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Taxation Implications of Policy Ownership

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Buy/Sell Cover:

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Aggregation onto One Policy:

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Death Benefits

 

Section 118-300

Under Section 118-300, Death Benefits will only be exempt from CGT, if the Recipient (or deemed Recipient) of the Insurance Proceeds is a person or entity that:

 

Multiple Beneficial Owners

In TD94/31, the ATO states that the Exemption extends to Policies that are owned by multiple Beneficial Owners:

"3. Where two or more persons jointly effect a policy of life assurance, each person may be an "original beneficial owner".

It also states that the Exemption extends to different types of person or entity:

"Furthermore, the person holding the rights or any interest in rights under a policy of life assurance may be an individual, a company or a trustee of a trust estate alone or in partnership."

This Determination expressly recognises the entitlement of a Trust to the Exemption.

 

Breadth of Exemption

Section 118-300 creates a generous exemption.

In effect, the owner of the Policy could be:

In effect, the only person who is intended to have a CGT liability is someone who has acquired the Policy for a payment or consideration.

However, while the exemption is generous, it needs to be strictly complied with.

 

Diagram

Click here to see a diagram that illustrates the operation of section 118-300.

 

The Concept of "Beneficial Ownership"

It is important to appreciate that the exemption is not based on the identity of the Owner of the Policy (i.e., the Policy Owner as far as the Insurance Company is concerned).

The exemption depends on the identity of the "Beneficial Owner" of the Policy.

To understand the meaning of the term "Beneficial Owner", it is first necessary to understand the nature of a "Trust".

The Nature of a Trust

A Trust is a legal mechanism or device that allows the ownership of an asset to be separated into two parts:

Normally, this separation requires the two parts to be owned or held by two different parties:

  • the Trustee is the legal or nominal owner of the asset; and

  • the Beneficiaries are the beneficial owners of the asset.

"Legal or Nominal Ownership"

Legal or nominal ownership means that the Trustee owns the asset in name only.

It might be registered as the "owner" of the asset in any government or private records of ownership.

For example, its name might appear on the policy schedule or the certificate of title of the property.

However, the Trustee does not own or hold the asset for its own commercial benefit.

It is held for or on behalf of the Beneficiaries who own or hold the beneficial interest in the asset.

In effect, the Trustee holds the asset as a custodian and must manage it for the commercial benefit of the Beneficiaries.

"Beneficial Ownership"

Beneficial ownership normally means that parties other than the Trustee own or hold or enjoy the underlying commercial benefit of the asset.

The Trustee must hold and manage the asset for or on behalf of the Beneficiaries.

If the asset has a substantive commercial value, the value belongs to the Beneficiaries, not the Trustee.

Normal Tax Treatment of Trusts

Normally, the Income Tax Assessment Act does not tax Income in the hands of the Trustee of a Trust if there is a Beneficiary who is "presently entitled" to the Income.

Section 97(1) of the Income Tax Assessment Act 1936 states that:

"Where a beneficiary of a trust estate who is not under any legal disability is presently entitled to a share of the income of the trust estate:

(a) the assessable income of the beneficiary shall include:

(i) so much of that share of the net income of the trust estate as is attributable to a period when the beneficiary was a resident; ... and

(b) the exempt income of the beneficiary shall include:

(i) so much of the individual interest of the beneficiary in the exempt income of the trust estate as is attributable to a period when the beneficiary was a resident."

Section 97(1)(a) looks through the Trust and taxes the income in the hands of the Beneficary who is presently entitled to it.

Section 97(1)(b) extends any exemption that applies to the Trustee to a "presently entitled" Beneficiary.

"Fixed Trusts"

In the case of a Fixed Trust, the Beneficiaries have a fixed and defined interest in the Capital and Income of the Trust.

The commercial benefit of the Capital and Income of the Trust can belong to one or more Beneficiaries.

Single Beneficiary

If there is one Beneficiary, that Beneficiary will be the Beneficial Owner of the Capital and Income of the Trust.

It will also be "presently entitled" to the Capital and Income of the Trust for Income Tax purposes.

Multiple Beneficiaries

If there are multiple Beneficiaries, the commercial benefit of the Capital and Income of the Trust will be split between the Beneficiaries proportionately.

The Beneficiaries will be the Beneficial Owners of both the Capital and the Income of the Trust in fixed proportions.

This means that they will be "presently entitled" to Capital and Income in fixed proportions for Income Tax purposes.

"Discretionary Trusts"

The Trustee of a Discretionary Trust holds the Trust Assets on behalf of all of the defined Beneficiaries.

However, because the Trustee has a discretion whether to give any one Beneficiary (a "Discretionary Beneficiary") any share of the Trust Assets (or the income from the Trust Assets), none of the Discretionary Beneficiaries has a fixed interest in the Trust Assets.

In this situation, the Tax Laws consider that:

  • none of the Discretionary Beneficiaries is a Beneficial Owner of the Trust Assets; and

  • the Trustee is the sole Beneficial Owner of the Trust Assets.

Because the one party is both the Legal or Nominal Owner and the Beneficial Owner of the Trust Assets, the Tax Laws overlook any theoretical distinction between the two forms of ownership.

In effect, the two forms of ownership are united and not separated at all in the case of a Discretionary Trust.

The union of the two forms of ownership for tax purposes does not mean that the Trustee owns the Trust Assets for its own commercial benefit.

The Trustee is still legally bound to administer the Trust in the interests of the Discretionary Beneficiaries.

However, the union of the two forms of ownership is relevant to the identity of the "beneficial owner" of a Trust Asset (such as an Insurance Policy) for tax purposes.

Direct Ownership

If the Owner of a Policy holds the Policy for their own exclusive commercial benefit, they will be both the legal (or nominal) owner and the beneficial owner of the Policy.

Like a Discretionary Trust, there is no separation of the two forms of ownership in this case.

 

Application of Section 118-300 to Trust Ownership

Section 118-300 is concerned with the beneficial ownership of the Policy.

It therefore envisages the possibility that the legal owner of the Policy might be different from the beneficial owner.

As a result, it expressly envisages the ownership of Policies by a Trust.

Separation of Legal and Beneficial Ownership

Under a Trust, it is possible to distinguish between:

  • the "legal ownership" of an asset; and

  • the "beneficial ownership" of the asset.

In the case of a Policy, it is possible for:

  • the Trustee of a Trust to be the legal (or nominal) owner of the Policy; and

  • a Beneficiary to be the beneficial owner of the Policy.

Focus on Beneficial Ownership

In these cases, section 118-300 will ignore the legal or nominal ownership of the Policy and focus on the beneficial ownership of the Policy.

The section will result in a CGT Exemption if the beneficial owner disposed of (or was deemed to have disposed of) the interest in the Policy.

This result will occur if the beneficial owner received (or was deemed to have received) the Insurance Proceeds.

IGS Business Insurance Trust Agreement

The IGS Business Insurance Trust Agreement utilises a Fixed Trust.

The Life Insured is normally the Beneficial Owner of the Policy under the Agreement.

Trust Ownership of the Policy therefore entitles the Trustee and the Beneficiary to an exemption under section 118-300.

However, one of the reasons that the Life Insured is the Beneficial Owner (rather than some other party) is the desire to satisfy the requirements of a CGT exemption with respect to Non-Death Benefits.

Discretionary Trusts

As mentioned above, if the Trustee was the Trustee of a Discretionary Trust, the Trustee would be deemed to be the beneficial owner of the Policy for the purposes of section 118-300.

Theoretically, it would receive the CGT Exemption.

However, if there was a "presently entitled Beneficiary" to whom the Insurance Proceeds were distributed, then the exemption would extend to that Beneficiary as well on normal income tax principles.

As mentioned above , the Income Tax Assessment Act does not tax income in the hands of the Trustee if there is a Beneficiary who is presently entitled to the income.

Section 97 of the Income Tax Assessment Act 1936 looks through the Trust and taxes the income in the hands of the Beneficary who is presently entitled to it.

Section 97 also extends any exemption that applies to the Trustee to a presently entitled Beneficiary.

Thus, it is arguable that section 118-300 grants an exemption to presently entitled Beneficiaries under a Discretionary Trust.

The IGS Business Insurance Trust Agreement utilises a Fixed Trust and is not dependent on the arguments with respect to Discretionary Trusts.

 

"Original Beneficial Owner"

Section 118-300 is not just concerned with the identity of the beneficial owner, but the "original" beneficial owner of the Policy.

This makes it important to legally define the original beneficial owner of the Policy from the date of application for or issue of the Policy.

If it is intended that parties other than the Policy Owner will be entitled to receive any of the Insurance Proceeds (or the benefit of any of the Insurance Proceeds), then they might have a beneficial interest in the Policy.

If this party is subsequently deprived of their interest, then the new beneficial owner might not be the original beneficial owner.

This makes it important to legally document the beneficial ownership of a Policy the whole way through the process of applying for a Policy as well as the life of the Policy.

If an agreement is not documented contemporaneously with the application, there can be changes of beneficial ownership that create CGT liabilities upon the payment of the Insurance Proceeds.

See here to see the implications of not having a contemporaneous agreement.

 

Acquisition of Policy from Previous Owner

Section 118-300 deprives a Policy Owner of a CGT exemption if they buy and sell (or trade in) Policies for money or other consideration.

However, if a Policy is acquired from a previous Owner, care must still be taken to avoid any risk that there might be deemed to be "consideration" for the acquisition that would make the new Policy Owners ineligible for the CGT exemption.

Consideration could be present if the Proprietors of a Business originally obtained Cross-Owned Policies and mutually agreed to transfer them to Self-Owned Policies in order to obatin a CGT exemption.

 

Acquisition of Beneficial Interest in Policy from Previous Owner

Similarly, the recipients of the Insurance Proceeds would not obtain an exemption if they had acquired a beneficial interest in the Policy for money or other consideration.

If a recipient of the Insurance Proceeds is not the original beneficial owner of the Policy, care must be taken to avoid any risk that there might be deemed to be "consideration" for the acquisition that would make the recipients ineligible for the CGT exemption.

See here to see how other parties can acquire a beneficial interest in a Policy that prevents the recipient from being an original beneficial owner.

 

Change of Trustee

If the parties change the Trustee under an IGS Business Insurance Trust Agreement, they will only change the "Legal Owner" of the Policy.

The Beneficial Owner of the Policy remains the same.

Thus, a change of the Trustee does not result in a change of the "Original Beneficial Owner".

As a result, there are no adverse CGT implications as a result of a change of the Trustee.

 

Assignment of Policy to Life Insured

When a Life Insured ceases to be a Proprietor of the Business under an IGS Business Insurance Trust Agreement, they are entitled to a transfer of their Policy from the Trustee to the Life Insured without any payment or consideration.

The transfer of the Policy will change the Legal Owner.

However, because the Life Insured was the "Original Benefficial Owner", the transfer of the Policy to the Life Insured will not change the Beneficial Owner of the Policy.

The Life Insured will remain the "Original Beneficial Owner" of the Policy.

As a result, there are no adverse CGT implications as aresult of a transfer of the Policy to the Life Insured..

 

Copyright: Ian Gray Solicitor

 

 

Adviser Tip

Trust ownership is an indirect form of self-ownership.

The Life Insured is the "beneficial owner" for legal and tax purposes under the roof of the Trust.

See more Adviser Tips

 

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