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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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Trust Ownership of Debt Reduction Cover
The Clover Law form of Trust Ownership means that a Trustee owns the Policy on behalf of the Life Insured.
Diagram Click here to see a diagram that illustrates the Trust Ownership of Debt Reduction Cover.
CGT Exemptions for Death and Non-Death Benefits Because the Life Insured is the Beneficial Owner of the Debt Reduction Cover, Trust Ownership obtains all available CGT Exemptions for Death and Non-Death Benefits. In addition, it can distribute the Debt Reduction Cover directly to the Creditor both securely and tax-effectively. The ATO Ruling with respect to the Clover Law Business Insurance Trust Agreement states that:
The Trust Structure avoids the problems of Self-Ownership of Debt Reduction Cover discussed here. This means that the repayment of the Debt owing to the Creditor can be achieved by a payment by the Trustee to:
However, for the reasons set out below, the standard Agreement uses a Substitute Loan Account Structure to channel the Insurance Proceeds from the Continuing Proprietors to the Business to the actual Creditor.
Commercial Implications of Repayment of Debt If the Business owned the Debt Reduction Cover in its own name (Cross-Ownership), 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:
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. Equally importantly, it is important to recognise that a Debt Reduction Strategy without a Buy/Sell Strategy can have adverse implications for the Continuing Proprietors. Trust Ownership Strategy The Clover Law Business Insurance Trust Agreement has been designed to avoid the adverse implications of these arrangements. The standard Agreement does not normally credit the Insurance Proceeds to the Business or Borrower directly. Instead, it credits the Insurance Proceeds to the Continuing Proprietors of the Business. They then lend the Insurance Proceeds to the Business, so that it can repay the Bank or Creditor. In effect, the Agreement creates new Loan Accounts owing to the Continuing Proprietors in substitution for the external Debt owing to the Bank or Crediotor. Because the overall Debt of the Business is the same after the repayment of the external Bank or Creditor, there is no change to the value of the Business or the Purchase Price of the Equity in the Business. Thus, the repayment of the Debt has no adverse implications for the Buy/Sell Strategy. If a Buy/Sell Strategy has not been implimented, then these arrangements have a neutral impact on the Purchase Price that would be payable to the Vendors.
Commercial Debt Forgiveness Provisions If the Life Insured owned the Debt Reduction Cover in order to obtain CGT Exemptions for both Death and Non-Death Cover (Self-Ownership), the arrangements can result in the creation of a "Right of Contribution" in favour of the Life Insured (or their Estate) and the application of the Commercial Debt Forgiveness Provisions. Click here to read an explanation of the implications of these arrangements. The Trust Structure is designed to avoid any application of the Commercial Debt Forgiveness Provisions to the manner in which the Debt is repaid by the Business. Under the standard Agreement, the Trustee physically pays the Creditor directly. However, the journal entries required by the standard Agreement can show a payment to either the Business or the Continuing Proprietors (as mentioned above, the standard Provision specifies the Continuing Proprietors). This avoids the creation of a "Right of Contribution" in favour of the Life Insured (or their Estate) . Whether the Insurance Proceeds are paid to the Business or the Continuing Proprietors, the Agreement specifies that the Insurance Proceeds are paid to them absolutely and not by way of a loan. The Insurance Proceeds are not paid to the Life Insured and on-lent to the Business (so that it an repay the Bank or Creditor). As a result, the payment does not create any Right of Contribution or Loan Account as between:
In the absence of a Loan owing to the Life Insured (or their Estate), there is no question of any Commercial Debt Forgiveness. Click here to read more about Trust Ownership and the Commercial Debt Forgiveness Provisions.
Secure Repayment of Creditor While Self-Ownership means that the Life Insured (or their Executor) will be responsible for distributing the funds of the Business to the Creditor, a Business Insurance Trust Agreement means that a Trustee will control distribution of the Insurance Proceeds to the Creditor in accordance with the terms of the Trust Agreement. This means that physical control of the Insurance Proceeds (and therefore the implementation of the "Business Will") is in the hands of a custodian that has a contractual and fiduciary obligation to comply with the directions of the Beneficial Owner in the Trust Agreement. The Trust is therefore a more secure vehicle for protecting the interests of all of the members of the "Business Family".
Substitute Loan Accounts As mentioned above, one of the unique features of the Clover Law Business Insurance Trust Agreement is the manner in which it it establishes Loan Accounts pursuant to which the Continuing Proprietors lend the Debt Reduction Insurance Proceeds to the Business, which in turn repays the Creditor. The journal entries required by the standard Agreement show a payment of the Insurance Proceeds to the Continuing Proprietors (who now own 100% of the Business between them). In effect, the Agreement creates new Loan Accounts owing to the Continuing Proprietors in substitution for the external Debt owing to the Bank or Creditor. The Continuing Proprietors are referred to as "Substitute Lenders". Under the Clover Law Trust Structure, the initial payment of the Insurance Proceeds to the Substitute Lenders does not create any Loan Account or other obligation owing by them to the Life Insured or their Estate. The new Loan Accounts are not intended or required to be "forgiven" . Instead, the existence of the new Loan Accounts in favour of the Substitute Lenders allows future cash flow of the Company to be paid to the Substitute Lenders as tax-free repayments of principal (rather than as assessable dividends).
Avoidance of Franking Credit Problem This structure avoids one of the adverse tax implications of Company Ownership of Debt Reduction Cover. 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. Under the Loan Account structure created by the Business Insurance Trust Agreement, the Debt Reduction Proceeds are lent to the Company. This enables the Loan Accounts to be repaid tax-free in the future (i.e., the payments are repayments of principal owing with respect to the Loan Accounts, not payments of dividends). Example In the above example, the Agreement would save:
Obviously, this level of saving more than funds the cost of setting up and updating the Agreement.
Use of Substitute Loan Acounts in the Case of Unit Trusts The franking credit problem doesn't arise in relation to the taxation of Unit Trusts. However, use of the Substitute Loan Account Structure would still result in the following benefits in the case of Unit Trusts: CGT Payable with respect to Non-Death Benefit The ownership of a Non-Death Benefit (such as TPD Cover) by the Trustee of a Unit Trust would not obtain a CGT exemption. This means that CGT might be payable by the Beneficiaries on the Insurance Proceeds at a rate up to approximately 25%. The Substitute Loan Account Structure would avoid this CGT liability. CGT Implications of Direct Payment to Unit Trust If a Unit Trust received a $1M Death Benefit attributable to the repayment of a Debt, there would be no income tax or CGT. However, the Benefit would increase the value of the Unit Trust by $1M. This would effectively increase the value of the Unit Holders’ Units by $1M. However, there would be no substantive addition to the Cost Base of these Units. Thus, upon a subsequent sale of the Units, there could be CGT payable on a higher Capital Gain (subject to any applicable exemptions). Again, the rate could be up to approximately 25%. The Substitute Loan Account Structure avoids any increase in the value of the Units and therefore avoids any future CGT liability attributable to the increase in value on a subsequent sale of the Units. Insurance Trust Solution In summary , the problems of both Cross-Ownership and Self-Ownership can be avoided by the use of a Business Insurance Trust Agreement (i.e., Trust Ownership).
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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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