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Self Managed Super Fund (SMSF) Article
It's wise to be prepared for contingencies

By Tony Negline.

This article may be out of date.

11th November 2009

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Succession planning for small to medium sized businesses typically involves developing a plan to ensure that the business survives after a significant event such as the death, permanent disablement, temporary disablement, imprisonment or bankruptcy of a key business owner or employee.

It involves establishing a written agreement between the shareholders, partners or principals which should discuss two aspects – the automatic disposal of business equity when adverse events happen to an owner and how the purchase price of that equity will be funded.

If the putative purchasers cannot personally raise the funds to acquire some or all of the equity the agreement demands then various types of life insurance policies will be used.  There is considerable debate amongst industry professionals as to whether superannuation funds should own these insurance policies.

Before a business succession agreement can be drafted it's essential to gather together a wide range of information from the owners such as asset ownership structure, asset net market values, corporate structure and due diligence.

Paul Hockridge, a Deloitte tax partner in Melbourne, believes that all business succession plans should be tested against three criteria – certainty, simplicity and flexibility.  However it is extremely difficult to achieve a high degree of all three objectives at the same time.

"It's often better to deal with the critical issues as soon as possible and then agree on a timetable to consider any other important issues," said Hockridge.

Unsurprisingly an important aspect in all business succession agreements is taxation including income tax, capital gains tax, fringe benefits tax, GST and stamp duty.

Over the years a number of different strategies have been used to implement business succession agreements but because of various tax changes many of them have fallen into disuse.  For example one arrangement, often referred to as a "cross insurance agreement", demanded that each business proprietor owned a fractional interest in the life insurance policies on the lives of all the other owners.  CGT changes introduced in the 1980s saw the death of this type of agreement.

The most common form of business succession agreement used these days involves 'self insurance.'  As might seem obvious from the structure's name, each proprietor takes out insurance on their own life.  Any claim on a life insurance policy is paid to the individual proprietor or their estate.

When the life insurance policy proceeds are paid the existing proprietor is deemed to have disposed of their equity to the remaining proprietors at market value.  The remaining proprietors are deemed to have acquired the equity at an equivalent value.

What happens if a proprietor cannot obtain life insurance?  Or similarly what happens if the required life insurance is too expensive?  Hockridge says, "You may still be better to proceed with the buy/sell agreement because solving some of a problem is better than solving none of it."

Business owners often make loans to their business or have been loaned money by the business.  They also often provide guarantees or indemnities for liabilities of the business.

If these debts are forgiven then this might trigger the commercial debt forgiveness rules which might cause tax losses, capital losses, the written down value of depreciated assets and the CGT cost base of assets all to be reduced.  The only way to fix this problem is for the debtor to insure the debts.

In the last 15 years it has become common for the business succession insurance contracts to be owned by a super fund trustee.  The advantage here is that the contributions made to a super fund to pay the insurance premiums are often tax deductible.

For the moment lets assume the death of a business owner whose business succession insurance is held in a superannuation fund.  The super fund will pay (under some sort of binding nomination) a beneficiary the proceeds of the death insurance policy and the beneficiary will have an obligation under the business succession agreement to officially hand over the equity in the business.

A key question will be whether using a super fund for business succession purposes satisfies the super laws.

There are many views in the super industry.  MLC's Jon de Fries believes that large super funds are fine for most business succession insurance except for medical trauma insurance.

de Fries and Hockridge both agree that a Self Managed Super Fund should be used with caution.

Hockridge argues that particular care must be taken if the business is owned by a family trust.  A super fund can only pay a deceased estate or dependant of the deceased which means that the notional sale proceeds cannot be paid directly to the family trust.  If the family trust disposes of its business interests without receiving anything for it, a breach of trust action might be levelled against the trustee of the family trust because they have disposed of an asset effectively for no money.

To avoid this type of claim, the family trust should have power to enter into the preferred business succession type of arrangements.

de Fries also has another solution for this problem.  He says that it might be possible for the beneficiary of the super proceeds to loan that money to the family trust and then the formal sale process can take place.

Anyone looking for certainty in using a Self Managed Super Fund for business succession insurance should consider getting a ruling from the Tax Office.

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