Over (it)** insurance and buy sell arrangements

There were a number of enquiries following last week’s post, and in summary, the answer to a number of these queries was that before implementing the kind of strategy explored, care should always be taken to make sure that all of the commercial, legal and transaction cost issues are properly considered.

One question that is also worth exploring further is the appropriate quantum of insurance cover in this type of situations.

Obviously, while we do an extensive amount of work in this area, we do not actually provide insurance product solutions, and instead work with specialists in this area to help clients get appropriate strategies implemented.

The advice that we often give however is that for a variety of reasons, we prefer that wherever possible the parties involved look to maximise the level of insurance cover able to be obtained.

Obviously, this approach is subject to specialist advice in these circumstances and the ability for the clients to commercially justify the insurance premium, however some of the practical advantages with this approach that we see include:

1. It reduces the need to uplift the quantum of insurance cover as circumstances change.
2. It reduces the risk that in the future appropriate levels of cover may not be able to be accessed (due to health reasons).
3. It guards against the risk that the underlying assets involved increases more rapidly than insurance protection is able to be updated.
4. If structured appropriately, the excess insurance can also be used to facilitate other non-business succession objectives.

** for the trainspotters, the title here is riffed from the Dinosaur Jnr song ‘Over it’.

Why contracts beat (it) ** wills

During the week, in the context of reviewing a buy-sell deed, we had to provide advice about whether the terms of the buy-sell deed would overrule the provisions of one of the partner’s wills.

While there were a number of factors that may potentially impact on the answer to this question, in very simple terms, contractual arrangements will always override the provisions of a will.

As the buy-sell deed was crafted on the basis of option agreements, then the position was therefore that they would override any inconsistent provision of the will.

In the context of the buy-sell arrangement here, there were two individual partners who had implemented buy-sell arrangements.

For a combination of reasons, the parties agreed to implement wills whereby they would each gift their respective partnership interest to their co-partner on death.

The agreement to make these gifts however was predicated on the assumption that the exiting partner’s estate would receive insurance proceeds at least equal to (if not greater than) the market value of their partnership interests.

Option agreements were still put in place however to cover the partners against a range of risks, including:

1.  a partner changing their will;
2. the will of an exiting partner being challenged; and
3. the insurance proceeds received being inadequate as compared to the market value at the date of death.

** for the trainspotters, the title here is riffed from the Michael Jackson song ‘Beat it’.

Buy sell deeds, family trusts and the deemed market value substitution rule

Click here for an overview of buy-sell arrangements

With thanks to co View Legal director Tara Lucke, today’s post considers an issue that has been raised with us by an adviser recently.

It is generally accepted that where a business succession plan is structured with self owned insurance policies and a buy sell deed using put and call options, the deemed market value substitution rules apply for taxation purposes.  This outcome occurs notwithstanding that the transfer has been funded (either wholly or partly) by insurance.

Given the recent changes to the rules relating to the taxation of trusts, some uncertainty has arisen in relation to the ability to effectively manage the taxation consequences of a deemed capital gain arising from a transfer under a buy sell deed.

Under the ‘interim’ taxation rules relating to trusts, there can be particular problems relating to distributions of capital gains arising under the deemed market value substitution rule.  In particular, it is generally not possible to create specific entitlement to a deemed capital gain, notwithstanding that there may be a streaming power in the trust deed. 

However, where $1 of consideration has been received (which is how we generally recommend buy sell deeds be crafted), provided a beneficiary is made specifically entitled to the $1 of consideration, the deemed gain should be distributed to that same trust beneficiary.

It will therefore be important in each case to consider the specific terms of the trust deed and the other income of the trust, and to craft the distribution minute correctly to ensure the gain can ultimately be distributed to individuals who can access the general 50% capital gains tax discount. 

Until next week.

Insurance premiums & FBT

As many regular readers would be aware, one particular innovation in recent times in relation to insurance funded business succession arrangements is the so-called 'debt reduction' strategy.

One aspect of the arrangement that is often raised concerns the fringe benefits tax (FBT) implications of the premium payments.

Broadly, there are a number of reasons as to why FBT will normally not apply to the payment of insurance policy premiums.

Generally the accountant for the business will always be best placed to give the guidance, however some of the reasons FBT will not apply can include –

1.    the arrangements not having anything to do with employment;

2.    in some instances, the otherwise deductible rule; or

3.    while for administrative ease the premiums might be paid by the business, the actual tax position is that the amount is included as part of other payments made (for example, a dividend).

It is important to remember that aside from FBT, there are a number of other tax issues that may also be relevant (for example division 7A or capital gains tax) so it is also best to ensure the exact circumstances are considered by the accountant for the particular client.

Until next week.

Insurance funding via superannuation

Earlier posts have mentioned the ‘debt reduction’ and ‘hybrid’ buy sell arrangements and I can forward information in this regard for those interested.

One particular issue raised with me recently in this area was the ability to use superannuation owned policies for insurance arrangements supporting a debt reduction (or asset protection) solution.

Generally the position is that the asset protection (debt reduction) component of any insurance policy should be self owned, rather than superannuation owned.

This is because a superannuation fund trustee is unlikely to be able to make the required payment directly to the other principals, as the fund can only pay a benefit to a member (in the case of disablement), or to the dependants or estate (in the case of death).

Furthermore, a superannuation fund could not be a party to the agreement as this would raise issues about compliance with the sole purpose test, and also might be construed as an assignment of a benefit, which super fund trustees are prohibited from recognising.

Given these technical limitations, there could be no certainty that insurance proceeds held in superannuation would find their way to the correct parties to enable them to pay down the external debt.

This said, it is often possible to have two policies for each principal under a hybrid buy sell deed, one being a self owned policy for asset protection (debt reduction) purposes and the other policy being owned through superannuation for equity transfer (that is, traditional ownership or buy sell) purposes.

Until next week.

ATO Discussion Paper on buy-sell agreements

Following last week’s post, we had a number of people contact us in relation to the, withdrawn, ATO Discussion Paper on business succession arrangements (i.e. buy-sell agreements).

As mentioned in last week’s post, the ATO has unequivocally stated its belief that the Discussion Paper is not current and that advisers in this area should be deterred from relying on it.

This said, the Discussion Paper remains (even 11 years after its initial circulation) the only comprehensive attempt by the ATO to articulate its view of the various business succession models.

For those interested in the issues addressed by the Discussion Paper, please email me. 

Please note the copy of the paper I have access to is shown in 'marked up' format as this was the final version released by the ATO before it was withdrawn from circulation.

Until next week.

Insurance funded buy-sell arrangements - ATO commentary

A number of earlier posts have considered various taxation aspects of insurance funded buy-sell arrangements.

Some minutes recently released from the National Tax Liaison Group meeting towards the end of last year provide an interesting insight to the latest ATO views in this area.

For those who have not seen a full copy of the minutes and would like a copy please email me.

As you will see, in summary:

1. The status of taxation ruling on absolute entitlement (TR2004/D25) remains unclear.

2. The ATO considers its finalisation intricately linked to how it will deal with bare trusts, which again remains an unresolved issue.

3. The ATO confirms that the product ruling released last year in relation to one provider’s insurance trust arrangement is based entirely on the assumption that absolute entitlement was created. As my post from last year indicated, this assumption may be an unwise one to make given the ATO’s apparent attitude in this area.

4. While the ATO is flagging that they will further consider providing appropriate guidance, they have specifically confirmed that the Discussion Paper from 2000 on business succession arrangements cannot be considered current.
Until next week.

Insurance funded buy-sell arrangements

Over the last 2 to 3 years, there has rarely been a week gone by where we have not been fortunate to help a risk adviser implement an insurance funded buy-sell arrangement with their clients.

One issue that comes up surprisingly more regularly than it probably should occurred again last week in relation to the structure of these arrangements and the use of options.

There is an enormous amount of material on insurance funded buy-sell deeds (if you are interested, spend some time looking at our website – see the following link viewlegal.com.au).

Invariably, most advisers in this area will, for a multitude of tax and wider commercial reasons, recommend an option based contractual arrangement – these arrangements provide the most amount of flexibility possible for each party.

Where however a discretionary trust is involved in the business structure, it is generally the case under trust laws that the trust deed must expressly permit the granting of options.

The technical reasons for this position revolve around issues concerning the fettering of a trustee’s discretion – practically however the position is that unless the trust does have the power to grant options at the date the buy-sell agreement is signed, there is a risk that the agreement may not be enforceable as otherwise anticipated.

Until next week.

Matthew Burgess

Can a company own shares in itself ?

A couple of days ago, a financial adviser and I were looking at helping a client to implement an insurance funded buy-sell arrangement.

Particularly since the downturn over 2008 and 2009, there seems to have been an increasing focus on insurance protection in the context of business succession (quite aside from any keyperson insurance) and we are regularly seeing bank funding approvals being made conditional on the insurance at least covering the bank’s lending exposure.

As part of the audit process that we were jointly performing on the client's circumstances, the financial adviser identified that one of the shareholders in the trading company was the trading company itself.

This was not a simple case of the trading company having done some sort of share buyback arrangement – the company was listed under the ASIC records as a one third shareholder in itself.

Although it is an area that is not often considered, the Corporations Act expressly prohibits companies owning shares in themselves and there are a series of practical consequences (as well as potentially significant penalties) that can flow.

It looks as though there will be a solution for this client, however as with most breaches of the law, prevention would have been infinitely more palatable than the cure.

And no - a company can not own shares in itself.
Until next week.

Matthew Burgess