UNIT LINKED INSURANCE POLICIES AND SETUP OF SUCCESSION: RISK ANALYSIS

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UNIT LINKED INSURANCE POLICIES AND SETUP OF SUCCESSION: RISK ANALYSIS

 

Many individuals, predominantly of Anglo-Saxon origin, living in Italy, as well as a  growing number of Italians are placing their savings into life insurance policies for financial and tax planning. In this connection, we would like to highlight some of the risks that should be taken into account.

Reclassification of the Insurance contract

An insurance contract, in fact, may be reclassified as a financial brokerage contract (and insurance policies as financial products) with effects from both a statutory perspective (being subject to the Consolidated Finance Act (“TUF“), the non-applicability of the rules of the Civil Code and a fiscal perspective (related to the elimination of the tax deferral on capital gains on redemption or inheritance or enforceability of taxation on inheritances and gifts). For succession purposes, reclassification of  insurance contracts could be possible if the financial element is predominant with respect to the social security insurance feature, and where the payment of the principal (annuity) does not depend mainly on an event relating to human life, but rather on the performance of financial tools that are the subject of the contract, and where the risk attached to them is the responsibility of the contracting party.

In recent years, the tax treatment of financial returns of insurance policies has gradually become less beneficial to taxpayers. The substitute tax applicable to such income was  raised from 12.5% to 26%; until 2014, the income paid to the beneficiaries of the insurance in the event of death was totally exempt, now it is exempt of the Irpef tax only for the portion allocated to cover demographic risk, which is usually contained.

More specifically, the reclassification can occur when the financial element is predominant compared to the social security feature and where the payment of principal (annuity) is not dependent mainly on an event relating to human life, but rather on the performance of financial tools that  are the subject of the contract, and where the risk attached to them is the responsibility of the contracting party. The insurance contract could, then, be reclassified as financial intermediation contract. To avoid future disputes, it would be wise to adopt from the signing of the policy criterion that allow for the significant transfer of the uncertainty of the policy for which the company is responsible (for example, by inserting a guarantee that is without prejudice to the premiums paid at the time of death, thus integrating a substantial demographic component).

Regarding the taxation of income, if the policy is made to a foreign trust that is resident in a white list country, all income indicated above is subjected to lower taxation. On the one hand, in fact, in this case, at the time the contribution to the trust is made, the gift tax,  at least according to the Revenue Agency, is due, which ranges from 4% to 8% depending on the degree of kinship that binds the settlor to beneficiaries, and which could be avoided by not contributing to the trust; but, on the other hand, this tax is generally lower than the one that over the years would be due, owing to the 26% levy on financial returns generated by the policy, with the result that recourse to the trust may still convenient for tax purposes. However it is necessary to carefully consider the use of  a trust in order to avoid disputes of utilization only for tax purposes.

We would also like to point out that there is an open discussion by the government concerning succession taxes. Italy has a particularly concessionary legislation regarding inheritance taxes.

Today the situation in the major countries is as follows:

 

 

 

Country

How inheritances are taxed in Italy and abroad

 

 Tax rate and allowances

Italy  Tax rate of 4%, 6% or 8% with strong allowances for first degree relatives and for spouses
France Tax rate from 5% to 45% for first degree relatives, from 35% to 55% for other family members, 60% for third parties.  Modest allowances
Germany Tax rate from 7% to 30% for spouses and first degree relatives, from 12% to 40% for other family members, from 17% to 50% for third parties.  Modest allowances
Spain Modest allowances and taxation, depending on the degree of kinship and the amount involved, and it differs in autonomous regions
Switzerland Tax rate up to 50%, variable from Canton to Canton.  Heirs are exempt in the majority of Cantons, whereas ascendants only in some Cantons.  In the Canton of Ticino, for siblings there is a progressive tax: 7.94% on 100,000 francs, 11.96% on 500,000 francs and 14.54% on 1 million francs
Luxembourg Tax rate from 2% to 15%, on the basis of kinship, with an additional tax ranging from 0.1% to 2.2% depending on the value of the inheritance.  Direct descendents and spouses with living children are exempt
United Kingdom As a rule, a tax rate of 40% for each heir, with the exception of the spouse
USA Maximum tax rate of 55% over 1 million dollars (with the exception of ad hoc legislation of each state)

 

It appears, however, that the Italian government is considering an increase in tax rates and a reduction of current allowances, except for first degree successions (for example, father-son), for which much lower allowances than currently allowed can be maintained, and it also seems that these possible measures do not cover government bonds or life insurance policies.

It is best, in any case, to be cautious, as there is a tendency on the part of the Revenue Agency to reclassify some types of life insurance policies so as to tax them as ordinary financial investments, with the result that they  would be subject to not only a less favorable taxation on income, but even to inheritance tax. Please note that this risk regards primarily insurance policies that are not set up to cover the insured from a risk, but rather they expose him to risk because of the investments made, consisting essentially of differently named asset management.  Index and unit linked policies are especially observed closely.

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