Key Person and Buy/Sell

1. Key Person and Buy/Sell Technical Services September 2010

2. Important information • The information contained in this presentation is intended to provide a brief outline of legislation applicable to superannuation funds and taxation laws at 1 September 2010. • It is based on our understanding of the present laws and Government announcements and the assumption that they will continue. • These are general statements and should be relied upon as a guide only, as an individual’s circumstances can be quite different. You should seek advice about how the relevant laws impact on your particular circumstances. • The rates of return and inflation used in the projections are estimates only and are intended to be only a guide to future performance. No guarantee of investment performance is given or implied through the use of these projections and actual returns will differ from those indicated. Past performance should not be taken as a guide to future performance. • We recommend that you refer to the relevant Product Disclosure Statement where reference is made to a particular product before taking any action. • Suncorp Portfolio Services Limited. ABN 61 063 427 958. AFS No 237905

3. Key Person and Buy/Sell insurance • These slides accompany the Asteron “Business owners reference guide” • The “Business owners reference guide” explains various topics in key person and buy/sell insurance • They also accompany Asteron’s “Guide to key person insurance” and “Guide to Buy/Sell Insurance” which outline a 5 step process to implementing business insurance

4. Business insurance • Keeping the business running and succession planning • includes lump sum or regular income needs Profits Keep business running Succession planning Protect person and family Business expenses “Key person” or “Guarantor” cover Buy/sell arrangements Personal insurance

5. Who is a key person ? • Someone whose presence: • Creates cost savings • Generates revenue • Adds goodwill • Provides access to credit • Has relationships with the customers Page 4

6. Alternatives to key person insurance • Use available cash flow • Sell business assets • Borrow cash • Use personal assets • Self insure Page 6

7. Products used • Life • Total and permanent incapacity • Trauma Page 6

8. Valuing a key person • Use the Fact Sheet “Business insurance – how much cover is needed” • depends on whether it is a revenue or capital purpose • look to what will be affected by the loss of the person • For revenue purpose options include multiple of salary, multiple of gross/net profit or cost in replacement • For capital purpose look to the debt or guarantee to be covered Page 7

9. Insurance considerations • For key person linked policies may be suitable as the loss to the business occurs on either death, disability or trauma • Stepped premiums may be suitable for shorter periods of insurance/level premiums for longer periods • The underwriter needs to be comfortable with the contribution of the person to the business and the method of valuation Page 8

10. Policy ownership - Revenue or capitalPage 9 Keep business running “Guarantor” cover “Key person” cover Business expenses Repay debt (Capital purpose) Replace lost value (Capital purpose) Cover expenses/ replace profits (Revenue purpose)

11. Revenue purpose • Revenue affects business profitability (P&L statement) • Replace revenue generated by the key person • Pay extra costs to replace person Continues profitability to stabilise business • How much cover is needed? • What is the impact of that person not coming to work Page 10 P & L

12. Policy ownership (revenue) Revenue purpose Business entity Note: business expenses may need to be owned by life insured (business owner) Default Policy owner  Page 10

13. Capital purpose • Capital – value of business (balance sheet) • May reduce value of goodwill • May be more difficult to secure credit • Lenders may want loans to be repaid • Loans may move to default • improve balance sheet to stabilise business and ease cash flow Page 11

14. Policy ownership (capital) Repay debt/release guarantee Compensate for lost business value Life insured (direct or bare trust) The business entity or owners Lender a transfer agreement may be required if money is paid to someone who is not final recipient Page 11

15. Taxation implications (revenue) Premiums ARE deductible Proceeds: Income tax – Yes CGT – No Expenses are deductible To claim a deduction, must suffer a loss of profits during the continuation of the business (IT2434) Page 12

16. Tax implications (capital) Premiums NOT deductible • Proceeds: • Income tax – No • CGT – Yes, if: • trauma or TPD and not life insured or relative, or • death and terminal illness and not original owner and some consideration paid Note: transfer agreement can create a CGT event if money goes to the business Page 12

17. Tax implications (capital) CGT cost base • If CGT on insurance, it is paid on claim proceeds less cost base • Cost base of policy is the premiums paid • Death and TPD: cumulative premiums* • Trauma: premiums paid in year of claim* • Seems to be a grey area so clients should always seek tax advice • What about 50% discount? • Asset only created at time of death, TPD assessment or diagnosis of critical illness • Based on ATO response at NTLG Losses and CGT sub-committee meeting minutes – 7 June 2006 and T/R 95/35 Page 13

18. Proving the purpose • When policy commences, record purpose in: • Minutes • Book entry • Sole trader could use letter to insurance company or file note • New records each year when renew policy • Purpose must still apply at time of claim • If changed, may need to amend tax returns Page 15

19. Business insurance – where buy/sell fits • Funding a transfer of a business share Profits Keep business going Succession planning Protect person and family Business expenses “Keyperson” or “Guarantor” cover Buy/sell arrangements Personal insurance

20. Insurance - who needs it? Importance of a business succession plan • Your client is a business operated by 3 partners • One partner of 45 has heart attack and dies • His business share was worth $500,000 • You have meetings with: • remaining partners to decide options • widow who wants to the money for her husband’s share and release his personal guarantees

21. Insurance - who needs it? Importance of a business succession plan Options: • Gradual buy-out over 10 years • At highest MTR need to earn $934,580 • Borrow $500,000 (10% interest) • At highest MTR need to earn $1,227,420 • Term insurance • Insurance policy held 10 years, total premiums $5,500

22. Business succession plans • For any business with two or more principals • Death, serious illness or incapacity can lead to closure of the business, forced sale or less than fair value for the business share • Agreement needs to • incorporate disposal of business share, ongoing operation • be drawn up with professional advice on form and content • Aim is to • maximise value of business/provide exit strategy/continuity/certainty Page 21

23. Business succession plans • A business succession plan has two elements • transfer (legal) agreement • funding mechanism Page 23

24. Transfer agreements • Drafted by solicitor • Sets out the rules for the transfer of business • What trigger events and when • What causes a transfer/timing /differing conditions • How business valued • industry multiples/net assets or book value/ capitalised future earnings/appraised value/agreed value • see the Fact Sheet “Business insurance – how much cover is needed?” • Procedures for transfer • timing/handover • Mandatory or put/call options Page 23

25. Options to trigger a transfer • Mandatory option • Buy/sell forces transfer when trigger event happens • CGT event may occur when agreement signed (depends on wording for conditions precedent) • Put/call options • Either party can choose to enforce a transfer • CGT event occurs when transfer happens • May provide flexibility, especially for critical illness events Page 24

26. Funding mechanism • Provides cash for buy out • Match events to funding mechanisms • Life insurance for death, TPD and critical illness • Savings/loans/gradual buy-out /realising business or personal assets for retirement or resignation • Need to review insurance regularly to manage funding gaps Page 23

27. Money and business in same hands Transfers of business sharesOne of two outcomes • Money and business in different hands Life insured/ estate Other owners Life insured/ estate Other owners  Buy/sell Buy/sell   Self, Super, Trust Cross, Company, Trust

28. Key questions in buy sell insurance Business and money in right hands Buy/sell arrangements Who is life insured? Who ultimately needs money? Who needs the business share? Remaining business owner(s) Departing owner or estate Page 28

29. Other partners (cross-owned) Policy ownership • Ownership options • Life insured • (self-owned) • Insurance trust • (bare trust) • Business entity • Super fund • Each option has advantages/disadvantages • To start, use our default method Page 29

30. Policy ownership • Default method • Start with “who ultimately needs the money” as policy owner ie. life insured • May choose another option after considering: • Control of policy • Ability to transfer policy • Structure of business and potential ownership changes • Taxation of proceeds • Payment of premiums • Need to ensure policies don’t lapse Page 29

31. Tax implications An insurance policy is a CGT asset • Issues • Deductibility of premiums • not deductible unless held in super • Receipt of insurance proceeds • depends on event and ownership of the policy • no exemption from CGT for life policies when rights of a policy are disposed of and the person acquiring the policy is not the original beneficial owner and paid money or gave consideration • TPD and trauma are assessable for CGT unless life insured or a relative Page 35

32. All ownership (except super) Premiums NOT deductible • Insurance proceeds: • Income tax – No • CGT – Yes, if: • trauma or TPD and not life insured or relative • death or terminal illness and not original owner and some consideration paid Transfer of business: • CGT may apply (consider small business concessions) Page 36

33. Owned by super fund Premiums deductible to trustee (except trauma) May also receive tax deductions for contributions • Insurance proceeds: • Income tax – No • CGT – No • Lump sum tax – if under age 60 (note terminal illness tax-free at all ages) or death to non-dependants Transfer of business: • CGT may apply (consider small business concessions) Page 37

34. Tax implicationsPayment of premiums • Policy owner is responsible to pay premiums • In practice, often the business who pays • Decisions: • Who pays • How to apportion costs (especially if premiums vary widely) • Tax and accounting implications (eg non-deductible expense, FBT, deemed dividend for company)

35. Business insurance - the place of the adviser • Adviser • Identify need & match product • Type of cover • Amount of cover • Underwriting process • Accountant • Value key person • Confirm business structure • Tax advice • Advice on CGT issues • Solicitor • Takes client instructions • Draft legal contracts • Amend wills