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 Contractual Promises to Distribute the Insurance Proceeds to Third Parties


Most Business Succession Lawyers and Advisers are conscious of the potential CGT liability with respect to the payment of the Insurance Proceeds by the Insurer.

In most cases, they avoid this liability by Self-Ownership (at least in the case of Buy/Sell Insurance).

However, this strategy might not always "get the right money to the right person at the right time".

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

This page examines some of the issues that arise when Self-Ownership is used when the Insurance Proceeds are ultimately intended to (or should) be paid to Third Party Recipients.


Third Party Recipients

There are many circumstances in which the ultimate intended Recipient of the Insurance Proceeds is actually a Third Party other than the Life Insured or Policy Owner.

Examples are:

  • Related Party Vendors (in the case of Buy/Sell Cover); and

  • Banks or Creditors (in the case of Debt Reduction Cover).

These examples are discussed below.


Related Party Vendors

A common example of a Third Party Recipient is where the Equity in the Business is owned by a party other than the Life Insured (e.g., a Family Trust or Family Company).

The duty of all of the Advisers is to get the right money to the right party.

However, most Self-Ownership Business Succession Agreements are content to distribute the Sale Proceeds to the Life Insured (or their Estate), on the assumption that "near enough is good enough".

Their primary goal is to avoid any CGT liability with respect to the Insurance Proceeds paid by the Insurer to the Policy Owner.

They ignore or overlook the fact that a Vendor should be entitled to receive the Sale Proceeds from the Equity it is obliged to sell.

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.

Ultimately, the role of Business Succession Agreements is to pay the Sale Proceeds to the appropriate Vendor.

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).


Repayment of Debt to Creditor or Bank

Another example is where the Insurance Proceeds are required to be paid to a Creditor or Bank.

In these cases, there is a mutual interest in ensuring that the payment is made to the actual Creditor, because:

  • the Business wants its Debt reduced; and

  • the Life Insured (or their Estate) will usually require a Release of their Personal Guarantee.


Ownership of Policy by Third Party Recipient

If the Third Party was the Policy Owner, they might not be entitled to a CGT Exemption with respect to the Insurance Proceeds.

In some cases, Advisers recogise that there might be a CGT liability and nevertheless adopt this method of ownership.

In these cases, they might "gross-up" the Cover to allow for the CGT liability.

See here to read more about this strategy.


Self-Ownership with Contractual Obligations

An alternative strategy is to:

  • adopt Self-Ownership of the Cover (in order to obtain the CGT Exemptions), and

  • insert contractual obligations into the Business Succession Agreement that compel the Life Insured (or the Executor of their Estate) to pay the Insurance Proceeds to the Third Party.


Examples of this type of contractual obligation are the obligation by the Policy Owner or Life Insured to:

  • pay the Insurance Proceeds to the actual Owner or Vendor of the Equity in the Business;

  • pay the Insurance Proceeds to a new Discretionary Trust, which then uses the Insurance Proceeds to enable the parties to comply with certain pre-agreed contractual obligations (e.g., to pay the Purchase Price of the Outgoing Proprietor's Equity to the Outgoing Proprietors on behalf of the Continuing Proprietors); and

  • repay a Debt of the Business to the Creditor.

CGT Liability

Unfortunately, these provisions will constitute a second level "chose-in-action", the performance of which will create a CGT disposal for CGT purposes.


Tax Treatment of Contractual Obligations

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).

A CGT disposal occurs because one party receives an economic benefit from the other (pursuant to a chose-in-action or contractual obligation).


Definition of "CGT Asset"

The definition of CGT Asset includes a "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".


"Deemed Disposal" of Chose-in-Action

When a contractual obligation is performed in accordance with the contract, the contract is terminated or discharged "by way of performance".

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.


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

" In that case, the Court held unanimously that the right to performance of an executory contract (in that case, an 'in substance' debt defeasance arrangement) was an asset for CGT purposes.

"It was further held that the asset was realised for CGT purposes when the other party gave performance of its obligations."

See here for a more detailed explanation of how a CGT liability will arise upon the performance or satisfaction of a contractual obligation or chose-in-action.


Tax Treatment of Insurance Policies

This legislation applies to the payment of Insurance Proceeds from the Insurer to the Policy Owner pursuant to the contractual obligations contained in the Insurance Policy (in this context, a first level chose-in-action).

Fortunately, the legislation contains exemptions specifically for Insurance Policies under sections 118-300 or 118-37 of the ITAA 1997.


Tax Treatment of Other Choses-in-Action

However, the legislation also applies to contractual provisions that bind the Policy Owner to distribute the Insurance Proceeds to other parties in a pre-agreed manner.

These provisions will constitute a second level chose-in-action, the performance of which will create a CGT disposal for CGT purposes.

The payment by the Insurer will still be exempt under sections 118-300 or 118-37.

However, these exemptions apply only to the payment by the Insurer.

They do not apply to a second or subsequent payment by the Policy Owner to a Third Party.

Therefore, the subsequent or second level contractual promise would be a chose-in-action, the performance of which will constitute a disposal of a CGT Asset for CGT purposes.


Self-Ownership of Debt Reduction Cover

Click here to read an analysis of this issue in the context of the Self-Ownership of Debt Reduction Cover.


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.

Clover Law Discussions with ATO

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


Checking Your Self-Ownership Agreement

Businesses and Advisers who use Self-Ownership should determine whether their legal arrangements are:

  • straightforward or simple Self-Ownership arrangements; or

  • merely one step in a complex sequence of arrangements that might include second level contractual obligations.


Clover Law Business Insurance Trust Agreement

The Clover Law Business Insurance Trust Agreement has been designed to avoid any CGT liability with respect to the payment of the Insurance Proceeds to the ultimate intended Recipient (e.g., a Related Party Vendor, the Business or a Creditor).

The Business Insurance Trust Agreement can distribute the Insurance Proceeds directly to Third Parties both securely and tax-effectively.

The ATO Ruling with respect to the Clover Law 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."



Copyright: Clover Law Pty Ltd



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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