Buy-sell agreements – can life insurance policies still be owned by an SMSF?

February, 2016

Last year, the ATO scrutinised the practice of an SMSF holding a life insurance policy in order to fund a buy-sell agreement. In what was described by commentators as a “harsh” decision and a backflip on the ATO’s prior position, the ATO ruled that such an arrangement was capable of contravening the sole purpose test in the SIS Act; namely the requirement that the sole purpose of the SMSF is to provide benefits for its members on and after retirement[1].

Of course, each ruling turns on the individual circumstances of the case, but the broader question remains: can an SMSF owned policy still be part of a business insurance strategy?

The breach

In the 2015 ruling, the Commissioner cited two key concerns which led to the conclusion that there was a breach of the sole purpose test. First, the insured amount in that particular case was based on the value of the business, rather than on the future needs of the member’s spouse arising from a death benefit. Secondly, the death benefit was in substance compensation for the spouse’s expected inheritance from the member’s interest in the business.

Hence, depending on the answer to the following key questions for business owners, it is possible that the purpose of insurance, in a buy-sell context, may still be consistent with the SIS sole purpose test:

  1. what are the business owners’ personal (and familial) financial needs and concerns?
  2. what are the business risks (insurable or not) that they want to protect against?

Naturally, not all business owners share the same risk appetite so the answer to these issues will guide and inform, not just the insurance requirements, but the legal ownership and documentation needs.  There may be circumstances where an SMSF owned policy is still appropriate and permitted.

For example, if a business owner is concerned to ensure their spouses are properly provided for in the event of their death, recognising that they will no longer enjoy ongoing income earned by the business owner then, regardless of what the parties think the business is worth, insurance obtained for the purpose of this personal financial goal is arguably still consistent with the sole purpose test.

That is, there could still be an opportunity to use an SMSF to hold the life insurance policy for the purpose of providing a death benefit for the spouse, whilst the business buy-sell agreement provides for an exit at an agreed price which may be funded outside insurance.

Importance of legal advice and the Statement of Advice

Legal and tax advice should always be obtained before pursuing any particular insurance ownership arrangement.  Until further guidance is issued by the ATO, it may also be appropriate to make a request to the ATO for SMSF specific advice or a private ruling to confirm the policy ownership will not contravene the SIS Act.

A well-drafted legal agreement underpinning the change of ownership will be critical to ensure that:

  1. The parties intentions with respect to personal and business succession are properly reflected and documented;
  2. No unexpected CGT events arise for the business or the owners; and
  3. There is an appropriate transfer of legal ownership.

Of course, there are some circumstances, such as in the ATO ID, where all of the factors will contribute to the sole purpose test being breached resulting in SMSF ownership of the policies not being viable.

The financial adviser’s Statement of Advice is important to demonstrate that the parties have considered all options for insurance and its ownership structure and documents the reasons for pursuing the chosen ownership option.  If an SMSF ownership strategy is pursued, the SMSF trustee should properly consider it and resolve to adopt it.

Contact Mills Oakley

For more information, please contact:

jennifer-yeo

Jennifer Yeo
Special Counsel
T: +61 2 8289 5881
E: jyeo@millsoakley.com.au

[1] ATO Interpretative Decision 2015/10 (ATO ID) issued in May 2015

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