This article from AIA Australia’s Ben Martin rolls up its sleeves in considering the fine details that can make all the difference when it comes to how advisers recommend the structuring of buy/sell arrangements in order to deliver the best and most tax-effective outcome for the client, their family and their business…
I’ve often found that advisers who arrange buy/sell insurance cover for their clients begin to consider the tax implications of structuring the policy at inception.
For example, a self-owned buy/sell insurance policy – which is a common and sensible way of structuring cover – is often preferred due to tax efficiencies at claim time (as well as the structure’s portability and relative simplicity). And if a business owner is reluctant to fund the non-tax-deductible premiums themselves, the client’s accountant can be engaged to see whether annual premiums can instead be funded out of the trading cash account of the business (subject to the usual FBT/Division 7A considerations).
Keeping capital gains tax in mind
One thing that often ends up being overlooked is the capital gains tax (CGT) event that crystallises in the hands of beneficiaries, or the estate, when the equity is relinquished to the surviving business owner(s) pursuant to the buy/sell legal agreement.
This CGT asset and CGT event are entirely separate to the life and disability insurance policies that are funding the buy/sell agreement. If we don’t take this into account, there is a risk of the client being short-changed.
It is important to remember that when a surviving spouse inherits shares from their late business owner spouse, the cost base they inherit will depend on when the shares were first acquired.
For example, if the shares were originally acquired by the deceased on or after 20 September 1985, the surviving spouse will generally inherit the cost base their spouse had when they died. The gross capital gain per share is the difference between this ‘inherited’ cost base and the market value of the shares when they’re relinquished in accordance with the buy/sell agreement.
The million-dollar question for the accountant thus becomes whether, on disposal of the shares, this CGT event is expected to crystallise a CGT liability in the hands of the beneficiary/estate, or whether CGT concessions can be utilised – in particular the small business CGT concessions, which can be accessed, but only to the extent that the deceased would have qualified immediately prior to their death. If a CGT impost is expected to ensue, a gross-up of the sum insured may be required.
Either way, it needs to be canvassed with the client’s accountant and the expectations of the client and their beneficiaries set accordingly.
Caught off guard
Naturally, the last thing anybody wants is the estate or surviving spouse getting slugged with an unexpected tax bill, which, in some instances, can be in the hundreds of thousands of dollars – especially if the shares, or equity interests, have a nominal cost base.
This can be mitigated by working with your client’s accountant from the outset and at each annual review, seeking to identify any likely tax imposts and grossing-up the sum insured if and as required. If in doubt, don’t hesitate to contact your technical team for more information.
This information is intended for financial advisers only and is not for wider distribution. This information is current at the date of distribution and is subject to change. This is general information in summary only, without taking into account the objectives, financial situation, needs or personal circumstances of any individual, and may not be exhaustive. It is not intended as financial, legal, taxation, medical or other advice
Benjamin Martin is the Senior Technical Manager and heads up the Technical Services division at AIA Australia. He regularly presents at licensee professional development days, is actively engaged in regulatory working committees and authors papers across the various trade press platforms. His qualifications include a Master of Taxation, Bachelor of Applied Finance and Advanced Diploma of Financial Planning…