The tax implications of business succession planning arrangements involving the use of insurance policies can broadly be split into the following three areas:
- Deductibility of premiums on policies owned as part of a business succession planning arrangement.
- Tax on receipt of insurance policy proceeds.
- Tax on the transfer of business ownership.
Further, there are a number of ways insurance policies used for business succession planning arrangements can be structured. These include:
- Self-ownership — where generally the life insured personally owns their own policy.
- Cross-ownership — where the policy on the life of one owner is owned by the other owners.
- Operating entity ownership — where the policy is owned by the business.
- Insurance trust ownership — where a specially drafted trust is set up to own the insurance policies.
In addition to the above, the use of superannuation fund-owned insurance policies has also been suggested by some industry participants. On this point, it should be noted that the Australian Taxation Office (ATO) may be reviewing its position on whether such arrangements breach the sole purpose test.
In this article, we will turn our focus to the key issues of:
- The tax deductibility of insurance policy premiums; and
- The tax implications of receiving insurance policy proceeds under the above ownership structures.
Tax issue 1 — Tax deductibility of insurance premiums
The premiums payable for insurance policies that are used to fund a business succession planning arrangement are typically not tax deductible. This is because they are not necessarily incurred in carrying on a business for the purpose of gaining or producing assessable income, and in any case would generally be considered to be of a non-deductible capital nature.
The potential exception to this is where the insurance policy is owned by a superannuation fund, whereby tax deductions for the premium expense may be claimed by the fund, if all the usual deductibility rules applicable to superannuation funds are satisfied.
It is also important to note in the case of total and permamemt disablility (TPD) insurance premiums, they are only fully deductible to the superannuation fund trustee to the extent that the policies have the necessary connection to a liability of the superannuation fund to provide disability superannuation benefits to their members.
Tax issue 2 — Tax implications of receiving insurance proceeds
The most common types of insurance policies used as part of a business succession planning arrangement are:
- Life insurance; and
- TPD insurance.
If the proceeds from the above types of insurance policies are to fund the transfer of ownership under a business succession planning arrangement, they will not be assessable under the income tax provisions as they are capital receipts. However, the proceeds may be subject to capital gains tax (CGT).
The CGT implications on receipt of the proceeds will depend on the type of policy taken out, and who the owner of the policy is.
It should also be noted that, for CGT purposes, life insurance policies are treated differently to TPD (and trauma) insurance policies.
Tax implications of receiving proceeds of life insurance policies
Under current tax legislation, if a CGT event happens to a life insurance policy, a capital gain or loss made by the following is ignored for CGT purposes:
- The original beneficial owner of the policy; or
- An entity that acquired the interest in the policy for no consideration; or
- The trustee of a complying superannuation entity.
For example, unless the recipient of the life insurance policy proceeds is someone other than the original beneficial owner of the policy, and the recipient acquired the interest in the policy for money or other consideration, life insurance policy proceeds taken out under a business succession planning arrangement should not be subject to CGT.
In this context, the term consideration has a very broad meaning and can be any of the following:
- Paying money;
- Exchanging property;
- Agreeing to do something in return for something else;
- Dual assignment of insurance policies; and
- Acquisition or disposal of a right.
Note: In Tax Determination TD 2007/4, the ATO also confirmed that for the purpose of receiving the above CGT exemption, a term life insurance policy includes a life insurance policy that provides for the payment of a terminal illness benefit. Therefore, this CGT exemption can also be used on the pre-payment of a death benefit under a terminal illness benefit clause, even though the life insured has not yet died.
Tax implications of receiving proceeds of TPD insurance policies
Importantly, the CGT exemption discussed above only applies to life insurance policies and not to accident or disability policies such as TPD and trauma insurance policies.
However, the Tax Act also disregards a capital gain or capital loss made upon the receipt of compensation for any injury or illness to the person insured or a relative — potentially providing a CGT exemption to TPD and trauma cover policies.
Therefore, if the proceeds of a TPD or trauma insurance policy are paid to someone other than the life insured or a defined relative, the proceeds will likely be subject to CGT.
Table 1 summarises the tax implications of receiving the proceeds of a TPD or trauma insurance policy under the various ownership structures that are commonly used under a business succession planning arrangement. It is nevertheless important that your clients seek professional tax and legal advice on these matters prior to entering into any insurance trust ownership structure.
Plannning Tip: In determining the sum insured for certain clients, you may need to consider grossing up the sum insured to take into account any CGT payable.
Amending legislation — CGT implications for super funds and trusts owning insurance policies
While not yet legislated at time of writing, long-awaited legislation aiming to retrospectively give effect to minor amendments to the CGT provisions in the Tax Act is currently before parliament.
These amendments, if legislated, will clarify and ensure that the specific CGT exemption currently available to trustees of superannuation funds for life insurance cover will also apply to insurance policy proceeds related to injury or illness insurance cover (such as TPD).
More broadly, these amendments will also ensure a CGT exemption is available to trustees and beneficiaries of non-super trusts (e.g. discretionary and fixed trusts) who receive such insurance policy proceeds.
These amendments are required because the wording of the existing legislation is unclear and has created some uncertainty. They will also, in essence, confirm existing ATO administrative procedures that have operated for a number of years so as to generally provide the CGT exemptions despite the uncertainty in the existing legislation wording.
John Ciacciarelli is the technical services manager at AMP TapIn
