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Taxation Implications: Taxation Implications of Policy Ownership
CGT Exemptions:
Methods of Policy Ownership:
Buy/Sell Cover: Implications for Buy/Sell Cover
Debt Reduction Cover: Implications for Debt Reduction Cover
Third Party Payments: Implications for Promises to Distribute Insurance Proceeds to Third Parties
Commercial Debt Forgiveness:
Super Fund Ownership:
Aggregation onto One Policy:
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Capital Gains Tax
Income Tax Click here to read about the Income Tax treatment of Insurance Proceeds.
Capital Gains Tax The introduction of Capital Gains Tax resulted in potential tax liabilities for all forms of Business Insurance (including Buy/Sell Insurance) under the Income Tax Assessment Act 1997 and earlier legislation. This liability will apply even if the purpose of the Cover was capital in nature and the Insurance Proceeds were not otherwise subject to Income Tax. Many Advisers are aware of this liability (and how it can be avoided legitimately) in the context of Buy/Sell Insurance. However, many of them are not aware of how it affects Debt Reduction Cover and Key Person Cover.
Assessability of Insurance Proceeds The CGT legislation treats:
The whole of the Insurance Proceeds are therefore potentially subject to CGT (subject to any available exemptions).
Definition of "CGT Asset" The definition of CGT Asset includes a "chose-in-action". "Chose in Action" A chose-in-action is a contractual promise to do something or to pay something. Pending its performance, the chose-in-action or contract is called an "executory contract". The word "executory" means yet to be performed. When the contractual obligation is performed, the contract is said to be "executed". Insurance Policy An Insurance Policy is a contractual promise to pay the Sum Insured upon the occurrence of an Insured Event. Therefore, an Insurance Policy is a "chose-in-action" and therefore a CGT Asset.
Disposal of CGT Asset The most obvious example of a "disposal" for CGT purposes is when a Vendor sells or transfers a CGT Asset to a Purchaser: CGT Event A1. This type of disposal might occur if one Policy Owner transfers the Policy to another party by way of a Memorandum of Transfer.
"Deemed Disposal" of CGT Asset The CGT legislation also deems a "disposal" to have taken place in some situations, even though there is no Vendor or Purchaser within the normal meaning of these words. One situation is if the ownership of the CGT Asset ceases or ends as a result of it being satisfied or discharged: CGT Event C2.
"Deemed Disposal" of Chose-in-Action This type of deemed disposal is relevant to choses-in-action. When a contractual obligation is performed in accordance with the contract, the contract is terminated or discharged "by way of performance". Contractual Obligation Ceases The CGT Legislation works on the basis that, if a party performs its contractual obligation under a contract or chose-in-action, the obligation has ceased. In other words, the other party has ceased to have the benefit of a right to enforce the performance of the obligation. In a sense, if you have done what you promised to do, I have ceased to have a right to make you do it. You can't be compelled to do it again, if you have already done it. Deemed Disposal Unfortunately, the termination or discharge of the contractual promise by its performance is treated as a disposal of the chose-in-action or CGT Asset under CGT Event C2. In other words, when the obligation ceases, the beneficiary of the obligation is deemed to have disposed of it. This termination or discharge satisfies the requirements of CGT Event C2 and therefore results in a disposal of the CGT Asset. Example If I contractually promise to pay you $200,000, then when I do:
Public Policy with respect to Choses-in-Action The treatment of contractual promises or "choses-in-action" under the CGT legislation is quite sophisticated. However, underlying the legislation is a public policy view that the transfer of an asset or money from one party to another pursuant to a contractual obligation is a transaction that should be subject to Capital Gains Tax (subject to any recognised exemptions). In the above example, $200,000 has been transferred from one party to the other. A CGT disposal occurs because one party receives an economic benefit from the other (pursuant to a chose-in-action or contractual obligation).
ATO's Views The ATO has most recently expressed its views on this issue in TD2008/22 in 2008. It states that this view is consistent with the decision of the High Court in FC of T v. Orica Limited (formerly ICI Australia Limited ) (1998) 194 CLR 500; 39 ATR 66; 98 ATC 4494. At paragraph 22, it states
Implications for Insurance Policies The above tax treatment applies to Insurance Policies. An Insurance Policy is a chose-in-action and therefore a CGT Asset. An Insurance Policy is a contractual promise to pay the Sum Insured upon the occurrence of an Insured Event. The payment of Insurance Proceeds from the Insurer to the Policy Owner will terminate the Policy (or that particular obligation within the Policy). As a result, there will be a disposal of the Policy (or the particular obligation within the Policy). It must then be determined whether any CGT exemptions apply.
Limited Exemptions The legislation contains exemptions from the CGT liability for Insurance Proceeds (the first level chose-in-action). However, they are limited. They also make illogical distinctions between the different Benefits under a Policy. As a result, the traditional methods of ownership of Business Insurance that applied before the introduction of CGT will now result in a CGT liability with respect to the Insurance Proceeds in many circumstances. In the case of Buy/Sell Insurance, any potential CGT liability would be additional to any CGT liability with respect to the disposal of the Equity in the Business. Thus, there is a risk that there could be CGT liabilities with respect to both the Insurance Proceeds and the sale of Equity. Click here to read about the CGT exemptions for Insurance Proceeds.
Implications for Contractual Promises to Distribute Insurance Proceeds Many Succession Planning Lawyers recommend Self-Ownership of the Policy to avoid CGT in the case of both Death and Non-Death Benefits. This strategy achieves a CGT Exemption at the level of the first level chose-in-action. However, there are many circumstances in which the ultimate intended Recipient of the Insurance Proceeds is actually a Third Party other than the Life Insured. The tax-effective ownership of the Policy does not necessarily "get the right money to the right person at the right time". Payment or Distribution to Third Party Recipients In these cases , the Business Succession Agreement might also contain other contractual provisions that bind the Policy Owner to distribute the Insurance Proceeds to other parties in a pre-agreed manner. These provisions apply once the Policy Owner has received the Insurance Proceeds from the Insurer. These provisions will constitute a second level chose-in-action, the performance of which will create a CGT disposal for CGT purposes. Click here to read about the CGT and other implications with respect to these provisions.
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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.
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