Tuesday, May 2, 2023

When cross owned insurance policies are Glorious

In business succession arrangements, cross owned insurance policies are rarely, if ever, utilised. Avoiding the use of cross owned policies is driven by a range of commercial reasons and the fact that invariably adverse tax consequences are unnecessarily triggered as the desired commercial outcomes can normally be achieved utilising self owned policies that almost always deliver favourable tax outcomes.

One scenario where cross owned insurance arrangements historically provided significant potential benefit however related to where a self-managed superannuation fund (SMSF) borrows funds via an instalment trust arrangement to acquire an asset which forms a substantial part of the total value of the fund.

An example of how this approach (which was given in principle support by the Tax Office historically) worked is as follows:
  1. The SMSF establishes an instalment trust and borrows funds from a third party to acquire an asset.
  2. The (say) only two members of an SMSF are concerned that on the death of one of them, the ability to pay out the member’s entitlement may be impossible to achieve without selling the underlying asset (i.e. neither member’s account balance is large enough to represent the entire value of the acquired asset).
  3. If the members took out self-owned insurance policies, this would obviously not assist, given that the exiting member would effectively be entitled to an even greater share of the total assets of the fund.
  4. In contrast, if permissible under the trust deed for the SMSF, if cross owned policies were implemented, then the remaining member’s balance would be the one that increases and the cash from the insurance policy could be used to pay the death benefit, while the continuing member would effectively have their member balance represented entirely by the asset originally acquired via the instalment trust.
Despite the above, since 1 July 2014, the view of the Tax Office has been that the superannuation rules do not allow SMSFs to provide insurance for a member, unless the insured event is consistent with one of the following conditions of release:
  1. death;
  2. terminal medical condition;
  3. permanent incapacity; and
  4. temporary incapacity.
The Explanatory Memorandum associated with the amended rules made it clear that the proceeds of an insurance policy must be released to the member who is the insured under the policy.

This means that cross-insurance arrangements where the proceeds of an insurance policy are paid to someone other than the insured under the policy are not permitted. 

** for the trainspotters, the title today is riffed from the Breeders song ‘Glorious’. 

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