Beware Life Insurance policies for Business Succession purposes in Self-Managed Super Funds

19 August 2020

One of the most important aspects of putting in place Buy/Sell Insurance for business succession planning is reviewing the purpose, strategy and sums insured each year to ensure they remain fit for purpose.

Often, the Findex Risk Insurance team are bought in to review shareholder agreements and the accompanying life insurance contracts that were put in place many years ago to fund them. During our reviews we often see the implementation of a strategy that was extremely popular in the 90’s and early 2000’s amongst accountants, lawyers, advisers and product manufacturers.

The strategy involved business owners setting up a Self-Managed Super Fund (SMSF) and then taking out Life and Total & Permanent Disability (TPD) insurance policies on the lives of their business partners, with the insurance policies both owned and funded by the SMSF.

If one of the business partners suffered a claimable event and the insurance policy was triggered, the contractual clauses in the Buy/Sell Agreement ensured the shares of the business changed hands in accordance with the receipt of the insurance proceeds.

While this might all sound fair and reasonable, unfortunately there is a potential roadblock. In 2015 the Australian Taxation Office (ATO) outlined its view of funding buy/sell agreements through super in the Interpretive Decision ATO ID 2015/10, where it said that holding insurance within an SMSF for a Buy/Sell purpose is likely to result in a breach of the Sole Purpose test.

The Sole Purpose test is very important - put simply it governs that the purpose of the super fund (and therefore it’s insurance arrangements) is for the ‘sole purpose of providing retirement savings for the member, or their dependants if the member passes away’.

The Australian Taxation Office (ATO) treats contraventions of the sole purpose test very seriously and Trustees of SMSFs may face losing their concessional tax treatment of the fund and possible civil and criminal penalties.

So, while this strategy was an extremely popular structure for many years, the ATO ID 2015/10 decision now suggests it may not deliver it’s intended outcome and could create a much larger compliance issue for SMSF’s.

Therefore, it is essential that business owners have their succession plans and life insurance contracts that fund them, regularly reviewed. An annual review is important for many reasons, including these key factors;

  • The purpose of the Business Succession plan and the associated Buy/sell insurance policies is documented on an annual basis. This could be important for an insurance claim if the ATO has a different view on the purpose of the policy and agreements and wishes to tax the proceeds.
  • The advice and structure of the fund, agreements and policies are reviewed to make sure they remain current from a compliance prospective.
  • The concessional tax treatment of the superannuation fund is maintained which is important for the SMSF Trustees.
  • Shareholder are provided an update regarding their holdings and values, and life insurance policies are reviewed to ensure the correct sums insured and policy terms and conditions are in place.

Best of all, an annual review helps provide the comfort for all involved that your best paid plans will continue to be just that.

Finally, keep in mind that the purpose of ATO ID 2015/10 is to provide the public with insights into how the Tax Office might interpret whether the sole purpose test has been breached in circumstances where an SMSF holds a life insurance policy pursuant to a buy/sell agreement. If you are currently using the SMSF structure outlined above or considering this structure, it is important you speak with an adviser and seek updated legal advice on the most appropriate structure for you, prior to making any decisions.

Get in contact with the Findex Risk Insurance team for more information on insuring your business succession plans.