Edited version of your private ruling

Authorisation Number: 1012536443942

Ruling

Subject: Key Person Insurance

Question 1

Are the proceeds received by the trust in respect of the insurance policy assessable income under section 6-5 of the ITAA 1997?

Answer

Yes

Question 2

Is the $X received by the insured person from the Trust for emergency expenses assessable as income in their hands?

Answer

Yes

Question 3

Is the balance of the proceeds received by the Trust from the insurance payout assessable income to the Trust?

Answer

Yes

Question 4

Are the premiums paid for the insurance policy deductible expenses under section 8-1 of the ITAA 1997?

Answer

Yes

This ruling applies for the following periods:

1 July 2010 to 30 June 2013

The scheme commences on:

2010

Relevant facts and circumstances

The Directors (who were also the Unitholders) of the Trust took up Key man Disability Insurance so that they would not be financially disadvantaged if one of the Directors/Unitholders died or had a significant critical illness.

By the 20XX financial year the Directors/unitholders were owed a substantial amount of money in their respective Loan Accounts by the Unit Trust. As the working capital requirements increased so too did the loan accounts.

In 20XX a Dlrector/unitholder was diagnosed with a critical illness and in month 20XX the insurance company issued the trust a cheque to pay out the sum insured. The insured Director was immediately paid $X, by the Trust which was less than monies owed in their loan account so that they would have cash for emergencies. The insured director recovered and returned to work quite quickly and the business didn't suffer any revenue loss nor incur additional expenses. It was felt that as there were no revenue or expense consequences the best use of the funds would be to return it to the unitholder. The remainder of the proceeds was used to pay down the Unit Holder Loans proportionate to the Unit Holder Balances.

Relevant legislative provisions

Subsection 6-5 of the Income Tax Assessment Act 1997

Subsection 8-1 of the Income Tax Assessment Act 1997

Reasons for decision

Subsection 6-5(2) of the ITAA 1997 provides that the assessable income of a resident taxpayer includes ordinary income derived directly or indirectly from all sources during the income year.

Income Tax Ruling IT 155 provides guidance as to the assessability of premiums paid in respect of life insurance for keyman insurance policies. The term "key man" insurance is used in the industry to denote insurance on the life of a director, partner, employer or other "key" person associated with the taxpayer in business. The types of policies involved are whole of life, endowment, term (or temporary) life assurance, sickness and accident insurance.

Income Tax Ruling IT 155 provides that it has been the Commissioner's practice in relation to insurance policies taken out by employers in respect of their employees to treat the proceeds as non-assessable if a life policy is involved.

In this case the insurance policy for the director was taken out in their name with Trust being the beneficiary and the policy owner. The critical illness policy stated that it is designed purely for revenue protection insurance and is not a savings plan and did not have a surrender or cash value. The premiums were paid by the trust. The critical illness insurance policy terms and conditions state that the insurer will pay the policy owner a lump sum equal to the sum insured if the insured person is diagnosed with a terminal illness that is likely to result in death of the insured person within 12 months of the diagnosis regardless of any treatment that may be undertaken.

The insurance company accepted the claim and paid the full benefit payment for policy to the Trust in 20XX as it was determined that the insured person's medical condition met the definition of terminal illness as per the terms and conditions of the policies.

The lump sum payment constitutes ordinary income and therefore is assessable under subsection 6-5(2) of the ITAA 1997 in the hands of the Trust.

The payment received by the director from the Trust for emergency expenses should be included in the individual return as it has the character of income.

The principle in paragraph 9 subparagaph (a) of IT 155 - Assessability of Proceeds and Deductibility of Premiums relates to life insurance funds where the key person has died and there is a payout of a debt to the estate of the deceased keyman. It has no application in this case.

In the current case the insured person recovered from critical illness, returned to work quite quickly and continued to work for the business. The business did not incur any revenue loss or additional expenses. The fact that the insurance payout was no longer needed for revenue protection purposes and was actually applied to paying down the Unit Holder Loans proportionate to the Unit Holder Balances does not change its character from revenue to capital.

The insurance proceeds are assessable income.

Section 8-1 of the ITAA 1997 allows a deduction for all losses and outgoings to the extent to which they are incurred in gaining or producing assessable income except where the outgoings are of a capital, private or domestic nature, or relate to the earning of exempt income.

In this case the critical illness policy was owned by the trust. The insured person was a company director. The insurance was payable if the insured person become terminally ill.

The policy was taken out to protect revenue and on this basis the expenses relating to the premiums are deductible under section 8-1 of the ITAA 1997.