The ATO has recently released an interpretative decision which says that a self managed superannuation fund (SMSF) may breach the sole purpose test and the prohibition on giving financial assistance when entering into a buy-sell agreement arrangement.
ATO ID 2015/10
In this interpretative decision the ATO explored a situation where a member of an SMSF and his brother ran a business through a company in which they were the only two shareholders.
The SMSF member and his brother entered into a buy-sell agreement. The terms of the agreement required:
- the SMSF to purchase a life insurance policy over the life of the member with the insured amount based on an agreed market value of the member’s shares in the company
- the company to make contributions to the SMSF which the SMSF trustee would then use to pay the premiums on the insurance policy. These contributions were in addition to superannuation guarantee contributions and salary sacrificed contribution, and
- on the death of the member:
- the insurance proceeds were to be paid to the SMSF trustee who would then add the proceeds to the member’s benefits
- the SMSF trustee would then pay the deceased member’s death benefit (including the policy proceeds) to their spouse, and
- the deceased member’s shareholding in the company would be transferred to the member’s brother for nil consideration and the deceased member’s spouse will relinquish all claims to that shareholding in the company.
The ATO ruled that the SMSF trustee’s purchase of the life policy contravened both the sole purpose test under section 62 and section 65(1)(b) of the Superannuation Industry (Supervision) Act 1993 (SIS Act) which covers the giving of financial assistance by an SMSF to a member or their relative. Breaching the sole purpose test and/or the financial assistance provisions can lead to the SMSF being non-complying and significant monetary penalties being imposed on the SMSF trustees.
Sole purpose test
Broadly the sole purpose test requires an SMSF to be created for the core purposes of providing retirement benefits and death benefits.
Whilst historically the ATO has provided guidance that superannuation funds involved in buy-sell arrangements would not contravene the sole purpose test, the ATO’s decision in ATO ID 2015/10 represents a new position taken by the ATO. Under this new position the ATO indicates that in assessing whether the sole purpose test is met, it will look at all the wider circumstances surrounding a trustee’s decision to make an investment or carry out a particular activity. In the context of buy-sell arrangements this involves the manner and circumstances in which the SMSF are to hold the insurance policy.
On a narrow view the SMSF’s acquisition of the life policy may be rationalised as meeting the sole purpose test because it has been bought to pay the deceased member’s death benefits. However, looking at the wider circumstances of the buy-sell arrangement the ATO revised that the SMSF breached the sole purpose test because it had been used as a conduit under the buy-sell agreement to release the member’s brother from having to pay for the member’s shares on the member’s death. In this respect a significant indirect benefit was being provided to the member’s brother. By participating in the buy-sell arrangement the SMSF was being required to invest in and asset (i.e. the life policy) in a way that may not be in accordance with its investment strategy.
Factors that the ATO cited to support is position included the fact that the calculation of the insured amount was not based on the further needs of the members spouse and the fact that in substance the life insurance proceeds represented compensation for the spouse’s expected inheritance of the member’s shares in the company.
Financial assistance provided to a relative of a member
In circumstances where relatives are parties to a buy-sell agreement, ATO ID 2015/10 indicates that the arrangement may contain section 65(1)(b) of SISA’s prohibition agent providing financial assistance to a relative of a member.
In the case outlined in the ID, the buy-sell arrangement allowed the brother to acquire 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 her inherited share of the company. The ATO concluded that the arrangement constituted the provision of financial assistance to the member’s brother which is in breach of section 65(1)(b) of the Act.
What should SMSF's involved buy-sell agreements do now?
Although ATO ID 2015/10 is not a binding public ruling, it outlines the ATO’s current position on superannuation and buy-sell arrangements. SMSF trustees should now be wary of entering into such arrangements and should seek expert advice when in doubt.
Disappointingly, despite ATO ID 2015/10 representing a change of position by the ATO on buy-sell arrangements, the ATO has not outlined any grandfathering provisions in relation to existing buy-sell arrangements where SMSFs have been involved on the basis of the ATO’s previous view that the sole purpose test was not breached. Accordingly, SMSFs should seek professional advice on their current position and whether such arrangements need to be unwound.