- There has long been uncertainty on whether or not CGT is payable on life insurance policies that paid a benefit for TPD, temporary disability or trauma.
- The industry has lobbied for change for many years.
- Legislation has recently been introduced to Parliament, which will rectify the issue and confirm that CGT will not be payable.
Late last year, the Federal Government introduced legislation into Parliament to fix a tax anomaly that has been hanging around for almost 30 years.
The problem involved capital gains tax on total and permanent disability, temporary disability (salary continuance) and trauma insurance policies purchased by super funds when a life insurance pays a claim.
The background
Here’s a quick historical timeline on how we got into a mess:
- September 1985 – capital gains tax is introduced but it doesn’t apply to super funds because, at that point in time, all their earnings were exempt from tax. For all other taxpayers, any assets purchased before 19 September 1985 are also exempt from CGT.
- July 1988 – super fund tax is introduced but applies to all assets owned by a super fund, regardless of when they were purchased (there is a special rule for valuing assets bought before July 1988).
- June 1998 – the Parliament passed rewritten CGT tax laws; this rewrite was meant to make the tax laws easier to understand but not how the CGT rules work.
Since these events have played out, there has always been some doubt as to how CGT might apply for super funds (and other trusts) if they own a life insurance policy that paid a benefit for TPD, temporary disability or trauma.
Death insurance policies held by super funds have always been exempt from CGT.
The commonly held view is that CGT applies to the difference between any claim proceeds and the cost of acquiring the policy (that is mostly the premium payments).
For example, suppose you became permanently disabled and your super fund claimed on a life insurance policy it has on your life and received $1 million from the life office. Suppose the super fund had paid a total of $20,000 of insurance premiums, which means CGT of 15% or $147,000 would have been payable on the difference (that is, $980,000).
Interestingly some have simply ignored this potential CGT event and taken the risk that their super fund won’t be checked by the ATO and penalised for not paying the right amount of tax.
As you can see, this is a very serious issue for some people because they purchased additional insurance to cover for the CGT their fund might have to pay in the event that there was a claim on a policy.
The attempts
The financial services industry has been regularly asking the ATO for its view. On the whole, it would be fair to say that it has been reluctant to issue a firm binding view of how the rules work. Over the years, it has sometimes released information that was confusing and incomplete.
In 2012, the Rudd/Gillard Government announced that it would amend the law to make it clear that CGT would not apply to TPD contracts from 1 July 2008.
That is, no mention of salary continuance or trauma insurance. Before the ALP lost the last election, it had not introduced into Parliament any legislation to implement this welcome policy change. It also hadn’t released draft legislation for interested parties to provide some commentary on.
The final change
The Abbott Government then announced in late 2013 that it would proceed with this amendment.
The legislation to put this into place has since been introduced into Parliament and applies to TPD, salary continuance and trauma insurance policies and applies from 1 July 2005.
As I mentioned – at long last it appears that we have some clarity around this issue. Better late than never, I guess!
Just a small point of clarification – from 1 July 2014, your super fund can’t purchase any new life insurance policy if the proceeds can’t be paid out of the fund. Typically this will mean trauma insurance policies and some salary continuance and TPD policies. See my article from last week [1] for important background information on this issue.
Important: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regards to your circumstances.