Self-Ownership Without An Agreement

Most Advisers assume that the exemption will be available for Buy/Sell Cover if the Life Insured is the Policy Owner, whether or not the parties sign a Buy/Sell Agreement.

As a result, some insurance companies estimate that 90% of Buy/Sell Cover is not backed up by a Buy/Sell Agreement.

Recent Land Tax Cases

The High Court has analysed the concept of "beneficial ownership" in a number of land tax cases in recent years.

While these cases are not immediately relevant to the taxation of Insurance Policies, they do contain views that could raise doubts about whether the Life Insured is the "beneficial owner" of the Policy where a Buy/Sell Agreement has not been signed.

What Happens When the Life Insured Dies?

The best way to illustrate the issue is to examine what would happen after the Life Insured died, in the absence of a Buy/Sell Agreement.

Because the Life Insured is the Policy Owner, the Insurance Company would be entitled to pay the Death Benefit to the Executor of the Life Insured's Estate.

At that moment in time, it is likely that the Executor will own both the Equity in the Business and the Insurance Proceeds that were attributable to the intended Sale Price.

The Continuing Proprietors of the Business need a Crediting Provision in a valid Buy/Sell or Business Succession Agreement to:

credit the Insurance Proceeds against the Sale Price they would have to pay; and
force the Executor to transfer the Equity without any additional payment by the Continuing Proprietors.

The Executor's Arguments

In the absence of an Agreement, there is no Crediting Provision.

As a result, the Executor could argue that, because the Policy is owned in the name of the Life Insured, it is Personal Cover (i.e., it is not intended to fund the Sale Price payable by the Purchasers).

After all, if the Policy was intended to be a funding mechanism for the Purchasers, wouldn't the Policy have been owned by them?

This is the worst case scenario.

Alternatively, a more generous Executor could argue that the Cover was Personal, unless and until the parties signed a Buy/Sell Agreement that determined the Sale Price and other terms of sale.

Until that happens, there is no certainty with respect to the terms of sale of the Equity. As a result, the Cover remains Personal and need not be credited against the Sale Price.

We know that the tax treatment of Insurance Proceeds is one reason why Cross-Ownership would not have been used.

However, how will the Purchasers get justice? How do the Purchasers refute the Executor's arguments?

Remember that the Life Insured is now dead, so the Purchasers are the only clients who the Adviser now acts for, so the Adviser wants to ensure that they get justice. Otherwise the Adviser might have a Professional Indemnity liability.

The Purchasers' Arguments

This is where the Purchasers' Lawyers get involved (possibly at great expense).

The law of Equity ( a different type of Equity to the Equity in a Business) is an area of the law that supplements contract law or what is called the Common Law.

It can remedy defects in Common Law and achieve a just and equitable outcome between the parties to a dispute.

One principle of Equity is that Equity regards as done that which ought to have been done.

Thus, if a Court considered that there was an equitable obligation to transfer the Equity in the Business for no consideration (because the Executor had received the Insurance Proceeds intended for that purpose), it would enforce the obligation to transfer the Equity, even though there was no formal, legally binding agreement or contract of sale.

In order to achieve this outcome, the Court can determine that the Purchasers have an "equitable interest" in the Insurance Proceeds.

In other words, the Executor cannot deal with the Insurance Proceeds, unless it recognises the equitable interest of the Purchasers.

This determination would create a "constructive trust" for the benefit of the Purchasers.

At the same time, the Court can determine that the Purchasers have an "equitable interest" in the Life Insured's Equity in the Business.

Again, the Executor must recognise the interest of the Purchasers.

Again, this determination would create a "constructive trust" for the benefit of the Purchasers.

The effect of these determinations is that the Executor must effectively transfer the equity to the Purchasers (for no additional consideration) so that it can extinguish their equitable interest in the Insurance Proceeds.

Only once this has occurred does the Executor have full title to the Insurance Proceeds.

This outcome still depends on the Purchasers being able to supply evidence of the intended agreement and prove their case.

The Executor can still try to prove that it was not intended that there be any agreement (contractual or equitable), until the Buy/Sell Agreement was signed.

Thus, this sort of dispute might have to be resolved by a Court at great expense to the parties.

The Purchasers Win

Let's assume that the Purchasers win.

The Court has had to find that they had an "equitable interest" in the Insurance Policy and the Insurance Proceeds.

The significance of the recent High Court cases is that this equitable interest is a form of "beneficial ownership".

In other words, the result might be that the Purchasers are the "original beneficial owners" of the Policy and the Insurance Proceeds, not the Life Insured.

The Executor is only able to become the beneficial owner of the Insurance Proceeds by transferring the Equity to the Purchasers.

Thus, it has given consideration for the acquisition of the beneficial ownership of the Policy and the Insurance Proceeds.

On this basis, it is arguable that there will be CGT payable with respect to the Insurance Proceeds.

Ultimately, this means that Self-Ownership without a Buy/Sell Agreement might not avoid CGT with respect to the Insurance Proceeds (even though the Life Insured is the Policy Owner).

Adviser's Responsibility

In effect, the Adviser should ensure that a Buy/Sell Agreement is prepared during the underwriting process and signed as soon as possible after the Policies are issued.

Adviser Tip

Self-Ownership must pay the insurance proceeds to the Life Insured or their Estate.

It cannot pay them to a Related Party that owns some of the Equity in the Business (e.g., a Family Trust or Company) nor can it pay them to a Creditor without adverse tax implications.

See more Adviser Tips

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