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Taxation Implications:

Taxation Implications of Policy Ownership

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CGT Exemptions:

CGT Exemptions for Insurance

2015 Amendments

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Methods of Policy Ownership:

Ownership Implications

Cross Ownership

Self Ownership

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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 of Debt Reduction Cover

 

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

 

CGT Exemptions for Death and Non-Death Benefits

This method of ownership obtains a CGT exemption for both Death and Non-Death Benefits.

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

This is only the first part of the journey required to repay the Debt owing by the Business to the Bank or Creditor.

Thus, while there might be no CGT liability with respect to the payment to the Life Insured or their Estate, there might be adverse commercial, legal and tax implications with respect to the arrangements by which the Insurance Proceeds are paid by the Life Insured to the Business, the Bank or other Creditors.

 

Diagram

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

 

Payment of Insurance Proceeds to Life Insured (or Estate)

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).

The payment of the Insurance Proceeds to the Life Insured or their Estate would be exempt from CGT.

 

Payment to Third Party

However, the issue is now: what arrangements need to be in place to get the Insurance Proceeds to the Business or its Creditor?

What are the commercial, legal and tax implications of these arrangements?

These issues are not generally understood by Advisers.

As a result , it is not normal for Business Debt Reduction Cover to be owned by the Life Insured.

However, if Self-Ownership is used, there can be serious commercial, legal and tax implications for all of the parties to the arrangements.

Below is an analysis of some of the implications of these arrangements.

 

CGT Liability with respect to Contractual Obligation

As mentioned above, 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.

The contractual or legal obligation would be a "chose-in-action", which is itself a CGT Asset.

Unfortunately, the discharge or performance of this obligation itself (i.e., by the payment of the Insurance Proceeds to the Business or Creditor) would create a CGT liability.

Click here to read more about this CGT liability.

This liability would be additional to the tax liability that arises under the Commercial Debt Forgiveness provisions discussed below.

 

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.

IGS Discussions with ATO

IGS investigated the Self-Ownership model in its discussions with the CGT Cell of the ATO in 2001 and confirmed the above interpretation of the CGT Provisions.

As a result, IGS discontinued its attempts to solve the problem with Self-Ownership and developed a solution that uses the Business Insurance Trust Structure.

 

Payment to Third Party as a "Gift"

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

However, this is both misguided and misleading.

In reality, the CGT test is not whether there was a "gift", but whether there was a contractual obligation.

However, in any event, it is not legally correct to describe the payment under these provisions as a "gift".

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 or Loan Account 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 used to pay principal and interest to the Outgoing Proprietor (or their Estate).

In effect, the Business now has to pay funds to the Outgoing Proprietor rather than the Bank.

In other words, it has not provided any net financial benefit to the Business.

This frustrates the Succession Plan.

If the Buy/Sell Strategy was intended to exit the Life Insured from any financial interest in the Business, the failure to structure the Debt Reduction Cover adequately undermines the strategy.

It creates a new financial interest and burden (rather than extinguishing a pre-existing one).

This problem can be avoided by the use of a Business Insurance Trust Agreement (i.e., Trust Ownership).

 

Commercial Debt Forgiveness Provisions

Many Advisers believe that this Debt or Loan Account can simply be ignored or "forgiven".

Unfortunately, any attempt to "forgive" the new Debt or Loan Account would incur a tax liability under the Commercial Debt Forgiveness provisions.

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

This problem can 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 means that a Trustee appointed by the Business will control distribution of the Insurance Proceeds to the Creditor.

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

The ATO Ruling with respect to the IGS Business Insurance Trust Agreement states that:

"the payment of an amount by the trustee to a nominated recipient in accordance with a nominated beneficiary's direction, will not be the discharge or satisfaction of an asset under CGT event C2."

The Trust Structure avoids the problems of Self-Ownership of Debt Reduction Cover.

 

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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