Issue
Does a self managed superannuation fund (SMSF) contravene section 62 and paragraph 65(1)(b) of the Superannuation Industry (Supervision) Act 1993 (SISA) by purchasing a life insurance policy over the life of a member of the SMSF where the purchase is a condition and consequence of a buy-sell agreement the member has entered into with his brother as co-owners of their business?
Decision
Yes. The trustee will contravene section 62 and paragraph 65(1) (b) of the SISA by purchasing a life insurance policy over the life of a member of the SMSF where the purchase of the policy is a condition and consequence of a buy-sell agreement the member has entered into with his brother as co-owners of their business.
Facts
A member of an SMSF (the Member) and his brother run a business through a company in which they are the only two shareholders (the company).
The SMSF's only other member is the Member's spouse. The SMSF has a corporate trustee (the Trustee).
The Member and his brother enter into a buy-sell agreement (the agreement).
The terms of the agreement require: • The SMSF to purchase a life insurance policy (the policy) over the life of the Member with the insured amount based on an agreed market value of the Member's interest in the company. • The company to make contributions to the SMSF to obtain superannuation benefits for the Member. The agreement specifies that these amounts are to be used by the trustee to pay the premiums on the policy. These contributions are in addition to any other contributions the company is required by law to make (for example, superannuation guarantee contributions), or as part of an arrangement with the Member (for example, as part of a salary sacrifice arrangement). • On the death of the Member, the following will happen: - the insurance policy proceeds are to be paid to the SMSF's Trustee - the Trustee will add the proceeds to the benefits of the Member - the Trustee will then pay all of the benefits of the deceased Member (including the insurance policy proceeds) to the Member's spouse - the Member's shareholding in the company will be transferred to the Member's brother and the Member's spouse will relinquish all claims on the Member's shareholding in the company.
The intended effect of the buy-sell agreement is the acquisition of the Member's shareholding in the company, on the death of the Member, by the Member's brother for no personal outlay by the Member's brother. The Fund would not have otherwise purchased the policy.
Reasons for Decision
The sole purpose test in section 62 of the SISA prohibits trustees from maintaining an SMSF for purposes other than for the provision of benefits specified in subsection 62(1) of the SISA. The core purposes specified in that subsection essentially relate to providing retirement or death benefits for, or in relation to, SMSF members: subsection 62(1)(a) of the SISA. The SMSF can also maintain the fund for one or more of these purposes and other specified ancillary purposes, which relate to the provision of benefits on the cessation of a member's employment and other death benefits and approved benefits not specified under the core purposes: subsection 62(1)(b) of the SISA.
Paragraph 6 of SMSFR 2008/2 [1] states that an SMSF must be maintained in a manner that complies with the sole purpose test at all times while the SMSF is in existence. This extends to all activities undertaken by the SMSF during its life cycle, including accepting contributions and acquiring and investing fund assets.
Paragraphs 7 to 8 of SMSFR 2008/2 go on to state the sole purpose test requires exclusivity of purpose. However, the test may still be satisfied where an SMSF provides benefits other than those specified in subsection 62(1) of the SISA, if those benefits are considered incidental, remote or insignificant. In any particular case, all the facts and circumstances associated with the maintenance of the SMSF are relevant in deciding if the trustee has complied with the sole purpose test.
Paragraph 16 of SMSFR 2008/2 further states the test 'requires a holistic assessment of all of the circumstances associated with the maintenance of an SMSF', and is 'particularly concerned with how a SMSF trustee came to make an investment or undertake an activity, which is likely to vary from trustee to trustee'.
The presence of certain factors may weigh in favour of a conclusion that in providing certain benefits, an SMSF is not being maintained in accordance with section 62 of the SISA. This includes (but is not limited to) instances where: • the benefit has influenced the decision-making of the trustee to favour one course of action over another, and/or • there is a pattern or preponderance of events that, when viewed in their entirety, amount to a material benefit being provided that is not specified under subsection 62(1) of the SISA (an example being the Swiss Chalet case - Case 43/95 95 ATC 374; (1995) 31 ATR 1067).
In this particular case, although subsection 62(1) of the SISA expressly allows an SMSF to be maintained for the provision of death benefits, the manner and circumstances in which the SMSF came to hold the insurance policy in question (as part and only because of the underlying buy-sell agreement), leads to the conclusion that the additional benefits sought by the parties in entering into the agreement cannot be regarded as being merely incidental to the core retirement income purposes of the SMSF.
The agreement is a major component of the Member's and his brother's company succession management. Having the policy held in the SMSF enables the Member's brother to gain total ownership and control of the company after the Member's death without personally incurring any expenditure.
Presumably, there exists no impediment to having the policy purchased or held outside of the SMSF (say, by the company or by the Member's brother). However, the SMSF has been utilised by an external agreement to which the SMSF is not a party in an arrangement which effectively relieves the Member's brother from having to provide money to pay the premiums on the policy and, in the event of the Member's death, from having to fund the purchase of the Member's share of the company. It is clear the SMSF acts as a conduit under the agreement. The SMSF is required to use contributions made to it in a manner that may not accord with its investment strategy. The SMSF is essentially directed to invest contributions made to it in an asset it may not otherwise choose to hold (with resulting potential financial detriment to the SMSF as it is not able to invest contributions made to it that objectively would provide an overall higher return).
As it were, the agreement was entered into with a specific purpose of obtaining a particular significant, albeit indirect, benefit to the Member's brother. This immediate benefit to a related party (who is not a member) of the SMSF cannot be described as something that is incidental, remote or insignificant provided to the members of the Fund (paragraph 120 of SMSFR 2008/2). It is noted that the Member's spouse (the SMSF's other member) could have received the insurance proceeds without giving up any rights in relation to the Member's share of the company had the policy been acquired by the SMSF independently and not subject to the agreement.
Two factors support the above-stated position. First, the calculation of the insured amount is not in any way based on the future needs of the Member's spouse, but is based on a valuation of the Member's share of the company. Secondly, what the Member's spouse receives from this agreement, whilst ostensibly a death benefit payment from the SMSF, is in substance compensation for the spouse's expected inheritance from the Member's share of the company. From this, it is arguable that the contributions received by the SMSF to enable the premium payments were never intended to produce retirement benefits. The collateral benefit to the (non-member) surviving brother is at least equal to what is being characterised as a future death benefit payment to the Member's spouse. This is a sought-for benefit that certainly isn't a mere incidental benefit. There is a deliberateness and purposefulness to this course of action which is difficult to reconcile with the underlying intention of the sole purpose requirements under section 62.
Having regard to all the facts and circumstances of the arrangement-most significantly, that the policy would not be purchased at all if it cannot be purchased by the SMSF in accordance with the terms of the agreement-leads to the conclusion that, in purchasing and holding the policy, the SMSF is not being maintained in accordance with the sole purpose requirements of section 62 of the SISA.
Paragraph 65(1)(b) of the SISA prohibits a SMSF trustee or investment manager from assisting a member or relative of a member using SMSF resources and therefore providing financial assistance in contravention of section 65 of the SISA. Subsection 10(1) of the SISA defines a 'relative' to include the brother of such a member of the fund.
In the Commissioner's view, financial assistance is given to a SMSF's member, or relative of a member, if some aid or help or benefit is given to that person whether or not such assistance was requested. A trustee or investment manager of an SMSF contravenes paragraph 65(1)(b) by satisfying, or taking on, a financial obligation of a member or relative of a member. An objective assessment of the substance of the relevant arrangement is required in determining whether such financial assistance has been given by the SMSF (paragraphs 7 and 46 to 54 of SMSFR 2008/1). [2]
In this instance, the terms of the agreement allow the Member's brother to obtain 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 expected inherited share of the company.
The agreement operates so as to compel the SMSF to convert a portion of its cash assets into another asset, the policy. Money is not leaving the SMSF but is merely converted into another asset. However, as noted at paragraphs 66 to 71 of SMSFR 2008/1, the Commissioner adopts the principle that an absence in the reduction in the SMSF's net assets does not preclude a finding that financial assistance has been given using the resources of the SMSF.
Applying the above stated principles to the facts and circumstances of this particular case, it is concluded that the arrangement as stipulated under the agreement will also constitute the provision of financial assistance to the Member's brother in breach of paragraph 65(1)(b).