30/07/2012

It might not have been on the front page, but for people with an SMSF a small overlooked announcement by the Federal Government on Budget Night might have opened the way for much more flexible use of life insurance as part of their SMSF strategy.

In "Part 1: Revenue Measures" of Budget Paper No.2 the Government announced the following:

"The Government will make minor extensions to the capital gains tax (CGT) exemptions for certain compensation payments and insurance policies, with effect from the 2005-06 income year ….  This measure will disregard CGT consequences where a taxpayer receives compensation, damages or certain insurance proceeds indirectly through a trust.  This will ensure that the taxpayer has the same CGT outcome as a taxpayer who receives such proceeds directly.  It will also ensure that insurance policies owned by superannuation funds that were treated as being CGT exempt prior to the 2011-12 Budget changes to compensation payments and insurance policies continue to be CGT exempt".

This change may mean that a life policy with bundled added covers can be held partly by the SMSF and partly by the member personally.

Let us explain.  Life insurance can come with a number of bundled covers.  Obviously the core cover is life insurance.  But the same policy can also cover the named person for other events such as total and permanent disability (TPD), trauma, permanent incapacity (falling short of TPD), temporary incapacity, disability and or terminal medical condition.  

The price of the policy can be dependent on (among other things) how many of these covers are included in the policy.  Generally, as with many products, it is cheaper to buy a number of different offerings together (‘do you want fries with that?’) than to purchase them separately (‘But sir it is cheaper for you to buy the happy meal than the burger and fries separately” – “I know but I just don’t want the drink”).

For some time it has been recognised that life insurance held inside superannuation can offer some benefits – offsetting the tax deductible premium against the contributions tax, enjoying the proceeds in a low tax or even no tax environment, quarantining proceeds from the member’s debts, to name a few.  But not all of the bundled covers are eligible to be held inside a super fund.

Life cover certainly is, as is TPD, provided the fund’s trust deed empowers the trustee to provide a ‘disability superannuation benefit’.  The other covers, maybe not.

The common solution has been to have the policy held by a ‘nominee’, partly for the superannuation fund in respect of the life and TPD cover and partly for the non-super beneficiary, being the member in their own right and not part of their super.  In this way the member gets the benefit of the lower bundled premium without the need to buy the more expensive individual separate policies.

But this nominee arrangement comes with its own challenges, not the least of which is the tax treatment of the trust created by this separate nominee arrangement.  Proponents of the arrangement argued that the nominee held the policy under a bare trust and therefore the respective beneficiaries were ‘absolutely entitled’ to their respective interests in the policy.

Section 106.50 of the Income Tax Assessment Act 1997 provides that the acts of a trustee are deemed to be the acts of the ‘absolutely entitled’ beneficiary.  Hence the beneficiary is the taxpayer and the trust is looked through, especially for, say, CGT purposes and in respect of the lodgement of a tax return.

But to be ‘absolutely entitled’ the ATO has ruled that the beneficiary must be able to call for the transfer to them of the trust asset by the trustee.  In the case of a bundled life policy it may not be possible to transfer some of the bundled covers and not all.

The Budget announcement may obviate the need for ‘absolute entitlement’ because it effectively says that if the beneficiary receives their entitlement under the policy indirectly through the insurance trust, that payment will have the same CGT outcome as if the beneficiary had received the entitlement directly. In other words the ATO will look through the trust.

No legislation or further ATO announcement has been released since the Budget and it may be many months or even years before it is.  But if the actual legislative and or regulatory changes that are made as a result of the announcement have the effect of doing away with the ‘absolute entitlement’ requirement, the involvement of self managed superannuation in the insurance needs of members may be significantly enhanced.

If you have any questions in relation to this article, please contact TOWNSENDS BUSINESS & CORPORATE LAWYERS on (02) 8296 6222.