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Taxation Implications:

Taxation Implications of Policy Ownership

Income Tax

Capital Gains Tax

 

CGT Exemptions:

CGT Exemptions for Insurance

2015 Amendments

Death Benefits

Non-Death Benefits

Terminal Illness

 

Methods of Policy Ownership:

Ownership Implications

Cross Ownership

Self Ownership

Trust Ownership

Super Buy/Sell

 

Buy/Sell Cover:

Implications for Buy/Sell Cover

Cross Ownership

Self Ownership

Related Party Vendors

Deemed Dividends

Risks If No Agreement

Trust Ownership

Super Buy/Sell

Origins of Self-Ownership

 

Debt Reduction Cover:

Implications for Debt Reduction Cover

Cross Ownership

Self Ownership

Trust Ownership

Bank Ownership

 

Third Party Payments:

Implications for Promises to Distribute Insurance Proceeds to Third Parties

 

Commercial Debt Forgiveness:

Commercial Debt Forgiveness

Cross Ownership

Self Ownership

Trust Ownership

 

Super Fund Ownership:

Super Fund Ownership

Tax Disadvantages

Cost Disadvantages

Other Disadvantages

Geared Premium Funding

 

Aggregation onto One Policy:

Methods of Aggregation

 

 

 

 

 

 

 

 

Self-Ownership (Overview)

 

Self-Ownership means that the Life Insured owns the Policy.

 

Diagram

Click here to see a diagram that illustrates the Self-Ownership of Buy/Sell Cover and Debt Reduction Cover.

 

CGT Exemptions for Death and Non-Death Benefits

This method of ownership obtains a CGT exemption for both:

 

Buy/Sell Cover

The normal method of ownership of all Buy/Sell Insurance is now:

By definition, Self-Ownership must pay the Purchase Price to the Life Insured or their Estate.

Unlike Trust Ownership , it cannot pay the Purchase Price to the correct Vendor in cases where the Owner of the Equity is not the Life Insured.

Self-Ownership Agreements

Please click here to read about Self-Ownership Agreements.

Click here to learn more about the standard IGS Self-Ownership Business Succession Agreement used for a Simple Succession Plan.

IGS normally uses a Business Insurance Trust Agreement, if any of the Equity is owned by a party other than the Life Insured (i.e., a Related Party Vendor such as a spouse, Family Company or Family Trust).

Need for Agreement

Please click here to read about the potential adverse CGT implications of not having a contemporaneous Buy/Sell Agreement.

Self-Ownership of Buy/Sell Cover

Please click here to read more about Self-Ownership of Buy/Sell Cover

 

 

Payment to Appropriate Vendor

By definition, Self-Ownership must pay the Insurance Proceeds to the Life Insured or their Estate.

Care should be taken to determine whether this is the right destination for the Insurance Proceeds from a commercial and family point of view.

In many cases, the Equity in the Business might be owned by a Third Party such as a Company or Family Trust.

Because Self-Ownership requires the Life Insured to own the Policy, the Insurance Proceeds attributable to the Purchase Price must be paid to the Life Insured or their Estate, even if the Equity in the Business is owned by a third party (such as a Company or Family Trust).

Thus, Self-Ownership can result in the Purchase Price being paid to the wrong party, in order to obtain a CGT exemption with respect to the Insurance Proceeds.

Failure to Receive Sale Price

The Vendor's failure to receive value for the Equity can create significant legal and commercial problems, especially where it must use the Sale Proceeds to:

  • release a mortgage with respect to the asset; or

  • pay a Capital Gains Tax liability with respect to its disposal.

In addition, the inappropriate payment of the Insurance Proceeds to the Estate means that they have to be distributed in accordance with the Life Insured's Will (rather than the terms of the Trust Deed).

The Life Insured might not always wish to treat the assets of their Family Trust in the same way as the assets of their Estate in the event of their death.

The Insurance Proceeds would also be subject to disputes with respect to the distribution of the Estate by disgruntled Beneficiaries.

Click here to read a discussion of the significant administrative, commercial and tax problems that can arise if the Owner or Vendor is not the Life Insured (e.g., a Company or a Discretionary or Family Trust).

Insurance Trust Solution

These problems can be avoided by the use of a Business Insurance Trust Agreement.

 

Implications for Contractual Promises to Distribute Insurance Proceeds to Third Parties

Click here to read about the CGT liability with respect to contractual promises by the Life Insured to pay the Insurance Proceeds to Third Parties once they have been received from the Insurer.

This tax liability is relevant when the Business Succession Agreement:

  • requires the Life Insured to own the Policy (so that they can obtain a CGT exemption for both Death and Non-Death Benefits); and

  • obliges the Life Insured (or their Estate) to distribute the Insurance Proceeds to a Third Party upon receipt from the Insurance Company.

 

Debt Reduction Cover

Diagram

Click here to see a diagram that illustrates the Self-Ownership of Debt Reduction Cover.

CGT Liability

While the payment of the Insurance Proceeds to the Life Insured or their Estate would be exempt from CGT, it is not normal for Business Debt Reduction Cover to be owned by the Life Insured.

Upon the occurrence of an Insured Event, any Insurance Proceeds would be received by the Life Insured or their Estate (not the Business or the Creditor).

It would be necessary to impose a contractual or legal obligation on the Life Insured or Estate to pay the Insurance Proceeds to the Business or its Creditor.

Unfortunately, this obligation itself can create a CGT liability upon the performance of the obligation.

Hybrid Business Succession Strategy

An example of this type of Self-Ownership Structure is a Hybrid Business Succession Strategy.

This Structure requires the Life Insured to own the Debt Reduction (or Key Person Capital Cover) on the basis that they will be contractually obliged to pay the Insurance Proceeds to the Business, the Continuing Proprietors or the Creditor.

Unfortunately, the discharge or performance of this obligation itself would create a CGT liability.

Payment to Third Party as "Gift"

When pressed, some advocates of this structure describe the payment as a "gift".

However, this is both misguided and misleading.

In the High Court case of FCT v. McPhail (1968) 117 CLR 111; (1968) 15 ATD 16; (1968) 10 AITR 552, Owen J stated:

But it is, I think, clear that to constitute a "gift", it must appear that the property transferred was transferred voluntarily and not as the result of a contractual obligation to transfer it and that no advantage of a material character was received by the transferor by way of return.

This case is authority for the proposition that, to be a gift, a payment must be made voluntarily and not as the result of a contractual obligation.

If there is no contractual obligation to make the payment to the Third Party, then there is no legal framework to ensure that it happens.

This subjects the parties who rely on the payment being made (the Business, the Continuing Proprietors and the Creditor) to the risk that the Life Insured (or the Executor of their Estate) will not make the payment.

In the absence of a contractual obligation, they would have no legal remedy to enforce the payment.

Therefore, under this structure, there is either:

  • a gift (which is unenforceable and cannot be remedied in the case of default); or

  • a contractual obligation (the performance of which is subject to CGT).

There is no middle ground in the case of Self-Ownership of Debt Reduction Cover.

Right of Contribution

In addition, the repayment of a Debt by a Guarantor or party other than the Debtor creates a "Right of Contribution".

A Right of Contribution entitles the Guarantor to be reimbursed by the Debtor and any other Guarantors for the payment it has made on their behalf.

This Right creates a new Debt between the Life Insured (or their Estate) and the Business.

In effect, it creates a new Loan Account in substitution for the Debt owing to the Bank.

Thus, future profits of the Business would have to be paid to the Outgoing Proprietor (even though the Buy/Sell Strategy was intended to exit the Life Insured from any financial interest in the Business).

Commercial Debt Forgiveness Provisions

Any attempt to "forgive" this Debt would attract CGT under the Commercial Debt Forgiveness Rules.

As a result, while the payment of the Insurance Proceeds would be CGT-exempt, other commercial elements of the transaction would attract CGT.

These problems can both be avoided by the use of a Business Insurance Trust Agreement (i.e., Trust Ownership).

Security of Repayment of Creditor?

Self-Ownership means that the Life Insured (or their Executor) will be responsible for distributing the funds of the Business to the Creditor.

There is therefore a commercial risk that there will be a default or delay in the performance of their obligation.

Insurance Trust Solution

A Business Insurance Trust Agreement means that a Trustee will control distribution of the Insurance Proceeds to the Creditor in accordance with the terms of the Trust Agreement.

This means that physical control of the Insurance Proceeds (and therefore the implementation of the "Business Will") is in the hands of a custodian that has a contractual and fiduciary obligation to comply with the obligations contained in the Trust Agreement.

The Trust is therefore a more secure vehicle for protecting the interests of all of the members of the "Business Family".

Self-Ownership of Debt Reduction Cover

Please click here to read more about Self-Ownership of Debt Reduction Cover

 

 

Self-Ownership as A Vehicle for Aggregation

One of the commercial justifications of Trust Ownership is its suitability as a vehicle for aggregation of Cover onto One Policy (i.e., the One Page, One Policy Strategy).

There have been attempts to use Self-Ownership to mimic this functionality of Trust Ownership (sometimes called a "Hybrid Business Succession Strategy").

These attempts aggregate different Cover onto one policy held by the Life Insured, on the basis that the Life Insured (or their Executor) has a legal obligation to distribute the Insurance Proceeds to the different recipients.

The above analysis shows that Self-Ownership can be an inadequate strategy even when the Cover is self-owned on separate Policies.

This inadequacy is still present and is not cured in the case of aggregation.

More importantly, the ownership of the Cover by the Life Insured gives the Life Insured (or the Executor of their Estate) control over the distribution of the Insurance Proceeds.

Click here to read more about the practical concerns with respect to this Strategy.

Click here to see a discussion of the concept of a Business Family Will and the implications of control of the Insurance Proceeds.

 

Hybrid Business Insurance Trust Agreement

Please note that the Hybrid Business Succession Strategy is different to the IGS Hybrid Business Insurance Trust Agreement discussed here.

 

Copyright: Ian Gray Solicitor

 

 

Adviser Tip

Self-Ownership must pay the insurance proceeds to the Life Insured or their Estate.

It cannot pay them to a Related Party that owns some of the Equity in the Business (e.g., a Family Trust or Company) nor can it pay them to a Creditor without adverse tax implications.

See more Adviser Tips

 

 

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