Get insurance settings right

Advisers are not structuring business insurance properly, which is causing problems later on, warns Tower tax counsel David Glen.

Glen told the AFA Conference in Melbourne this week that it was important the insurance had a self-ownership structure and not a company owning the policies.

“The required payment must be made to the insured person or a related party.

“If there is a crossover where the payment is paid to the company and then onto the insured party, the payment will be subject to CGT.”

Glen said the ownership of business insurance is where most of the problems occur in this type of insurance. The purpose of business insurance is to ensure the owner is given a fair value on their share when exiting the operation, which can be through disability, death or retirement. Glen said it can also smooth the change of ownership by minimising the disruption caused by one owner leaving the business.

“An insurance policy on the life of each owner of the business will enable a buy/sell arrangement to come into play on the occurrence of an event,” he said.

“The business is transferred to the remaining owner for a nominal sum while the insurance pays the value of the business to the estate.”

Because the premiums are paid by the owners they are non-tax deductible, however, an increased salary can be paid to cover these costs, Glen said. If the company paid the premium, apart from ownership issues, the insured would also be subject to FBT.

Another issue that can arise is unequal insurance premiums between the two owners. Glen said there is no rule that says there has to be equal premiums.

"The owner with the health problem will be paying more and frankly they are going to die first, so the younger owner will eventually benefit by becoming sole owner,” he said.

However, the transfer of the business will be liable to CGT although there are exemptions.

“The ATO will ignore the transfer of the business at nominal value, it will treat the transaction at market value,” he said.

However, if the business was started before September 20, 1985, the business could be exempt from CGT.

“There are other exemptions for small business, such as holding the asset for more than 12 months grants a 50 per cent exemption from tax.”

Glen said it was important the adviser checks with the business’ accountants on what the tax liability is for any sale.

An alternative to avoiding some of tax problems is to put the insurance within superannuation, such as a self-managed fund.

“The company pays the contributions to the fund and this then pays the policy,” he said.

“The policy is owned by the trustee of the fund and any claim will be paid into the fund.”

Glen said the attraction of this is that when the proceeds are transferred to the spouse or dependent children, the distribution is tax free.

“The contribution (cost of premium) to the fund is taxed, but it is offset by the payment of the premium,” he said.

“So the fund is in a tax neutral situation.”

The situation with TPD insurance in a fund is not so clear, Glen said, as there is a question over the tax treatment of deductions for premiums at present.