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Overview: Business Succession Agreements
Types of Agreement: Cross Ownership: Self Ownership: Trust Ownership:
Drafting Issues: Put and Call Options vs. Conditions Precedent
Other Issues:
Debt Reduction Agreement:
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Tax Implications with respect to IGS Trust Ownership Agreement
ATO RulingClick here to read about the CGT implications of Insurance Policies (including the Trust Ownership of Policies). IGS has submitted the Business Insurance Trust Agreement for Tax Rulings several times since 1987. When IGS makes material improvements or changes to the body of the Agreement, it resubmits the documentation for review by the ATO. The current Ruling was issued in December, 2001.
Exemption for Both Death and Non-Death Benefits The CGT Cell of the ATO has reviewed the Business Insurance Trust Agreement used by IGS and formed the views that:
The Agreement therefore qualifies for an exemption with respect to both:
Sources of Exemption The source of the exemption with respect to each Benefit is:
Click here to read how these provisions apply to Trust Ownership.
Third Party Recipients One of the benefits of a Business Insurance Trust Agreement is that it can distribute the Insurance Proceeds directly to Third Parties both securely and tax-effectively. In this case, there is no change to the identity of the Beneficiary or Beneficial Owner of the Policy. The fact that there might be Multiple Recipients does not mean that there are Multiple Beneficiaries for CGT purposes. The one Beneficary simply directs the Trustee to pay amounts to Third Parties on its behalf. The ATO Ruling with respect to the IGS Business Insurance Trust Agreement states that:
TR2004/D25 Since the issue of the ATO Ruling with respect to the IGS Agreement in 2001, the ATO has issued Draft Ruling TR2004/D25. The Draft Ruling sets out the draft views of the ATO with respect to Absolute Entitlement Trusts under section 106-50. This Draft Ruling was first issued in 2004 and is not likely to be finalised within the foreseeable future, because of the level of controversy with respect to its content. Section 106-50 Superficially, section 106-50 is a very simple provision:
In effect, section 106-50 provides that a disposal of a CGT Asset by a Trustee will be treated as a disposal by the Beneficiary, if it is "Absolutely Entitled" to the CGT Asset as against the Trustee. Purpose of Section 106-50 Theoretically, in the absence of section 106-50, there is a risk that there might be two CGT Disposals whenever a Trustee disposes of a CGT Asset:
The theoretical risk of a disposal at step two does not take into account the normal tax treatment of the distribution of a Capital Gain to a Beneficiary of a Trust. However, section 106-50 makes the normal tax treatment irrelevant if the Beneficiary is an "Absolutely Entitled Beneficiary". In effect, if the requirements of the section are satisfied, the section ignores:
It collapses the disposal down to a disposal of the CGT Asset by the Beneficiary. By doing so, it removes any risk (if there was one) that there might be two CGT Disposals and therefore two CGT Liabilities. Application to Insurance Policies Section 106-50 refers to CGT Assets generally. There is no reference in section 106-50 or the Draft Ruling to Insurance Policies, although it is accepted that it applies to Insurance Policies. Additional Source of Exemption Section 106-50 effectively creates a source of exemption from CGT in addition to other substantive CGT or Income Tax exemptions. If there is already an exemption with respect to a particular type of disposal (regardless of the type of asset), then it is not necessary to rely on section 106-50. If there is already an exemption with respect to the disposal of a particular type of CGT Asset, then it is not necessary to rely on section 106-50. All CGT Assets In the case of any type of asset, section 106-50 would not be relevant, if there was no CGT or Income Tax Liability, because the Beneficiary was "presently entitled" to the Capital Gain or Income of the Trust. In other words , if a Beneficiary of a Trust is not subject to CGT or Income Tax on normal principles, it is not necessary to rely on an exemption under section 106-50. Insurance Policies In the case of Insurance Policies, section 106-50 effectively creates a source of exemption in addition to sections 118-300 and 118-37. If an exemption is available to the Beneficiary of a Trust under section 118-300 or section 118-37, it is not necessary to rely on an exemption under section 106-50. Section 118-300 Exemption for Beneficiary Section 118-300 already grants the Beneficiary an exemption from CGT on the basis that it is the "Original Beneficial Owner" of an interest in the Policy. Section 118-300 itself avoids the risk of two CGT liabilities. Section 118-37 Exemption for Beneficiary Section 118-37 grants an exemption to the Taxpayer if they receive the payment as compensation or damages for any illness or injury they suffer. If the Taxpayer is a Beneficiary who is "presently entitled" to the Income of the Trust attributable to the Policy, then they will be exempt under section 118-37. This is the basis upon which the ATO applies the exemption under section 118-37 to Policies held by Trusts under TD 14. Again, section 118-37 itself avoids the risk of two CGT liabilities. Conclusion It is not necessary to rely on, or satisfy the requirements of, section 106-50, if another source of exemption from CGT or Income Tax applies to the payment.
Absolute Entitlement Trusts with Multiple Beneficiaries It is important to recognise that TR2004/D25 does not say that Multiple Beneficiary Trusts cannot satisfy the requirements of Absolute Entitlement. Instead, it sets out the basis upon which the ATO believes the requirements will be met. The ATO has adopted a narrow view of what constitutes an Absolute Entitlement Trust where there are Multiple Beneficiaries. Some competitors have argued that there is an inconsistency between the Draft Ruling and the IGS Tax Ruling in relation to Multiple Beneficiary Trusts. Single Beneficiary Trust Under the standard IGS Trust Agreement, there is only one Beneficial Owner with respect to each Policy. The fact that there might be Multiple Recipients does not mean that there are Multiple Beneficiaries for CGT purposes. The IGS Ruling and the Draft Ruling are consistent with respect to this version of the Agreement. Multiple Beneficial Owners In some cases, the IGS Agreement splits a Policy into separate components, each of which is beneficially owned by a different Beneficiary or Beneficial Owner. An example of this structure is the situation where:
Where there are two or more Beneficial Owners under the IGS Agreement, the Agreement has been drafted so as to obtain an exemption without having to rely on section 106-50 (see the above discussion). Instead, it relies directly on the exemptions for Trust Ownership available under sections 118-300 (Death Benefits) and 118-37 (Non-Death Benefits). The IGS Tax Ruling did not rely on section 106-50 in order to grant the exemption where there are Multiple Beneficiaries. It is sufficient that the Agreement qualify for an exemption under section 118-300 with respect to a Death Benefit or section 118-37 with respect to a Non-Death Benefit. This means that it is irrelevant whether section 106-50 creates a CGT exemption with respect to Multiple Beneficiary Trusts. Thus, there is no inconsistency between the IGS Tax Ruling and the Draft Ruling.
IGS Submissions with respect to TR2004/D25 IGS is actively involved in the review of TR2004/D25 and has made several submissions to the ATO with respect to the correctness of the Draft. The Relevant "CGT Asset" One area of criticism is that the Draft insists that the "CGT Asset" must prima facie be the whole of the physical asset. In other words, it argues that, if the Beneficiary owns part of the asset beneficially, it is not possible to satisfy the requirements of section 106-50 with respect to that part only. The requirements of the section must be satisfied with respect to the whole of the physical asset. This view makes it difficult to establish "Absolute Entitlement" where other Beneficiaries have an interest in the same physical asset. The ATO's view is contrary to the express provision of section 108-5, which states that a "CGT Asset" includes "part of, or an interest in, an Asset". This means that the Beneficiary only has to be "Absolutely Entitled" to the CGT Asset in which it has an interest. Because the relevant asset is the part or component in which it has a 100% interest, then it will be absolutely entitled to that part or component. The Beneficiary would therefore be entitled to call upon the Trustee to transfer legal title to that part or component to it. "Fungible Assets" Notwithstanding the ATO's views on the relevant CGT Asset, the Draft permits Multiple Beneficiaries in some circumstances (e.g., where the physical assets are "fungible"). The ATO takes this to mean that:
In these cases:
Physical Divisibility The concept of "fungibility" is a relatively novel concept. There does not seem to be any legitimate foundation for it in the wording of the section itself or in the definition of the term "CGT Asset". However, even if the concept of "divisibility" was relevant, it is arguable that the divisibility should be or include the "legal" divisibility of the underlying physical asset. The emphasis on "physical" fungibility does not adequately recognise that the relevant asset can be "legally" broken up into separate components, each of which could be legally or beneficially owned by a separate Beneficiary. The ATO has to take into account the terms of the Trust Deed. If it is the intention of the parties that the Trust constitute a "tenancy-in-common" between the different or separate Beneficiaries, then there would a clear indication that:
This should be sufficient to make each Beneficiary "Absolutely Entitled" to its own CGT Asset. Replaceability An alternative argument applies to Insurance Policies in particular. If two Beneficiaries each beneficially owned one-half of a $1M Policy, then there would be no substantive difference if each Beneficiary was issued a $500K Policy in substituition for their interest in the One Policy. Thus, it is arguable that an Insurance Policy is a perfect example of a CGT Asset that is "fungible" in the sense of being able to be replaced by a similar asset. A Trustee could satisfy the requirements of both Beneficiaries by cancelling the One Policy and taking out two separate Policies, without detriment to the interests of either Beneficiary. Conclusion IGS does not accept that the Draft correctly applies the current law. However, even if the Draft is correct, IGS submits that the correct application of the ATO's own views with respect to Multiple Beneficiaries would result in a CGT exemption with respect to Insurance Proceeds payable to Multiple Beneficiaries, because an Insurance Policy is "fungible" (i.e., divisible into separate components, each of which may be owned by different or multiple Beneficiaries). Most importantly, it is not necessary to rely on section 106-50 in order to obtain an exemption under section 118-300 or 118-37. These sections are direct sources of exemptions for Trust Ownership of Insurance Policies.
Directions to Trustee Because the Life Insured is the Beneficial Owner of the Policy, it is entitled to direct the Trustee (or Legal Owner) how to distribute the Insurance Proceeds on behalf of the Life Insured.
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Adviser Tip Trust Ownership can do everything that Self-Ownership can do, but Self-Ownership can't do everything that Trust Ownership can do.
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