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Publications and Documents:
Adviser Tips:
Adviser Updates:
Individual Updates (Most Recent First): Adverse ATO Advice on Super Buy/Sell Cover Partnership and Trust Loan Accounts Effect of Debt Reduction Cover on Buy/Sell Cover Tax Treatment of Self-Ownership Agreements Vested and Indefeasible Interest Simplifying the Valuation Issue Simple or Complete Succession?
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Equity vs Loan Capital
Many Clients and Advisers misunderstand the difference between Equity Capital and Loan Capital when they design a Succession Plan. A proper understanding is required in order to structure an effective Succession Plan.
Equity Capital Your Equity is your ownership interest in the Business. It is capital in nature. It is an asset that you can buy and sell. It should be the primary focus of the Asset Strategy in a Succession Plan. The Asset Strategy needs to buy and sell the Proprietor's Equity in the Business.
Loan Capital On the other hand, many Proprietors also have Loan Capital tied up in a Business. This means funds that they have lent to the Business (or funds that are otherwise owing by the Business to the Proprietors).
Initial Loan Capital Loan Capital is often required in order to meet the capital requirements of the Business, when the Business is established. The Proprietors might structure their investment in the Business partly as a capital investment (e.g., shares in a Company) and partly as a Loan. Normally, they would expect that the Loan would be repaid in the short to medium term. The need for Loan Capital can also occur during the life of the Business, in order to:
"Retained Profit" During the life of the Business, the Proprietors would expect it to generate profit from its business activities. Companies In the case of a Company, the Profit is taxable in the hands of the Company. However, the Net Profit after Tax can be:
If it is retained as working capital, the Retained Profit would normally be reflected in the capital value of the shares or Proprietor's Equity. Partnerships and Trusts However, in the case of Business Structures like Partnerships and Unit Trusts, Profits retained by the Business have a different accounting and tax treatment. In these cases, the taxpayers are normally the individual Partners or Unit Holders (or Beneficiaries), which pay tax on their share of the profit of the Business. For accounting and tax purposes, the Profit is treated as if it has been distributed to the individual Partners or Beneficiaries. One repercussion of this practice is that, if some or all of the Net Profit of the Business is required by the Business as working capital, it must effectively borrow the funds back from the Partners or Beneficiaries. Unlike a Company, the "Retained Profits" do not reflect in the higher value of the Equity owned by the Proprietors. Instead, they are reflected in a Loan Account owing to the Partner or Beneficiary.
Need for Asset and Liability Strategies If a Proprietor has both Equity and a Loan Account, it is important that their Succession Plan facilitates both:
In effect, their Succession Plan needs both:
The Liability Strategy involves different legal, commercial and insurance considerations to an Asset or Buy/Sell Strategy. A Complete Succession Plan is designed to address these considerations cost- and tax-effectively.
Case Study Each Proprietor in the Business has an Equity worth $400K and a Loan Account of $150K owing to them personally. Informally, the Proprietors believe that their investment in the Business is worth $550K. This belief leads many Clients to state that the value of their Equity is $550K, which results in the Adviser obtaining a Buy/Sell Policy for $550K with respect to each Proprietor. The Buy/Sell transaction is a transaction between the Vendor and the Purchaser. It does not necessarily involve the Business itself. Thus, upon the payment of a claim, the Life Insured (or their Estate) would:
The incorrect analysis of the Proprietors' interest in the Business would deprive the Business of the ability to arrange Key Person Capital or Debt Reduction Cover designed to facilitate the repayment of the Loan Account. It also increases the amount of the Sale Price and therefore the Capital Gain upon which any Capital Gains Tax would be payable.
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Adviser Tip The One Page Strategy is designed to help you simplify Succession Planning. It helps you understand your needs, it helps you quantify them, it helps you cost them, and it helps you prioritise them.
Please contact us to arrange a meeting or teleconference.
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