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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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Adverse SMSF Specific Advice re Super Buy/Sell Cover and Agreement
Overview On 12 March, 2014, the ATO issued a private SMSF Specific Advice which effectively concludes that the practice known as “Super Buy/Sell” contravenes the Sole Purpose Test under section 62 of the Superannuation Industry (Supervision) Act. In recent years, it has become increasingly common for:
This practice is colloquially known as "Super Buy/Sell". IGS has always expressed concerns about this practice: The ATO Advice will require many Insurance Arrangements and Super Buy/Sell Agreements to be terminated, in order to avoid ongoing contravention of the Sole Purpose Test.
What is "Super Buy/Sell Cover"? Michael and Mark each own ten shares in a Company. It is agreed that the Net Asset Value of the Company is $2M, and that the Purchase Price of a half-share should be $1M. They agree to obtain an Insurance Policy for $1M each. Their Insurance Adviser suggests that each Policy be held by the Life Insured’s SMSF, so that the premium will be paid out of their Concessional Contributions (and will therefore effectively be deductible). Upon the payment of a Claim, the Policy will pay the Insurance Proceeds of $1M to:
The Insurance Adviser recommends that Michael and Mark sign a Buy/Sell Agreement. The purpose of the Buy/Sell Agreement is to ensure that the deceased Life Insured transfers their shares to the surviving Life Insured upon the payment of a claim. The Agreement contains a clause that effectively provides that, if the value of the shares is fixed at $1M and the Insurance Proceeds are $1M, then the surviving Life Insured will not be obliged to pay any additional amount for the shares. Alternatively, if the Purchase Price is subject to a valuation (which determines that the value of the shares is $1.2M), then:
Buy/Sell Cover Relating to SMSF Assets Where two or more Lives Insured are Members of an SMSF that owns property or other assets, it might be appropriate to hold Buy/Sell Cover in the SMSF, so that a Member can effectively buy the interest of a deceased Member on their death. This fact situation is not within the scope of the ATO Advice. There is no suggestion in the ATO Advice that it would contravene the Sole Purpose Test.
Taxpayer’s Contentions The Taxpayer argued that:
Summary of ATO’s Decision The ATO accepted that the benefits would be paid to [Life Insured 1]’s dependants on his death.
Reviewing a Trustee’s Decision In paragraph 17 and 18, the ATO confirms that:
However, it acknowledges that:
It adds that:
Did the Underlying Purpose of the Buy/Sell Agreement Accord with the Sole Purpose Test? The ATO considered the underlying purpose or purposes of the Buy/Sell Agreement in its decision. The Company’s Business Succession Plan One purpose was the extent to which the Policy and the Agreement formed part of the process of managing the Company’s Business Succession Plan:
Tax Deductibility of Premium The ATO then considered the role of the tax deductibility of the premiums in the decision:
Commercial Implications for Life Insured 2 (the Purchaser) The ATO also considered the implications of the Cover for the Purchaser:
SMSF was a “Conduit” The ATO drew an adverse inference from the fact that the SMSF was a conduit for the funds in a broader commercial transaction (paragraph 26). Even though it was not a party to the Buy/Sell Agreement, it still participated in the transaction, by being the vehicle by which the Insurance Policy was maintained. Opportunity Cost to the SMSF The ATO considered that:
In effect, but for the Buy/Sell arrangements, the Fund might not have obtained:
In other words, it might have invested the contributions in an accumulation or investment strategy for retirement purposes. The payment of the premium by the Fund detracts what might otherwise have been a more appropriate investment strategy. Method of Determination of the Sum Insured When considering the investment strategy of the Fund, the ATO drew an adverse inference from the fact that the Sum Insured:
“Compensation for Expected Inheritance” The ATO also drew the following conclusion from the Buy/Sell Agreement:
Collateral Benefit to the Purchaser The ATO expressly recognised the extent of the benefit obtained by the Purchaser as a result of the Insurance Cover:
ATO’s Conclusions on Purpose In paragraph 27, the ATO concluded that:
Evidence Relied on by ATO In this case, the SMSF applied for Specific Advice from the ATO. Thus, it would have been the source of all of the documentation and information upon which the ATO made its decision. However, it is clear from the ATO’s conclusions that it was prepared to draw alternative inferences from the circumstances than those that were submitted by the SMSF. It was not prepared to accept that:
In practice, it has always been necessary for a Super Buy/Sell Arrangement to be documented in an Agreement, so that there is a legally binding arrangement to give the Purchaser “credit” for the Insurance Proceeds. It is inevitable that the terms of the Agreement will assist the ATO draw its inferences about the true purpose of the Cover. The ATO’s Advice does not mention the Insurance Adviser’s Statement of Advice. However, if the Statement of Advice identified the purpose of the Cover as Buy/Sell Cover, then it to would be fatal to the Fund’s attempt to argue that it had complied with the Sole Purpose Test. If the Statement of Advice attempted to conceal the real purpose of the Cover, then it is likely that it would at least breach the compliance provisions of the Corporations Act applicable to the Adviser.
Conclusion Many Advisers and Lawyers have willingly contributed to the breach of the Sole Purpose Test by their Clients. In many cases, it could be argued that there has not been an adequate consideration of how the ATO would apply the Sole Purpose Test. The ATO Advice will require many Insurance Arrangements and Super Buy/Sell Agreements to be terminated, in order to avoid ongoing contravention of the Sole Purpose Test. Because the Advice is specific to a particular Fund, it is not clear how the ATO will deal with historical breaches.
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