Key points

• A properly constructed business succession needs to address two key issues – disposal and funding.
• Sometimes business owners will want to have life insurance policies in a super fund so they can get tax concessions on the insurance premiums and the proceeds can often be paid out tax free when initially paid to the deceased’s dependant.
• However a recent interpretive decision from the Tax Office didn’t like an arrangement in which two brothers had arranged to execute a buy-sell agreement that said their SMSF would purchase a life insurance policy. The brother would then use the proceeds to pay out the spouse’s interest in the business if her husband were to die.

There are more than 1 million small businesses in Australia and all of them will have issues about succession.

What do I mean by this term? Basically ensuring a business survives when owners, key employees and managers can’t work in the business because of death, permanent or temporary disablement, imprisonment and even bankruptcy.

Planning for these potential events can sometimes be a complicated affair. And to make matters slightly more difficult, the Tax Office may have made it harder to solve this issue using an SMSF. Fortunately solutions are at hand.

Make a succession plan

A properly constructed business succession plan involves establishing a written agreement between business owners that needs to address two key issues – disposal and funding.

In an ideal world a business succession plan will provide certainty but will also be flexible enough to take into account changes in business circumstances and dynamics. It also needs to be simple. Often achieving these competing objectives to high degree can be tough – sometimes too tough.

One option is to solve immediate critical issues and then agree on a timetable to consider other matters.

Important considerations when sorting out business succession are various taxes such as CGT, stamp duty and GST.

As an example, let’s consider a business owned equally and run by two brothers who are both married. They agree that if the worst were to happen to one of them, it would be better if the surviving spouse didn’t work in the business and her inherited ownership of the business would be compulsorily acquired by the living brother.

In many cases, owners don’t have sufficient personal resources to buy out their unowned share of a business. The only way to effectively solve this problem for death and disablement is via various life insurance policies.

There are many ways to structure these arrangements. For example, one brother might take out a death insurance policy and nominate his other brother as the beneficiary of that insurance. A signed written agreement is executed which deals with a range of issues including how the business will be valued, how the proceeds from the insurance policy will be used as consideration for the business, which will then enable the surviving brother to compulsorily take ownership of the deceased’s business interests.

Using super funds

Sometimes business owners will want to have the life insurance policies in a super fund so they can get tax concessions on the insurance premiums and the proceeds can often be paid out tax free when initially paid to the deceased’s dependant.

The option of using super funds in this way has been around for years and some large retail super funds have regulatory approval, which they have used to market their offering. Often they have also provided pro-forma business succession agreements, which businesses have used as a handy template.

The ATO’s interpretation

Recently the Tax Office issued an Interpretative Decision (ID) that looked at a specific business buy-sell agreement that used an SMSF.

The proposed arrangements had the following details: two brothers would execute a buy-sell agreement that said an SMSF which has two members – one of the brothers and his spouse – would purchase a life insurance policy with the sum insured based on an agreed market value of 50% of the business.

The business would pay for the insurance policy via super contributions that would be in addition to any Super Guarantee or salary sacrifice contributions that the business would make.

If any insurance policy claim proceeds were received, they would be paid to the super fund, which would then distribute this to the brother’s spouse who, in turn, would agree that this would represent her interest in the business and would formally transfer ownership of her inherited portion of the business to the surviving brother.

The Tax Office said it didn’t like this arrangement. In its view the SMSF would be part of an agreement but wasn’t actually a party to it. The ATO concluded that such a proposal would be a breach of the sole purpose test (that is, a specific test which funds must satisfy at all times).

It also said the agreement indirectly provided financial assistance to the fund member’s brother, which is prohibited. It argued that “the terms of the agreement allow the member’s brother to obtain total ownership and control of the company upon the member’s death without the need to pay any consideration either in the way of insurance premiums or as a direct sum to the member’s widow for the expected inherited share of the company”.

Can you use super for business succession?

Brian Hor, Special Counsel at Townsends Business and Corporate Lawyers says that it appears this arrangement provided too much detail and it could have been better structured. He added that businesses wanting to use super funds for buy-sell arrangements might be better utilising the insurances offered in retail or industry super funds rather than a SMSF and to be very careful in how they draft their agreement.

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.