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LIFE INSURANCE HELD BY AN SMSF FOR A BUY-SELL AGREEMENT

LIFE INSURANCE HELD BY AN SMSF FOR A BUY-SELL AGREEMENT

Current as of June 2015

It is a very common practice for a self-managed superannuation fund (SMSF) to purchase a life insurance policy where the purchase is pursuant to a business buy-sell agreement the member has entered into with their business partners.

However, the Tax Office has stated that they believe this common practice is now a breach of the legislation.

In ATO ID 2015/10 the Tax Office has stated that this common practice is a breach of the “sole purpose test” – section 62 of the SIS Act.

The facts of this case were:

  • A member of an SMSF and his brother run a business
  • The member and his wife are the only members of their SMSF
  • The member and his brother enter into a buy-sell agreement
  • The agreement requires:
    • the SMSF to purchase a life insurance policy over the member’s life for an amount based on the agreed market value of the member’s half of the business
    • the business to make contributions to the SMSF and that those contributions are used to pay the premium on the life insurance policy
    • on the death of the member, the insurance proceeds are paid to the SMSF. The SMSF will pay the proceeds to the member’s spouse, and the member’s half of the business will be transferred to the brother. The member’s spouse will relinquish all claims on the member’s half of the business

The intended effect of the buy-sell agreement is the acquisition of the member’s half of the business on the death of the member, by the brother for no personal outlay.

If not for this intention, the fund would not have purchased the policy.

It is noted that Section 62 of the SIS Act states that the core purpose of an SMSF is to provide retirement or death benefits. It does allow certain ancillary purposes on the cessation of a member’s employment and other approved benefits not specified under the core purpose.

In this case, and we suspect many similar circumstances, the buy-sell agreement is a major component of the brother’s succession management. The agreement was entered into with a specific purpose of obtaining a particular benefit for the brother. This immediate benefit to a related party was not incidental, remote or insignificant and was deemed to be a breach.

Two factors support this. First, the calculation of the insured amount was not based on future needs of the member’s spouse, but based on the valuation of the member’s share of the business. Secondly, what the spouse receives looks like a death benefit, but it is, in substance, compensation for the expected proceeds from the member’s half of the business.

If your circumstances sound similar to this case, then we may need to discuss possible alternative options.

 

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This newsletter has been produced by Stanley & Williamson as a service to its clients and associates. The information contained in the newsletter is of general comment only and is not intended to be advice on any particular matter. Before acting on any areas contained in this newsletter, it is imperative you seek specific advice relating to your particular circumstances. Liability limited by a scheme approved under Professional Standards legislation. 

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