense of the Business Owners collectively.

By extension, a proportionate part of every Business expense is an expense of the individual Business Owner.

Thus, it is arguable that the payment of the Buy/Sell Premiums by the Partnership or the Trustee of the Unit Trust is not in fact a payment on behalf of the Lives Insured or Proprietors in their capacity as Employees, but will always be a payment on behalf of the Business Owners (i.e., the actual Partners, Beneficiaries or Unit Holders) in proportion to their Equity.

In reality, there would be no way for the Business to pay the Premiums, except on behalf of the actual Partners, Beneficiaries or Unit Holders in proportion to their Equity.

The standard IGS Agreement specifies that the Buy/Sell Premiums will ultimately be payable by the Proprietors (and their Related Parties) proportionately.

In the case of Partnerships and Unit Trusts, it is arguable that the commercial result of the standard Provisions is exactly the same as the Business paying the Premiums .

 

Copyright: Ian Gray Solicitor

 

 

Adviser Tip

The One Policy Strategy "aggregates" Premiums that would otherwise have been separate.

When the responsibility for payment of the Premium is calculated, you can "segregate" or split the total Premium proportionately to the amount of each component of the Sum Insured.

See more Adviser Tips

 

Current Marketing Schedule

Current Marketing Schedule

Ian Gray travels to most capital cities regularly throughout the year and is available for Meetings.

Please click here to see his availability in Brisbane, Sydney, Melbourne, Adelaide and Perth.

Please contact us to arrange an appointment or teleconference.