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Tax benefit can’t justify SMSF risk cover

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A technical mentor has warned against using tax deductions and cash-flow convenience as justification to hold insurance cover within an SMSF.

Trustees and their advisers should be mindful that receiving a tax deduction for premiums and other cash-flow benefits cannot be relied upon as the main justification for holding insurance cover inside an SMSF, a technical mentor has said.

Holding cover such as temporary incapacity insurance inside an SMSF is sometimes favoured because the premiums are tax deductible and paid directly out of the super fund as opposed to the policy beneficiary’s personal account.

However, SMSF Alliance principal David Busoli suggested neither of these two benefits could validate holding insurance cover within the fund when justifying the strategy strictly using the sole purpose test.

“An insurance premium is automatically tax deductible to the individual as well as the SMSF. But the fund has a maximum tax rate of 15 per cent and the individual could be on the highest marginal rate. So clearly from the strict viewpoint of wealth creation or wealth retention it’s better for the policy premium to be paid by the individual because they are going to get a higher tax deduction,” Busoli said.

“Also [it leads to] a reduction in investable funds in the fund. The individual only has a $25,000 grant of concessional contribution … [and] if you’re now using a portion of that $25,000 to pay an insurance premium, which you could have paid with a better tax result outside, you are decreasing the level of investable funds. Is that a sole purpose breach?”

According to Busoli, the ATO is currently focusing on sole purpose test issues, but is yet to question whether the holding of insurance inside an SMSF may constitute a breach of the sole purpose test. He did though caution against believing it could never happen.

“That doesn’t meant that one day they won’t have a look and say: ‘Why did you pay [the premium] from the fund? Is it because that was where you had the cash flow?’” he warned.

“Dare I say it, I’m sure some people make the decision based on that’s where [they] had the cash flow, but that’s not really in keeping with the sole purpose test, is it.”

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