There has been much conjecture as to whether a self managed superannuation fund (‘SMSF’) trustee can implement a cross-insurance strategy after 1 July 2014. The ATO recently addressed this question; which is discussed below.
However before discussing the ATO’s view, we begin by briefly discussing what cross-insurance is.
What is cross-insurance in an SMSF context?
Broadly, a cross-insurance strategy involves an SMSF trustee taking out an insurance policy over a member’s life but deducting the premium related to that policy from another member’s account. Accordingly, upon an insured event arising in respect of say member A, the other member’s (eg, member B) account receives the proceeds from that insurance policy.
For more detail of how the strategy works, please see our article titled ‘Cross-insurance in an SMSF’ (http://www.dbalawyers.com.au/limited-recourse-borrowing-arrangements/cross-insurance-smsf/).
However, as foreshadowed in that article, there has been conjecture as to whether these strategies could be implemented after 1 July 2014, when changes to the Superannuation Industry (Supervision) Regulations 1994 (Cth) (‘SISR’) to effect.
For completeness, any cross-insurance strategies that were implemented prior to 1 July 2014 will not be affected by these changes and can be grandfathered moving forward. Broadly this grandfathering applies despite an increase or decrease in insurance cover provided that cover continues.
Specifically from 1 July 2014, regulation 4.07D(2) of the SISR, now reads as follows:
A trustee of a regulated superannuation fund must not provide an insured benefit in relation to a member of the fund unless the insured event is consistent with a condition of release specified in item 102, 102A, 103 or 109 of Schedule 1. [Emphasis added.]
This can be read in two ways.
The first is that the regulation prohibits an SMSF trustee from providing an insured benefit unless it is consistent with a condition of release. That is to say, as long as the insured benefit is provided in relation to a condition of release, irrespective of which member, it is not prohibited.
The alternate view is that one is the precondition of the other. More specifically, the insured benefit must be in relation to that member’s condition of release and that the two limbs are in fact linked.
What did the ATO say?
On 17 November 2014, the ATO published its view to the following question:
Can an SMSF take out insurance on a cross-insurance basis?
In response the ATO provided:
Regulations that came into operation on 1 July 2014 do not permit cross-insurance on any new insurance products. These types of insurance arrangements are not permitted because the insured benefit will not be consistent with a condition of release in respect of the member receiving the benefit.
Are the ATO correct?
On a strict reading of the regulation, the second condition is not expressly linked to the first. Therefore, the ATO view is not consistent with a strict legal construction of the legislation. If this was the intended consequence, then perhaps the legislation should have read ‘unless the insured event is consistent with the member’s condition of release’.
However, the ATO may argue that its view is consistent with a purposeful and practical construction of the regulation.
If you have implemented a cross-insurance strategy before 1 July 2014, then as long as such cover continues, it will continue to be grandfathered.
If, on the other hand, you have implemented a cross-insurance policy after 30 June 2014, then careful consideration should be given to what you do as regulation 4.07D(2) of the SISR is an operating standard, contravention of which, can result in significant penalties.
This may result in other strategies being examined such as whether insurance being held outside of super or via a reserving strategy will prove more effective strategies. Given that an ‘insured benefit’ is defined for a member to broadly mean a right for the member’s benefit to be increased on realisation of a risk, reserving does appear to be a possible alternative strategy. However, if significant insurance proceeds are captured in reserves, then it may result in an ongoing management issue so as not to result in an application of those reserves being added to the relevant member’s assessable income if it exceeds his or her concessional contribution cap for a financial year.
We also understand that there may be some interested parties seeking further clarification on the above ATO view. Accordingly, while new cross-insurance strategies should no longer be implemented in an SMSF, it is worthwhile ‘watching this space’ to see if anything further unfolds.
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This article is for general information only and should not be relied upon without first seeking advice from an appropriately qualified professional.