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Publications and Documents:
Adviser Tips:
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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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The Origins of Self-Ownership of Buy/Sell Insurance
Most Advisers believe that Self-Ownership is and always has been the only way to hold Buy/Sell Cover. They don't realise that it was a remedy for CGT issues that first arose in 1985. It is helpful to understand how Self-Ownership came to be used as a method of ownership of Buy/Sell Cover.
Self-Ownership of Personal Cover Self-Ownership is and always has been an appropriate method of holding Personal Cover. In most circumstances, the only question will be whether the Life Insured wants to hold some or all of their Personal Cover in the Superannuation environment, so that they can effectively obtain a tax deduction for the Premium.
Policy Ownership Before Capital Gains Tax Before the introduction of Capital Gains Tax, it was not common for Self-Ownership to be used as a method of ownership for Business Insurance. It was accepted practice for:
We now describe these methods of ownership as Cross-Ownership.
Policy Ownership After Capital Gains Tax The introduction of Capital Gains Tax caused a major re-consideration of the methods of ownership of Business Insurance. The most immediate concern was the ownership of Buy/Sell Cover.
Different Tax Treatment of Death and Non-Death Benefits Many Lawyers and Advisers recognised that, while Cross-Ownership would obtain a CGT exemption for the Death Benefit, it would not qualify for an exemption for any Non-Death Benefit (such as a TPD or Trauma Benefit). The reason is that the exemption in section 118-37 effectively requires the Non-Death Benefit to be paid to the "Injured Person" (or a Relative). Because Death and Non-Death Benefits are usually bundled on the one Policy, it was not practical to split the Cover into:
Lawyers and Advisers had to come up with an alternative method of ownership, in order to qualify for a CGT exemption for both Death and Non-Death Benefits.
"Self-Ownership" of the Non-Death Benefit The narrow definition of the exemption for Non-Death Benefits really dictated that the method of ownership had to be a form of Self-Ownership. This could include direct Self-Ownership, where the Life Insured is the Policy Owner. However, as a result of the 1991 CGT Tax Determination TD14, it could also include indirect Self-Ownership, where a Trustee owns the Policy for (or on trust for) the Life Insured or Injured Person. Ultimately, the Business Insurance Trust Structure takes advantage of TD14, while Self-Ownership takes advantage of the literal wording of section 118-37 itself.
Exchanging the Purchase Price for a Transfer of the Equity Both methods of ownership qualified for CGT exemptions for both Death and Non-Death Benefits. However, in the context of Buy/Sell Cover, it was necessary to solve another problem. Self-Ownership must pay the Insurance Proceeds to the Life Insured (or their Estate). Unlike Cross-Ownership, it does not pay the Purchase Price to the Purchasers, who can then pay it to the Vendor in exchange for a transfer of the Equity in the Business. Self-Ownership effectively by-passes the Purchasers and pays the Purchase Price directly to the Life Insured or Vendor. Now that the Life Insured or Vendor has both the Equity and the Insurance Proceeds, we need a mechanism to make sure that the Purchasers receive a transfer of the Equity. The Purchasers need recognition of the fact that the Purchase Price has been paid directly to the Life Insured or Vendor. This was achieved by a novel method of legal drafting.
Crediting Provision A modern Self-Ownership Agreement doesn't provide for a traditional "exchange". Instead, it contains a "Crediting Provision" that gives the Purchasers "credit" for the funds paid to the Vendor by the Insurance Company and therefore requires the Vendor to transfer the Equity without any additional payment by the Purchasers.
Market Value Substitution Rules The ATO treats the Buy/Sell Agreement as a "non-arm's length" agreement, which entitles it to apply the Market Value Substitution Rules under section 116-30. As a result:
Thus, the Purchasers will have a substantive Cost Base, but the Vendors will incur a CGT liability with respect to the sale, as if they had received the market value.
Summary It is clear from this history that Self-Ownership is a solution to one particular issue: the different CGT treatment of Death and Non-Death Benefits in the context of Buy/Sell Cover. To a certain extent, it is a band-aid. The ATO recognises that Lawyers and Advisers use Self-Ownership as a method of avoiding the CGT on Non-Death Benefits that would have applied if the Buy/Sell Cover was owned by the Continuing Proprietors or Purchasers. It recognises that Self-Ownership is non-arm's length. However, for the moment, it allows the practice to continue, on the basis set out in a non-binding Statement of Principles issued in 2001. In other words, Self-Ownership is a "band-aid" for some CGT problems. The question is whether it is a "cure" for all CGT problems that affect Business Insurance? This question is the origin of Trust Ownership, an indirect form of Self-Ownership that was designed to address the other CGT problems.
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