Life Insurance Held by an SMSF for a Buy-Sell Agreement

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Role of SMSF Accountants in Life Insurance Acquisition

SMSF accountants often facilitate their clients in purchasing a life insurance policy as part of a business buy-sell agreement within their self-managed superannuation fund (SMSF). This practise is prevalent among SMSF trustees who have negotiated with their business partners. The inclusion of life insurance in such agreements serves as a protective measure, ensuring a structured approach to business succession planning and financial stability within the context of SMSFs.

ATO’s Stance on Common Practises

However, the Tax Office has stated that they believe this common practise is now a breach of the legislation. This development adds a layer of complexity for SMSF accountants and trustees who may need to reassess their approach to ensure compliance with evolving regulatory requirements.

In ATO ID 2015/10, the Tax Office has stated that this common practise 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, along with his wife, are the only members of their SMSF
  • The member and his brother enter into a buy-sell agreement
  • The terms of the agreement requires the following:
    • The SMSF is obligated 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 makes contributions to the SMSF, which are used to pay the premium on the life insurance policy.
    • The insurance proceeds are paid to the SMSF on the member’s death. 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 member’s death by the brother for no personal outlay.

The fund would not have purchased the policy if not for this intention.

Section 62 of the SIS Act states that the core purpose of an SMSF is to provide retirement or death benefits. It does allow specific 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 significant component of the brother’s succession management. The agreement was entered into with the 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 a breach.

Two important factors support this view. First, the calculation of the insured amount was not based on the future needs of the member’s spouse but on the valuation of the member’s share of the business. Second, 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 resemble this case, SMSF accountants may need to discuss possible alternative options or if you have any queries in relation to the above, the Kreston Stanley Williamson team is here to help. Don’t hesitate to reach out and contact us.

Kreston Stanley Williamson

*Correct as of June 2015

Disclaimer – Kreston Stanley Williamson has produced this article to serve its clients and associates. The information contained in the article is of general comment only and is not intended to be advice on any particular matter. Before acting on any areas in this article, you must seek advice about your circumstances. Liability is limited by a scheme approved under professional standards legislation.

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