Ask an Expert – Tax deductibility for insurance advice fees

National Technical Manager

David Glen

Tax deductibility for insurance advice fees

The financial services industry has been arguing for tax deductibility for financial advice fees (including fees for insurance advice) over many years. A tax deduction for these fees will reduce the cost to the consumer of obtaining advice and encourage more consumers to seek financial advice. Australian consumers are presently under insured and would benefit from access to affordable insurance advice.

Tax deductibility for advice fees remains an aspirational target. This article suggests a practical way forward of securing partial deductibility under the existing rules for fees paid for insurance advice.

In a recent tax determination (TD 2024/7) the Australian Taxation Office (“ATO”) provides guidance for taxpayers on the operation of the rules for claiming a tax deduction for financial advice fees paid by individuals who are not carrying on an investment business.

What are the rules for advice fee deductibility?

There is no special tax deduction for insurance advice fees. Deductibility is determined by applying the general principles for claiming a deduction for any expense. These general principles are:

• The fee must be incurred. The client must have paid the fee or have a binding legal obligation to pay the fee if it is unpaid on the last day of the income year.
• The fee must be incurred during the relevant income year. Tax works on an annual cycle of income derivation and expense deductibility.
• The fee must be incurred in the production of assessable income. There needs to be a link between the assessable income of the recipient of the advice and the advice itself. This means that the income should be identified, and a link established with the relevant fee expense. The income does not have to exist at the time of the expense, but there needs to be a reasonable prospect of an income flow linked to the expense.
• The fee must not be of a capital nature. Capital expenditure is expenditure which is linked to the structure of the client’s business operations, as opposed to the operations themselves.
• Private or domestic related expenditure is not deductible for tax purposes.

How do these rules apply to insurance related advice fees?

The above principles generally mean that:

• Insurance premiums other than income protection premiums fail both the production of income and revenue expenditure tests. Fees for providing advice on managing the risks associated with life cover, TPD cover, and trauma cover are generally not deductible.
• Income protection premiums to the extent that they relate to the protection of an income stream stand on a different footing. The premium represents a cost of protecting an income flow and is not a structural expense. It is an ongoing expense not linked to the structure of the taxpayer’s business. The fees associated with income protection advice would have the same characteristics and be deductible.

Where the advice fee is a mixed expense covering deductible and non-deductible items, the expense needs to be apportioned on a reasonable basis between its deductible and non-deductible components.

Some hope on the horizon

Fortunately, Section 25-5 of the Income Tax Assessment Act 1997 presents an opportunity for a partial deduction for advice fees related to death, TPD and trauma cover. This section allows a tax deduction for the cost of advice relating to the management of a person’s tax affairs. The ATO have accepted in TD 2024/7 that the cost of obtaining tax (financial) advice qualifies for a tax deduction under this section.

Tax (financial) advice is a tax related service provided by an AFSL holder or authorised representative in the course of giving advice of a kind usually given by that person. The tax related service covers advice on tax liabilities, obligations or entitlements arising from the relevant life insurance product.

Advice on death, TPD or trauma cover will involve in part advice on the tax treatment of premiums and claim proceeds for the life insured, the policy owner, and any nominated beneficiaries. The tax treatment of life insurance premiums and claim proceeds is complex and contains many pitfalls. This means advisers spend a substantial portion of time on explaining and exploring different tax outcomes with clients.

This presents an opportunity for those advisers to apportion the advice fee delivered in respect of an insurance product into a component related to tax (financial) advice which will be deductible for tax purposes and the balance of the advice which will probably not be deductible unless it is related to income protection advice.

How do we apportion the fee into its deductible and non-deductible components?

TD 2024/7 is silent on this point leaving advisers to determine their own apportionment methodology. This absence of a prescriptive rule should be seen as a positive, rather than a negative. This allows an adviser to choose the most appropriate apportionment methodology in the circumstances. The methodology used must be reasonable bearing in mind that the onus of proving deductibility under taxation law rests with the taxpayer and not the ATO.

Advisers should therefore consider an apportionment between deductible and non-deductible components based on time spent on each component. This percentage can then be applied to the total fee charged to the client.

The deductible portion of the advice fee can be isolated by firstly removing any component related to income protection advice. This is deductible under general principles. The balance of the advice fee covering insurance other than income protection insurance will be deductible to the extent that it relates to taxation matters. This taxation component will include time spent on discussing taxation issues with the client and incorporating these discussions into the Statement of Advice. The apportionment percentage will depend upon the surrounding circumstances, including the complexity of the advice. For example, a substantial portion of business insurance advice will relate to the tax impact of the business insurance strategy on the operating entity, the proprietors of the business, and the holders of the equity.

These percentages could be derived from the management accounts and procedure manuals from the adviser’s practice. Those advisers with robust and comprehensive management account systems in their practices will be at an advantage compared to their counterparts who have not reviewed and costed the components of their advice processes.

At the TAL Risk Academy, we have suggested that advisers perform a functional analysis detailing each step in the advice processes used by them and the time spent in executing each step of the process. This functional analysis has the benefit of identifying opportunities for streamlining the advice process and also for ensuring that the cost of delivery of the advice is accurately calculated. The functional analysis ensures that remuneration derived in the form of commissions or fees is above the cost of delivering that advice.

The functional analysis is also an ideal tool for isolating the tax related steps in the advice process. These tax-related steps can be expressed as a percentage of all steps required for completion of the advice process. If a functional analysis has not been undertaken, advisers should consider using any other information in their management accounts and procedures manuals. The exercise of isolating the tax (financial) advice component is worth the effort as it reduces the after-tax cost of the advice for the client.

Example

Adviser Jane has provided comprehensive insurance advice to Dr Jameson, a medical practitioner. The advice fee is $10,000. Jane’s records show that 20 percent of her time was spent on advising on the complexities of income protection insurance including the pros and cons of an age 65 benefit. $2,000 of the fee could therefore be attributed to the income protection component. This would be deductible. The tax related advice on the lump sum cover would also be deductible. Let us assume Jane’s records show that 15% of her time is tax related, the tax-deductible component would be $1,200 ($8000@15%). This gives a tax-deductible component of $3,200. If Dr Jameson’s marginal tax rate is 47%, the Apportionment would deliver a tax benefit to Dr Jameson of approximately $1,500.

Way forward

Tax is but one component of the holistic advice process. However, it is a vital component, and estimates could justify a meaningful percentage of the total advice fee being allocated to the tax process. There is no safe harbour percentage but is worth the time and effort to add value to clients by establishing a fair and reasonable estimate of time spent on tax related advice.

For more information, please do not hesitate to contact the TAL Technical Team at AskAnExpert@tal.com.au.

Disclaimer

The information contained in this article is general information only and is not intended to be legal, taxation or financial advice. TAL Australia, its subsidiaries, and its representatives have not taken into consideration any individual’s personal circumstances, financial needs, or objectives. If any person is intending to act on the information contained in this article, consideration should be given to the appropriateness of this general information in the light of that person’s own objectives, financial situation or needs before acting on the information. Persons acting on any matter covered in this article should seek independent professional advice on the application of that matter to their individual circumstances. In relation to any financial product referred to in this email, a copy of the Product Disclosure Statement should be obtained and read prior to making any decision regarding the acquisition that financial product.