Q: My client is looking to take out buy/sell insurance to protect themselves in the event of their death, disability or illness. How should the buy/sell policy be structured and what are the tax implications?
A: There are many different policy ownership structures that are available when funding a business succession plan with insurance. As a general rule, buy/sell cover is typically owned outside of the trading entity. Thus self-ownership is a preferred ownership structure as it is a tax effective and efficient way of ensuring the proceeds end up in the right hands.
Under the self-ownership option, each business owner owns an insurance policy on their own life. If a business owner exits the business due to death, TPD or crisis recovery (trauma), the following will generally occur:
- The insurance proceeds are paid to the departing owner or their estate
- The recipient (i.e. the departing owner or their estate/beneficiaries) accepts the insurance proceeds as consideration/payment for the departing owner’s interest in the business, and
- The departing owner’s business interest is transferred to the remaining business owners.
Note that success depends on an effective buy/sell agreement. If there is no buy/sell agreement then the departing owner/beneficiary will retain both the insurance proceeds and business ownership interest.
From a tax perspective, self-ownership is tax effective as no CGT is payable on life insurance proceeds if the recipient is the original owner of the policy (or they acquired the policy for no consideration). Further, CGT is not payable on TPD or crisis policies as the life insured is the owner of the policy.