Insurance funded buy sell agreements are an important tool for dealing with the death or disability of a business partner.
As the name suggests, insurance is taken out to fund the acquisition of the departing partner’s interest in the business by the remaining partners.
There are a number of different ways to take out the insurance policy including through a self-managed super fund.
A typical arrangement might be:
- two brothers operate a business through a company in which they are the shareholders
- one brother is a member of a SMSF whose only other member is his spouse
- the brothers enter into a buy sell agreement which includes the following terms:
- the SMSF must purchase a life insurance policy over the member brother
- the insured amount is the agreed value of the member’s interest in the company
- the company makes contributions to the SMSF to be used to pay the premiums on the insurance policy
- these contributions are in addition to any SGC obligations of the company to the member
- on the death of the member:
- the insurance proceeds are paid to the SMSF trustee and added to the member’s death benefit
- the death benefit is then paid to the member’s spouse
- the members shares in the company will be transferred to the member’s brother and the member’s spouse relinquishes all claims on the member’s shareholding in the company
The intention of the buy sell agreement is to fund the acquisition of the member’s shares in the company on the death of the member for no personal outlay by the surviving brother. Importantly, the SMSF would not have otherwise purchased the policy.
On its face, the sole purpose test (which essentially relates to providing retirement or death benefits for, or in relation to, SMSF members) would not be breached by taking out life insurance for a member.
However, the ATO states the following two factors in relation to the above arrangement support its decision:
- the calculation of the insured amount is not in any way based on the future needs of the member’s spouse but on a valuation of the member’s share of the company; and
- what the spouse receives from the agreement (whilst ostensibly a death benefit payment from the SMSF) is in substance compensation for the spouse’s expected inheritance from the member’s shares and arguably the additional contributions received by the SMSF from the company were never intended to produce retirement benefits.
The ATO also took the view that the arrangement contravenes the SIS Act by providing financial assistance to the brother as it allowed the brother to obtain total ownership and control of the company upon the member’s death without the need to pay any consideration to the member’s spouse for the transfer of the shares.
Accordingly, any insurance held in an SMSF purely to fund a buy sell agreement may need to be terminated to avoid contraventions of the SISAct.
Prepared by Leanne Matthewson
This publication has been carefully prepared, but it has been written in general terms and should be viewed as broad guidance only. It does not purport to be comprehensive or to render advice. No one should rely on the information contained in this publication without first obtaining professional advice relevant to their own specific situation.