Monday, February 4, 2013

Company owned insurance policies for business succession

We recently had an adviser seeking more detailed comments about company owned business succession insurance policies.

In particular, feedback was requested about the specific reservations with insurance policies for business succession being owned by a company. In summary, and with thanks to co View Legal director Tara Lucke, we provided the following reasons:

1   while capital gains tax (CGT) should not be payable on receipt of life insurance proceeds, it will be payable on any total and permanent disablement or trauma proceeds that are paid to a company. In contrast, no CGT should be payable on receipt of the insurance proceeds where the policies are self owned;

2   there can also be significant practical difficulties in extracting insurance proceeds from a company to the appropriate recipient. This is particularly important when the main purpose of the policy is for an equity payment, as opposed to debt cover. Again, where the policy is self owned, the exiting principal or their estate will receive the proceeds directly and none of these practical issues will arise, as long as an appropriate agreement is implemented;

3   where insurance proceeds need to be accessed by the exiting principal (or their estate) this is generally only achievable via a share buy-back or dividend. A dividend will likely be tax inefficient and generally a buy back will also have an inefficient tax outcome for the following reasons:

(a) the consideration will be split between an assessable capital gain and a dividend, which restricts access to the full benefit of the CGT 50% discount and small business CGT concessions;

(b) while a company may be able to pay the proceeds to the exiting shareholder/s as a partially or fully franked dividend, this will use franking credits that would otherwise have been available for distributing profits; and

(c) the surviving owner/s will own 100% of a company after a share buy-back, however their cost base in the shares will not have increased;

4   insurance proceeds will be under the control of the remaining director/s of a company, in contrast with a self owned or superannuation owned policy where the estate directly receives the benefit of the proceeds; and

5   finally, the legal documentation required for company ownership is comparatively complex to all other policy ownership approaches.

Until next week.