CGT & Insurance Proceeds in Business Succession Planning

CGT & Insurance Proceeds

Death Benefits

Pursuant to section 118-300 of the Income Tax Assessment Act 1997, insurance proceeds paid on the death of a person (‘Death Benefits‘) will be exempt from CGT if the recipient of the proceeds is the person or the entity who was the “original beneficial owner” of the policy.  Therefore, a Death Benefit will potentially be exempt from CGT whether the policy was self owned, cross owned or owned by a trust.  CGT will only be payable on a Death Benefit where the recipient is not the original beneficial owner of the policy, for example, where:

  • The benefit of the policy is purchased by a third party;
  • The legal owner of the policy makes a declaration that it thereafter holds the benefit of the policy on trust for a third party, or
  • A Court finds that a third party had an equitable or beneficial interest in the benefit of the policy. (See below, why buy/sell arrangements should always be documented in a formal agreement).

Non-Death Benefits

Non-Death Benefits (such as Total and Permanent Disablement and Trauma Benefits) received under an insurance policy are not specifically dealt with by the CGT legislation.  The exemption for these proceeds is more limited and does not depend on the notion of “original beneficial owner“.  Section 118-37 of the Income Tax Assessment Act 1997 provides an exemption for “compensation or damages you receive for any wrong, injury or illness you or your relative suffers personally“.  The exemption is only available if the person who receives the proceeds was the injured person or a relative of that person. The ATO’s current view is that Non-Death Benefits will only be exempt from CGT for Self Ownership and Trust Ownership.

Therefore, the Cross Ownership of an insurance policy for total and permanent disablement and/or trauma will result in a liability for CGT in the event of a claim.

Terminal Illness Benefits

On 28 March 2007 the ATO issued Tax Determination 2007/4 in which it expressed the view that a benefit received under an insurance policy as a result of a terminal illness is to be treated as if the benefit was a Death Benefit.  The result of the Tax Determination is that the proceeds of insurance as a result of a Terminal Illness Benefit will be exempt from CGT regardless of the nature of the legal ownership of the policy, provided that the recipient of the proceeds is the “original beneficial owner“.

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By Sam Roberts,
Managing Director, Accredited Specialist (Commercial Litigation)