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Incorrectly documenting Key Person Insurance leads to extra tax

Key Person is insurance taken out by the business. The business insures its Key Persons - employees or directors. If the Key Person dies, the company gets the insurance to help it cope with that loss.

What are the Tax Implications of Key Person Insurance?

Will I have to pay income tax on the proceeds from Key Person Insurance? This depends on whether the purpose of the Key Person Insurance is to replace income or capital.

For example - You own a policy on your life. You transfer ownership by Memorandum of transfer to your company, XYZ Pty Ltd, for either revenue or capital purpose. You die. When the company receives the proceeds the tax office assesses proceeds according to the purpose.

KEY PERSON TO REPLACE INCOME

Payouts received by the business under an accident or term policy, taken over its Key Persons, are assessable as ordinary income. The purpose of the insurance is to fill the place of a revenue item. For example, to replace profits lost through the loss of the employee's services is an income purpose.

The good news is that if the business Minutes are updated each year and are complying, then the business usually gets a tax deduction for the payment of the premiums. Beware! On a Tax Audit, you may lose the deductions and suffer penalties if there are no annual Minutes as evidence.

KEY PERSON FOR A CAPITAL PURPOSE

What if the Key Person policy protects against a capital loss? For example, the company takes out life insurance to payout a debt that a director guaranteed. Why would a dying director want this? If the director dies, the guarantor is in default. The lender then has the right to go to the guarantor’s Estate and take what it wants to satisfy the debt. Directors don’t like the grieving widow to lose the family home.

Thankfully, the proceeds of the Key Person policy are not assessable as income. This is provided the purpose of the insurance is to guard against a capital loss. Again, the business must create appropriate Minutes each year.

The down side is that the premiums paid on the insurance each year are generally not tax deductible.

Avoid the domino effect by insuring your Key Persons

What other taxes do I need to worry about?

The next edition of Legal Brief will look at the issue of Capital Gains Tax and Key Person insurance.

While there are tax breaks available for Key Person insurance, it is vital that it is documented and Minuted correctly. A complete kit including draft Minutes on how to document your Key Person policy is available from www.LawCentral.com.au for only $66.

Basic rules of Asset Protection

We are often asked to provide Manuals and written information on Asset Protection strategies. We don't publish information on this subject. However, before your Accountant, Adviser and Tax Lawyer start working on this important part of your Estate Planning, you can learn the basic rules.

Avoid losing everything to the wolf at the door!

Does bankruptcy release you from all debts?

You are released from most of the debts at the start of your bankruptcy. Generally, your creditors cannot recover any money after you are bankrupt. They lodge claims with your trustee instead. You are only responsible for any new debts after your date of bankruptcy.

Surprisingly, there are some exceptions.

You are still liable to:

·      pay fines and penalties imposed by a Court.

·      pay child maintenance.

·      pay for damages from accidents, eg. motor vehicles.

You can only escape these payments, if before bankruptcy, you have a court judgement or you have agreed in writing to the liability and the amount.

What about the “Repo Man”?

Your secured creditors, (e.g. creditors who have the ability to repossess the house, car or TV you obtained under finance) may sell the item to recover their money. But only if you fall behind in your payments.

Sometimes you don’t have to pay GST when you buy a business

Let's say you have been working hard as a junior dentist in a 2 person Dental Practice. Your big day comes. The 2 dentists are happy to sell 1/6th each of their interest in the partnership. You will be a 1/3rd owner (Yippee! – Ed.). Do you have to pay Stamp Duty? Do you have to pay any GST?

Will the Tax Man take a bite out of your Practice?

Sadly, there isn’t much you can do about stamp duty. You can reduce it a little by having a tax lawyer draft your contract to give maximum true value to exempt items. In most instances, you pay full stamp duty on most of the purchase price. The business premises, the goodwill and plant and equipment are hit with full duty.

The news is better with GST. Although, in this instance, it is impossible to get the “going concern exemption”, you won't pay GST. Why? Because the ATO said so in Ruling (GSTR 2002/5).

GST is normally payable when a business (called an “enterprise”) makes a “supply” to someone. On the face of it, the interest in the partnership is a “supply”. Therefore, GST is normally payable by you.

However, in that Ruling, the ATO said that the sale of the partnership interests by A and B to you is a supply by the partners to you as

the new partner. As the partners are not carrying on an enterprise of buying and selling partnership interests, there is no GST payable.

What if A and B were carrying on such an enterprise by buying and selling partnership interests in different ventures? You can still get out of GST, as the sale may be an input taxed financial supply from A and B to you (see GSTR 2003/D4). This later situation is more challenging, so talk to your Accountant and Adviser first before making any assumptions.

A similar result happens if A and B run the business through a company or unit trust and sell the shares or units to you.

Despite the Government’s promises of a “Simplified Tax System”, GST adds a whole new complexity to business ownership. Talk to your Adviser, Accountant and Tax Lawyer first, before you sign on the dotted line - otherwise you may end up paying 10% more for the business.

Delay paying your stamp duty bill?

Normally you pay stamp duty on your dutiable documents soon after they are signed. However, in some States, extensions of time for the payment of stamp duty is granted where:

1.        completing the agreement is conditional on an event; and

2.        the parties don't have control over the event.

Trying to hold back from paying Stamp Duty?

This is provided you use your best endeavours to make the event happen.

In Business Succession Planning this is helpful where:

·         a mandatory Buy Sell agreement has been used for a Business Succession Plan (generally by mistake);

·         your agreement is subject to obtaining from the Australian Taxation Office a satisfactory private taxation ruling as to the taxation consequences of the transaction (we do a lot of these – Ed.);

But there are also other opportunities:

·         approval of finance satisfactory to the purchaser;

·         a purchaser obtaining a satisfactory building inspection report from a third party;

·         the obtaining of a licence to trade or granting of a franchise (e.g. liquor licence or Australia Post franchise)

·         the vendor of a commercial property obtaining renewal of existing leases;

·         the vendor of a leasehold business obtaining from the landlord an assignment of lease to the purchaser, or obtaining a new lease;

·         the sale being subject to the sale of another property.

As you can see some of these can be quite useful in delaying the payment of Stamp Duty.

It is a sad fact that Stamp Duty is a major cost in any transaction. Always involve your Adviser in important transactions to ensure that you keep Stamp Duty to a minimum.

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