Key Personal Capital Insurance and Capital Gains Tax


I recently was invited to speak at the Business and Estate Planning Specialists annual conference in Cairns. One issue raised, was whether there was any way to limit exposure to Capital Gains Tax for the reduction of debt in a business, from the payment of Key Person Capital, or Debt Reduction, Insurance.

This is a very good question and opens up many issues relating to Capital Gains Tax and the ownership of insurance policies.

The issues to be addressed when considering a Key Person Capital insurance policy are:

  1. What exactly are the tax implications?  Unless a specific exemption applies, the proceeds of a policy may be subject to Capital Gains tax;
  2. Who should own the policy?  Should it be the individual, the business or a trust?;
  3. The different tax treatment for death benefits and non-death benefits (such as TPD and trauma);
  4. Can a CGT exemption apply?;
  5. How do we bind the beneficiary of the policy to actually use the proceeds to reduce the debts of the business;
  6. The need to avoid capital gains tax on insurance policies if new owners are introduced to the business;
  7. How do we protect the estate of a deceased from any contribution claims by the Business for debt? Here it is very important to ensure that the policy is sufficient to cover all debts that are personally secured by the insured parties.

One potential solution to the Capital Gains Tax issue is to establish a Hybrid Trust or Business Insurance Trust Agreement

Hybrid Trust – Business Insurance Trust Agreement

This is a specialised document that requires careful consideration and specialised advice, to ensure that Capital Gains Tax is not payable. The key attributes to this type of agreement are:

  1. Insurance policies are taken out on the life / TPD / Trauma of each owner;
  2. Policies can be held on trust (CGT exemptions available for “beneficial owners”)
  3. Beneficiaries of policies must be noted in the agreement (must be the life insured to satisfy ATO);
  4. The type of insurance is noted (i.e. key person cover, death etc)
  5. It sets out responsibility for the payment of premiums;
  6. It can include buy and sell options for certain trigger events such as death and TPD;
  7. It deals with the collection of the proceeds of policy by the Trustee, in the event that a policy is enlivened;
  8. It deals with payment of the proceeds of policies in different circumstances (ie to an estate upon death if an option is exercised, or to a beneficiary for trauma);
  9. The beneficiary can direct the Trustee to pay part of the proceeds to a third party recipient, such as a creditor of the business to reduce debt.  This is very important as it ensures the debt is reduced and not paid out to an estate, which may then spend it.  It is also important that this part of the agreement is worded properly to satisfy the ATO in the treatment of Capital Gains Tax;
  10. The entry and exit of proprietors is dealt with in a way so as to avoid the situation where Capital Gains Tax may be triggered by a deemed acquisition of an interest in a policy

Very detailed consideration needs to be given to these types of agreements. It is essential to get advice from your Lawyer, Accountant and Advisor before implementing this type of arrangement in your business. Please contact me if you have any queries or would like to discuss this in more detail.

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