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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

 

 

 

 

 

 

 

 

Implications for Buy/Sell Cover

 

Overview

The tax implications of Policy Ownership generally are discussed here.

Income Tax

Buy/Sell Cover is generally regarded as Capital in nature.

As a result, the Insurance Proceeds are not subject to Income Tax on normal principles.

Capital Gains Tax

However, the Insurance Proceeds might be subject to Capital Gains Tax (subject to the availability of an Exemption for the particular method of Policy Ownership).

 

Alternative Methods of Ownership

The following pages summarise the tax implications for the three alternative methods of ownership of Buy/Sell Cover:

 

Pre-CGT Ownership of Buy/Sell Cover

Before the introduction of Capital Gains Tax, the standard method of ownership of Buy/Sell Cover was Cross-Ownership.

Each Proprietor's Policy was owned by the other Proprietor.

If there were a number of other Proprietors, the Policy would be owned by all of them jointly.

If an Insured Event occurred with respect to the Life Insured, the other Proprietors would receive the Insurance Proceeds.

At this moment in time:

  • the Executor of the Life Insured's Estate would hold the Equity in the Business; and

  • the other Proprietors would hold the Purchase Price that has been funded by the Insurance Policy.

This situation is identical to any situation where a Vendor wishes to sell an asset to a Purchaser.

All that is necessary is a contractual framework that requires the Vendor to transfer the asset to the Purchaser in "exchange" for payment of the Sale Price at the time of completion.

Outside the context of Buy/Sell Insurance, the contract is a normal Contract of Sale or conveyancing agreement.

Within the Buy/Sell context, the contract is a Buy/Sell or Business Succession Agreement.

Pre-CGT, therefore, Buy/Sell Agreements were drafted in the same manner as any other Contract of Sale or Conveyancing Agreement.

 

Introduction of Capital Gains Tax

The introduction of Capital Gains Tax in 1985 had significant implications for both:

  • the Ownership of Business Insurance Cover; and

  • the drafting of Buy/Sell Agreements.

These implications still cause confusion for Advisers and Clients.

 

Post-CGT Ownership of Buy/Sell Cover

The introduction of CGT resulted in a CGT liability on Buy/Sell Cover in some circumstances, over and above any CGT payable with respect to the sale or disposal of the Equity in the Business.

The Cross-Ownership of Buy/Sell Cover will normally obtain an exemption with respect to a Death Benefit.

Unfortunately, it will result in a CGT liability with respect to a Non-Death Benefit.

The different tax treatment of Death and Non-Death Benefits created a problem for the traditional method of Cross-Ownership of Buy/Sell Cover.

This is the origin of the practice of using Self-Ownership to hold Buy/Sell Cover.

Self-Ownership obtains a CGT exemption for both Death and Non-Death Benefits.

Therefore, Insurance Companies and Lawyers sought a solution pursuant to which Buy/Sell Cover could be Self-Owned.

Click here to read more about the origins of the Self-Ownership of Buy/Sell Cover.

 

Legal Consequences of Self-Ownership

The problem with the Self-Ownership solution is that upon payment of the claim:

  • the Executor of the Life Insured's Estate would hold the Equity in the Business; and

  • the Executor (not the other Proprietors) would hold the Purchase Price that has been funded by the Insurance Policy.

In other words, at this moment in time, the Executor has both the Equity and the cash.

There is no need for a formal "exchange", because the Executor already has everything it could want...and more!

This leaves the Purchasers very vulnerable to the risk of default by the Executor.

What happens if the Executor declines to transfer the Equity?

 

The Need for a "Crediting Provision"

A modern Self-Ownership Agreement doesn't provide for a traditional "exchange".

Instead, it contains a "Crediting Provision" that:

  • gives the Purchasers "credit" for the funds paid to the Vendor by the Insurance Company; and

  • therefore requires the Vendor to transfer the Equity without any additional payment by the Purchasers.

This Crediting Provision is unique to Self-Ownership Buy/Sell Agreements.

It won't be found in a standard Contract of Sale or Conveyancing Agreement.

These Agreements always assume that the Purchasers must fund their own Purchase Price.

A Crediting Provision is only required because someone other than the Purchaser is funding the Purchase Price.

 

Tax and Other Implications

Self-Ownership is so common now that most Advisers don't realise that it is a non-arm's length solution to a CGT issue.

However, because it is intrinsically non-arm's length, caution must be used.

Click here to read about the tax and other implications of a Crediting Provision in a Self-Ownership Buy/Sell Agreement.

 

Consequences of Not Having An Agreement

The need for a Crediting Provision makes it vital to have an Agreement, if Self-Ownership is used.

If you haven't signed a Business Succession Agreement, then there is no "Crediting Provision" and the Estate can ask for payment (even though it has already received the Insurance Proceeds).

Self-Ownership without a Business Succession Agreement is the most dangerous outcome for the Purchasers.

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

 

Trust Ownership

Under the form of Trust Ownership used by IGS, the Life Insured is the Beneficial Owner of the Policy.

It is therefore an indirect form of Self-Ownership, which obtains the same tax treatment as Self-Ownership.

However, IGS uses Trust Ownership to overcome the disadvantages of Self-Ownership (e.g., the inability to pay the Purchase Price to a Vendor other than the Life Insured or their Estate).

 

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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Current Marketing Schedule

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