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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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Cross-Ownership (Overview)
Cross-Ownership means that a person or entity other than the Life Insured owns the Policy.
Diagram Click here to see a diagram that illustrates the Cross-Ownership of Buy/Sell Cover and Debt Reduction Cover. Buy/Sell CoverIn the case of Buy/Sell Cover, the Policy Owner might be the other Proprietors or Purchasers. This method of ownership allows the Purchasers to obtain funds out of which they can pay the Purchase Price in exchange for a transfer of the Vendors' Equity in the Business. Death Benefit Cross-Ownership will normally obtain a CGT exemption for the Death Benefit. Non-Death Benefits Unfortunately, Cross-Ownership will result in a CGT liability in the case of Non-Death Benefits. Implications for Policies that Bundle Death and Non-Death Benefits Because Non-Death Benefits are usually bundled with a Death Benefit under the one Policy, it is no longer normal for the Purchasers to own Buy/Sell Insurance. The normal method of ownership of all Buy/Sell Insurance is now:
Cross-Ownership Agreements Please click here to read about Cross-Ownership Agreements. Cross-Ownership of Buy/Sell Cover Please click here to read more about Cross-Ownership of Buy/Sell Cover
Debt Reduction CoverDiagram Click here to see a diagram that illustrates the Cross-Ownership of Debt Reduction Cover. CGT Liability Business Debt Reduction Cover has traditionally been owned by the Company or Business (i.e., the Debtor). This method of ownership allows the Debtor to obtain funds out of which it can reduce the Debt owing to the Creditor. Death Cover Company or Cross-Ownership will normally obtain a CGT exemption for the Death Benefit. Income Tax Liability with respect to Subsequent Dividends Unfortunately, while the receipt of Death Benefits by a Company would be CGT-free, there is an adverse income tax implication: because no tax has been paid, 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. In other words, you can get funds into a Company tax-free, but you can't get them out tax-free. Non-Death Cover Because the Life Insured is not the "beneficial owner" of the Policy, Company or Cross-Ownership will now result in a CGT liability in the case of Non-Death Benefits. "Grossing Up" the Sum Insured Where the CGT liability of Non-Death Benefits owned by the Business is recognised, 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. 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. Cross-Ownership of Debt Reduction Cover Please click here to read more about Cross-Ownership of Debt Reduction Cover
Insurance Trust Solution The adverse implications of Cross-Ownership can be avoided by the use of a Business Insurance Trust Agreement (i.e., Trust Ownership).
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Adviser Tip Most Advisers and Accountants are aware that Cross-Ownership can result in a capital gains tax liability with respect to Buy/Sell Cover. However, they don't realise that it can also result in a CGT liability for Debt Reduction and Key Person Capital Cover. Unfortunately, Self-Ownership can solve the problem for Buy/Sell Cover, but it can't solve it for Debt Reduction or Key Person Capital Cover.
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