Death benefits under a life insurance policy are only exempt from CGT, if the person or entity who receives those benefits:
(i) is the “original beneficial owner” of the policy; or
(ii) did not give any consideration for the acquisition of the policy.
TD94/31 and multiple policy owners
This taxation determination makes it clear that the exemption under s 118-300 extends to policies that are owned by more than one person.
It states: “Where two or more persons jointly effect a policy of life assurance, each person may be an ‘original beneficial owner’ ”.
It is also clear from the taxation determination that the exemption extends not just to individuals, but also to companies and the trustee of a trust whether on its own or in partnership.
“Furthermore, the person holding the rights or any interest in rights under a policy of life assurance may be an individual, a company or a trustee of a trust estate alone or in partnership.”
The exemption is very wide
The exemption under s 118-300 means that the policy owner could be any of the following:
– the life insured. So self-ownership is covered by the exemption.
– the purchasers in the circumstances of a buy-sell agreement. So cross-ownership is covered by the exemption.
– in the case of key person or debt reduction cover, the business (again, an example of cross ownership);
– a bank or a creditor where debt reduction cover is sought. So bank ownership is covered by the exception.
The exception also covers the trustee of a trust where any of the above parties is the beneficiary. This means that the trustee of a self managed superannuation fund (or indeed the trustee of any superannuation fund) can take advantage of the exemption granted by the section.
Indeed, CGT will only apply to the insurance proceeds if the holder acquired the policy from someone else and did not pay for the acquisition.
The section is straight forward, but like most tax law, it has to be strictly complied with if you want to benefit from it.
“Original beneficial owner”
To benefit from the section, you have to understand who is the owner of the policy. But s 118-300 refers to the “beneficial owner”. So you have to look at who is going to benefit from the policy. Moreover, you need to determine who is the “original beneficial owner”.
So the original beneficial owner of the insurance policy should be carefully considered and identified at the time an application is made to take out the policy.
A situation could occur by which a person who is not the owner of the policy might be entitled to some of the policy proceeds. In such circumstances, that person could have an interest in the policy. That interest could be a beneficial interest.
If that person is changed, for example a trustee may take out the policy for two people as beneficiaries each with a fixed entitlement under the trust. If one beneficiary dies before the life insured dies, it is possible (depending on the terms of the trust) that the surviving beneficiary will receive the whole of the insurance proceeds when the insured dies. In that case the ATO may be of the view that the surviving beneficiary is not “the original beneficial owner”.
So it is important to think through who you want to be the “original beneficial owner” and what structure (direct ownership or trust) should be adopted.
If the identity of the life insured is not clear, or the documentation as to who is the “legal” owner and who is the “beneficial” owner (if not the legal owner) is not clear, or is subject to change, then CGT liabilities on the insurance proceeds can arise. Proper documentation is essential.
THE PREVIOUS OWNER TRANSFERS THE POLICY TO YOU
If a person acquires the policy from a previous policy owner, by buying it from them or having it transferred to that person from the previous policy owner for other consideration, then s 118-300 will prevent that person (or their estate) from receiving a CGT exemption on the proceeds.
So it is important to ensure that there is no “consideration” given for the acquisition of the policy. If it is given then the CGT exemption will not apply. One way consideration could apply is if cross owned policies between business owners were cancelled and replaced with self owned policies.
THE PREVIOUS OWNER TRANSFERS THE BENEFICIAL INTEREST IN THE POLICY TO ANOTHER
Following the analysis above, if a person receives the beneficial interest in the life policy for money or other consideration, then CGT would apply to the insurance proceeds once a claim is made.
Therefore, it is important to ensure that in circumstances where a person receives the proceeds of the insurance and that person is not the original beneficial owner, care is taken to ensure that no consideration is given for the acquisition. Any set of “mutual promises” could easily give rise to consideration sufficient to torpedo any right to receive the proceeds CGT free.
WHAT IF THE TRUSTEE OF THE LIFE INSURED ASSIGNS THE POLICY?
The Leigh Adams Lawyers Insurance Trust Deed provides that the business owner or shareholder can call for the policy to be transferred by the trustee to the business owner or shareholder (i.e. the life insured) without any consideration. So the business owner or shareholder can become the legal owner of the policy without any payment to the trustee and without having to give the trustee any promise whatsoever.
The business owner or shareholder is always the beneficial owner – the “original beneficial owner” – and so in these circumstances the beneficial ownership of the policy has not changed. Therefore, no CGT issue arises because the life insured was, before the assignment, the “original beneficial owner” and after the assignment, the life insured is still the “original beneficial owner”.