Buy/Sell Agreements and SMSF’s
Where life or TPD insurance is held by a SMSF to pay out under a Buy/Sell Agreement, the SMSF may breach the sole purpose test in the SIS Act. One significant consequence of this is that the total value of the assets in the SMSF will be taxed at the highest marginal rate of tax.
The sole purpose test in section 62 of the Superannuation Industry (Supervision) Act 1993 (SIS Act) prohibits trustees from maintaining a Self Managed Superannuation Fund (SMSF) for purposes other than for the provision of specified benefits. The core purposes is to provide retirement or death benefits for, or in relation to, SMSF members. So where insurance is bought to satisfy obligations under a buy/sell agreement, care is required with the arrangements under that buy/sell agreement to avoid the possibility of this section being breached.
Of course, most SMSF do hold life insurance for the benefit of members. This is perfectly acceptable and subsection 62(1) of the SIS Act expressly allows an SMSF to be maintained for the provision of death benefits.
However, where there is a buy/sell agreement in place it is necessary to look in detail at the manner and circumstances in which a SMSF comes to hold the insurance policy. If it came about as part of and only because of an underlying buy-sell agreement, the buy/sell agreement may need to be changed and the insurance shifted (as the benefits conferred by the buy/sell agreement cannot be regarded as being merely incidental to the core retirement income purposes of the SMSF).
For people involved in a family business, the situation is more complicated. In that case, if there is a pay out there will also be the question of whether or not applying the proceeds of the policy to fund the purchase of a business interest from a relative, breaches the SIS Act- as a SMSF cannot benefit a “relative” of a member (Section 65 SIS Act).
Contact us if you believe that you may have an issue.