Planning ahead for the day that you leave your business is a vital business planning strategy. No matter what your business is currently worth, owners who plan now for the succession of their business can put themselves a step ahead in ensuring the future success and value of the business.

Astute business owners realise that taking the time to put a succession plan in place for their business gives them a clearer picture of the future. They recognise that it prepares the business for acquisition or extending ownership and ensures that the business will continue to serve its clients when the business owner retires or wishes sell down part of her business equity in transitioning to full retirement.

After identifying the appropriate successor(s) for the business one of the fundamental issues for business owners is to seek advice on how to identify and establish an appropriate funding mechanism that is both tax effective and supports any buy/sell or key man arrangements that have been put in place with the proposed successors.

A strategy to consider for the business owner is a funding mechanism based on investment bonds which offer several benefits including taxation and protection from creditors in the event of bankruptcy.

Investment Bonds

A ten year investment bond offers key advantages when used as part of a strategy to fund a business succession arrangement. An investment bond is a tax paid structure that, under current taxation law, pays tax on earnings throughout the life of the bond to a maximum of 30%. The proceeds of an investment bond are received without any additional taxation after year 10; are protected from creditors while held as investment bond and do not form a part of the estate of the bond owner in the event of death. On the latter point, the proceeds are paid directly to the bond owner or, in the event of death, the bond owner’s estate or nominated beneficiary.

As such, investment bonds can be used successfully to provide the business owner with some certainty of transition of their business interests at an agreed price over a ten year time-frame.

Tax Issues

If the investment bond is withdrawn within the first eight years all of the growth is assessable in the bond owner’s income tax return. If withdrawn during year nine, two thirds of the growth is included as assessable income and if withdrawn in year ten, one third of the growth will be assessable. Beyond the ten year period none of the growth is assessable to the bond owner.

Ownership Structure

There are two parties to an investment bond and they are the bond owner and the life insured. In the case of funding business succession, the bond owner will be the business successor – the person who will by buying all/part of the business. The second party – the life insured – will be the current business owner. In the event of the death of the business owner before completion of the ten year period, proceeds from the investment will be paid to the bond owner. Note that as per the above, taxation will be a consideration in such an event for the bond owner (business successor) if a death payment is made prior to the end of year ten.

Will the investment bond savings plan be sufficient?

Very likely, in the early years of saving via an investment bond, the accrued savings will not be sufficient to purchase a business, or part of it, in the event that the business owner dies. There could be a substantial shortfall which dictates that the business successor should implement a stand-alone life insurance policy(s) on the of the business owner which will facilitate purchase of the business from a deceased business owner’s estate if the owner were to die.

Note here that the receipt of life insurance policy proceeds might l have tax implications and each situation will require tailored legal advice before the stand-alone insurance policy on the business owner’s life is established.

ncome in the bond owner’s tax return and during year ten, one third of the growth is included

Advantages of utilising a bond structure to fund succession

There are a two key advantages to using an investment bond to fund a business succession arrangement:

1. There is no additional tax payable on withdrawals after 10 years.

Where a buy/sell agreement is established between a business owner and an employee to transfer all or part of a business at a future date for an agreed value, the agreement can reference the establishment of an investment bond to be funded through regular savings by the employee/successor which can, for example, be derived from all or part of the employee’s/successor’s future remuneration increases. Such savings could also, for example, be derived from part/all of the employee’s/successor’s future bonus payments.

2. Importantly, the proceeds of the investment are protected from creditors in the event of bankruptcy.

Case study– Business succession planning

John and Jane

John wants to sell half of his business to Jane over the next ten years – the future value of the business is valued at almost $1 million and Jane agrees to lock in the sale price to purchase 50% of the business in ten years’ time.

With the appropriate buy/sell agreements in place, Jane invests $35,000 into an investment bond. Subsequently, Jane then invests a combination of her savings and bonuses – of $35,000 per year – over the next nine years. After the tenth anniversary of her bond and using a hypothetical after tax and fees earnings rate of 5% per annum, Jane will have $460,000* to fund the purchase of 50% of John’s business.

*Illustrative example only. 5% post tax and fees return equating to a 6.5%pre-tax return and assumes 1% p.a. fees). Each bond will have different investment strategies and risk profiles and may experience both positive and negative returns, and this would materially impact the outcome.  The examples given may not reflect the real outcome achievable and is not a forecast or opinion in respect of any of returns achievable within any investment bond.

Other benefits of utilising an investment bond for business succession

The main benefit of an investment bond is its potentially advantageous taxation features, however, it also offers other benefits that make it a good option in funding a business succession.

Flexible investment options

Investment bonds allow investors to access many asset classes and provide a market-linked investment vehicle to help meet investment goals.

No limit on the investment amount

There is no limit on the amount that can be invested to establish an investment bond. Investors can also make subsequent investments up to maximum of 125% of the previous year’s contribution without restarting the ten year period. Investors can choose to start new investment bonds if higher amounts are to be invested.

Flexibility

While there is a ten year period in regards to taxation, investment bonds give investors the flexibility to access funds at any time.

Capital gains tax simplicity

Investment bonds provide simplicity as earnings are automatically reinvested in the bond. This means reinvestment dates do not need to be tracked for capital gains tax purposes. Investors can also switch between investment options without triggering personal capital gains tax.

Transfer of ownership

The ownership of the investment bond can be easily assigned or transferred at any time. The original start date is retained for tax purposes. This may not be achieved within a company structure without creating tax liabilities.

Bankruptcy protection

Investment bonds may offer protection from creditors in the case of bankruptcy (subject to certain rules), which may not be provided through a company structure.

Conclusion

If you are an advisor looking for a tax effective investment to help your clients fund their business succession plans, then investment bonds offer one potential solution which is accompanied by a range of investment options. When anchored to a well-constructed Buy/Sell Agreement, investing in an Investment Bond enables a business owner to establish an agreed business exit strategy while enabling the successor to accumulate the assets needed for the purchase of their share.

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Disclaimer: This whitepaper is issued for the use of financial advisors only. Suitability of an investment in a Centuria Investment Bond will depend on a person’s circumstances, financial objectives and needs, none of which have been taken into consideration in preparing this whitepaper. Prospective investors should obtain and read a copy of the Product Disclosure Statement (PDS) for any investment bond and consider the information in the PDS in light of their circumstances, objectives and needs before making a decision to invest. This document is not an offer to invest in any of Centuria’s Investment Bonds. Issued by Centuria Life Limited ABN 79 087 649 054 AFSL 230867.

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