Business Succession Agreements and SMSFs

The ATO has issued a new Interpretative Decision (ATO ID 2015/10 - 1 May 2015) which suggests a common form of business succession agreement between business co-owners involving SMSFs, may have regulatory compliance issues.

The form of the agreement is that business co-owners (in the particular example cited in the ATO ID, there were two brothers conducting a business) who enter into an agreement with each other and the Trustee of their SMSF that they will make contributions to the SMSF (of a certain amount which is sufficient to finance life insurance on their lives) and the SMSF undertaking to effect life insurance on each member for an amount agreed to be the value of the member’s interest in the business.  On the death of the member, the insurance proceeds are collected by the SMSF, allocated to the death benefit of the member and paid out as a death benefit to the spouse of the deceased member.  

In exchange for the payment of the death benefit to the spouse, the surviving member obtains the interest of the deceased member in the business.

The ATO considers that this arrangement fails the sole purpose test (as set out in s62 of the Superannuation Industry (Supervision) Act 1993) and also contravenes the financial assistance prohibition (set out in s65 of the Act).

While it is always easier to be intelligent in hindsight, involving the SMSF Trustee as a party to the succession agreement was probably not a good move.  The terms of the SMSF could have been amended to confer on the member the ability to direct the Trustee to provide risk cover of a certain level.  If so, the involvement of the SMSF Trustee would have been reduced to simply providing a death benefit of an amount specified by the member which was financed by contributions made by or in respect of the member.

If, instead of using their SMSF, the two brothers had joined an APRA regulated fund and requested risk only death benefits, would the APRA regulated fund have contravened the sole purpose test and the financial assistance prohibition? (It is assumed that the trustee of the APRA regulated fund is not a party to the business succession agreement.)