A method of implementing this strategy has been scrutinised by the Commissioner of Taxation in ATO
ID 2015/10: Superannuation – Self managed super fund: Life insurance – Buy sell agreement – financial assistance – sole purpose.
This article considers the view of the Commissioner and whether key person insurance strategies can still be employed without contravening superannuation law.
1. Key issues
The key issues in ATO ID 2015/10 were whether a fund contravenes:
- the sole purpose test in s 62 of the Superannuation Industry (Supervision) Act 1993 (Cth) (‘SISA’); and
- the prohibition against providing financial assistance to a member or member’s relative under s 65 of the SISA, by purchasing a life insurance policy over a member’s life where the purchase is a condition of a buy-sell agreement the member has entered into with his brother as co-owners of their business.
2. Background
The facts of ATO ID 2015/10 involved a fund member and his brother entering into a buy-sell agreement under which the fund trustee was required to purchase a life insurance policy over the member’s life.
On the member’s death, the insurance policy proceeds were to be paid to the fund trustee, and the fund trustee would then pay the deceased member’s superannuation death benefits (including the insurance policy proceeds) to the member’s spouse. The member’s shareholding in the company would then be transferred to the member’s brother and the member’s spouse would relinquish all claims on the member’s shareholding in the company.
3. ATO position
3.1. Sole purpose test
The ATO formed the view that the agreement was fundamental to the succession of control of the company. Further, the insurance policy enabled the member’s brother to gain sole ownership and control of the company on the member’s death without incurring any expenditure. The role of the fund
trustee was to act as a conduit under the agreement to facilitate the transfer of control of the company.
Thus, the effect of the agreement was to provide a significant, albeit indirect, benefit to the member’s brother. The ATO focused on two key factors in forming their decision:
- the calculation of the insured amount was not based on the future needs of the member’s spouse; and
- while the member’s spouse ostensibly receives a death benefit payment from the fund, the amount is in substance the market value of the member’s interest in the company.
3.2. Provision of financial assistance
The ATO formed the view that the agreement operated so as to compel the fund trustee to utilise a portion of the contributions received to fund the insurance policy premiums. The Commissioner, however, determined that an absence in the reduction of the fund’s net assets did not preclude a finding that financial assistance has been given using the fund’s resources.
Thus the Commissioner concluded that the arrangement constituted the provision of financial assistance to the member’s brother in contravention of s 65 of the SISA.
4. Analysis
In analysing ATO ID 2015/10, consider the fundamental basics of an agreement that obligations arising under an agreement can generally only rest with entities that are parties to the agreement. This is known as the ‘doctrine of privity’, which is a common law concept that provides that an agreement cannot confer rights or impose obligations on a third party that is not a party to the agreement.
As the parties to the buy-sell agreement are the member and his brother, the agreement does not impose any obligations on either the fund trustee or the spouse. Thus, it is likely that the agreement is ineffective to the extent that it purports to require the fund trustee to apply contributions to the payment of premiums in respect of the insurance policy on the member’s life.
The agreement may be expressed such that the member must ensure that the fund trustee applies the contributions in payment of the premiums. As the fund trustee, however, is a multi-director company and is required to comply with the fund’s trust deed, the constitution, superannuation law and
general trust law provisions, any direction of the member is likely to be ineffective unless specifically provided for in the trust deed.
Further, the payment of the deceased member’s death benefits (including the insurance policy proceeds) would be at the discretion of the fund trustee, subject to a valid binding death benefit nomination, automatically reversionary pension or a death benefit rule hardwired into the terms of the fund deed.
Thus, any agreement between the member and his brother is a secondary agreement that cannot override the duties and obligations of the fund trustee under superannuation law or the trust deed or impose positive requirements on the fund trustee.
Similarly, as the member’s spouse is not a party to the agreement, the agreement is unlikely to be binding on the spouse such that the spouse could seek to exercise the member’s rights connected with the shareholding or require payment for the market value of the deceased member’s shareholding in the company, subject to the company’s constitution.
5. What are the alternatives?
The ATO have confirmed that ATO ID 2015/10 is confined to its facts. Any insurance arrangement involving a fund, however, will need to be closely scrutinised in light of the ATO’s view to ensure that the
arrangement does not contravene the sole purpose test or the prohibition on providing financial assistance.
On this basis, members may prefer to consider other strategies, for example, holding insurance outside of the superannuation environment. The alternatives will need to be considered on a case by case basis, depending on the member’s circumstances and ultimate aim in taking out life insurance.
