Home

 

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

 

 

 

 

 

 

 

 

 

Cross-Ownership of Debt Reduction Cover

 

Debt Reduction Cover has traditionally been owned by the Company or Business.

This method of ownership allows the Debtor to obtain funds out of which it can reduce the Debt owing to the Creditor.

 

Diagram

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

 

Death Benefit

Company or Cross-Ownership will normally obtain a CGT exemption for the Death Benefit.

For example, a Death Benefit of $200K would be tax-free in the hands of the Company.

See below for the adverse Income Tax implications of this method of ownership.

 

Non-Death Benefits

Unfortunately, this method of ownership will now result in a CGT liability in the case of Non-Death Benefits.

For example, a Non-Death Benefit of $200K would be subject to CGT of $60K in the hands of the Company.

After the CGT liability has been allowed for, only $140K would be available to reduce the Company debt.

 

Adverse Tax Implications of Company Ownership of Death Benefits

While the Company Ownership of a Death Benefit will obtain a CGT exemption, the eligibility for the exemption actually creates another Income Tax problem.

The shareholders of Companies normally obtain a "franking credit" for any dividend paid out of funds upon which the Company has already paid income tax (at the rate of 30%).

Instead of paying income tax on the dividend at their marginal tax rate (e.g., 46.5%), the shareholder's tax rate will be reduced by 30% (e.g., to 16.5%).

Unfortunately, while the receipt of Death Benefits by a Company would be CGT-free, the very availability of the exemption has an adverse income tax implication: because no tax has been paid by the Company, there would be no franking credits attributable to the Insurance Proceeds.

Therefore, any subsequent dividends attributable to the Insurance Proceeds would be taxable at the full marginal rate of the shareholders (e.g., 46.5%).

In summary, you can get insurance proceeds into a Company tax-free. However, you cannot get them out tax-free.

Example

The Death Benefit of $200K would be tax-free in the hands of the Company.

The whole amount would be available to reduce the Company debt at the time of the claim.

However, the reduction of the debt by $200K would reduce the demand on the cash flow of the Company that would have been required to fund principal and interest payments.

Ignoring the interest payments, this means that over time it would be possible to pay $200K to the Proprietors or Shareholders by way of dividends.

Because they would be un-franked, they would be subject to income tax of up to $93K.

Thus, out of the total of $200K, only $107K would be available to the Shareholders after tax.

 

"Grossing Up" the Sum Insured

Where the CGT liability of Non-Death Benefits owned by the Business is recognized, some Advisers recommend that the Business increase or "gross-up" the sum insured to allow for the CGT liability.

For example, if the desired amount of debt reduction is $200,000, they increase the sum insured to allow for the tax payable on the insurance proceeds by the Company at the rate of 30%.

In order to pay the tax liability and end up with the correct net amount, it is necessary to gross-up the sum insured by 42.86%.

Thus, in order to repay $200,000, the sum insured must be $285,720.

The tax liability on this amount will be approximately $85,720, which will leave $200,000 available to repay the debt.

Ironically, because most Non-Death Benefits are bundled with a Death Benefit, this will increase the premium for both Benefits by 42.86%.

In addition, this solution increases the franking credit problem by 42.86% as well.

Thus, while the correct amount of debt is repaid, there is still income tax payable at marginal rates on subsequent dividends.

Example

If the Premium was 0.3% of the Sum Insured, the Premium with respect to:

  • a Sum Insured of $200K would be $600 per annum; and

  • a Sum Insured of $285,720 would be $857 per annum.

Thus, the gross-up strategy would cost an additional $257 per annum to achieve the same targeted repayment of debt.

In the case of a Death Benefit, there would be no CGT payable by the Company.

However, the income tax payable by the Shareholders with respect to a dividend of $285,720 would be up to $132,860.

 

Commercial Implications of Repayment of Debt

If the Business owned the Debt Reduction Cover in its own name, normally the payment of the Insurance Proceeds would increase the value of the Business by the amount of the Sum Insured.

Even though the funds would be used to repay the Debt to the Bank or Creditor, the payment would:

  • reduce the amount of a Creditor on the Balance Sheet; and

  • increase the Net Asset Value of the Business.

Example

Assume a Company is owned by two equal Shareholders and it owes $400K to a Bank.

The Bank requires each Life Insured to hold Debt Reduction Cover of $200K.

If one Life Insured died, the payment of the Claim and the repayment of $200K to the Bank would increase the Net Asset Value of the Company by $200K.

One implication of this is that the value of the Life Insured's Shareholding would increase by $100K.

In a sense, the repayment of the Debt has made it $100K more expensive to buy the shares held by the Life Insured's Estate.

Care must be taken with respect to the implications of the Debt Reduction Strategy for the Buy/Sell Strategy.

Trust Ownership Strategy

The adverse implications of these arrangements can be avoided by the IGS Business Insurance Trust Agreement.

Click here to read about how the Trust Ownership of Debt Reduction Cover structures the repayment of the Debt.

 

Bank Ownership of Debt Reduction Cover

A common variation of the Cross-Ownership of Debt Reduction Cover is Bank Ownership.

Under this variation, the Bank is the Policy Owner.

Click here for an analysis of Bank Ownership of Debt Reduction Cover.

 

Insurance Trust Solution

The CGT liability of the Non-Death Benefits and the income tax liability of subsequent dividends attributable to the Death Benefits can both be avoided by the use of a Business Insurance Trust Agreement.

As a result, the Agreement can save the additional Premium cost of grossing up the Cover.

Businesses can use this component of a Business Insurance Trust Agreement, even if no Buy/Sell Cover is required.

 

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

 

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.