It was generally assumed that an insurance donation could prevent the application of inheritance tax. Now, the Flemish tax authority (VlaBel) has adopted a new point of view. The registered donation of an insurance policy (combined with the payment of gift tax) is no longer liberating in respect of inheritance tax.
Here is a slightly simplified explanation of the issue:
Investment insurance policies are very popular among private savers in Belgium. In particular, the so-called "Branch 21" insurance policies (fixed-interest insurance) and "Branch 23" insurance policies (linked to a non-guaranteed fund-based return) are very successful. The success of these types of investment insurance is tax-related: in most cases, the income is exempted from withholding tax. Over the years, these insurance policies have become popular as an estate-planning instrument. In practice, policyholders often opt for what is known as an "AAB configuration", where A as policyholder (the parent) insures himself (decease of the parent), and subsequently the insurance company pays the capital at the time of decease to the beneficiary (the child). From a legal point of view, this is classed as a clause for the benefit of a third person (the child). In the absence of a legal fiction, the payment of the capital at the time of decease would not be subject to inheritance tax in the Flemish Region, because the payment by the insurance company is the mere consequence of the execution of the insurance policy. The legislator obviously noticed and corrected this, through a legal fiction treating the payment of the capital to the beneficiary as inheritance, and thus subject to inheritance tax.
It is rather simple to avoid the occurrence of this legal fiction, in three steps: (i) First, the initial policyholder (the parent) buys off the capital, as a result of which the insurance company pays out the capital. (ii) Subsequently, this capital is donated (possibly subject to gift tax) to the initial beneficiary (the child). (iii) The initial beneficiary (the child), in turn, can then take out a new insurance policy.
However, this procedure has some major disadvantages. First of all, it is common practice for insurance companies to apply a buy-off fee. Furthermore, there is a risk of withholding taxes being imposed when a Branch 21 insurance policy is bought off before it reaches a lifetime of 8 years. When entering into a new insurance policy, a 2% premium tax has to be taken into account. And, finally, when a Branch 21 insurance policy is bought off after several years, it can be assumed that the guaranteed return on the new insurance policy will be lower than the guaranteed return on the initial insurance policy.
These disadvantages are the reason why, in practice, the insurance policy itself is often donated (a technique known as "insurance donation"). Through an insurance donation, the policyholder transfers his claim on the insurance company to a new policyholder, free of charge. This method is only useful if, in the case in question, a "BAB configuration" can be established, with a clause for the benefit of the policyholder himself. The new policyholder (the beneficiary of the insurance donation) enters into the rights of the old policyholder and becomes the new policyholder/beneficiary of the insurance policy. The insured person in our example does not change and is still the original policyholder. The general view was that the legal fiction was no longer applicable, since the clause for the benefit of a third person had now become a clause for the benefit of the policyholder himself.
An insurance donation is realised through a notarial deed and an annex to the insurance policy. If the notarial deed is drafted and signed before a Flemish notary, the deed is automatically registered, and a gift tax of 3% (in direct line, e.g. for children) or 7% (in all others cases) becomes due.
The crucial question is, of course, whether or not the legal fiction still applies when the insurance policy has been registered and the gift tax has been paid. On this matter, the general consensus up to now was that the legal fiction no longer applied, because the beneficiary was no longer a third party to the insurance policy, since all the rights of the original policyholder had been passed to the beneficiary. This point of view was confirmed by the Federal tax administration.
However, the Flemish tax administration, which has had responsibility for succession taxes in the Flemish Region since 1 January 2015, sees things differently. In its decision dated 12 October 2015, the Flemish tax administration confirms that an insurance donation can be registered and the gift tax will then become due. But, when the insurance company subsequently pays out the capital of the life insurance policy, this will still be seen as a payment that is the consequence of a contractual clause drafted by the original policyholder for the benefit of the new policyholder. The Flemish tax administration will therefore tax the entire distribution of the capital as an inheritance. This is a totally new point of view. Note that the law has not changed at all; the only difference is that the (same) applicable rule has now shifted places from the Federal inheritance tax code to the Flemish tax code!
This decision is the most remarkable decision the Flemish tax administration has taken so far, and it will come as a big surprise to most estate planners. It was known that an inheritance gift was viewed with suspicion by the tax authorities, but such a drastic change in the point of view was unexpected. For those private individuals who have paid the gift tax (3% or 7%) on an insurance donation, the new decision is quite inequitable, as the new policyholder (often the children) will still have to pay inheritance tax when the insurance company pays out the insurance capital after the insured person is deceased. Note that inheritance tax in Flanders quickly amounts to 27%. At least from an economic point of view, this is a case of double taxation. Given that the technique is very common in estate planning, hundreds of private individuals will be faced with this situation.
The new decision enters into force for deaths from 1 January 2016 onwards.
Simple techniques exist for avoiding the high inheritance tax. First of all, the new policyholders could opt to buy off the capital of the insurance policy. If the initial policyholder/donor lives for another three years or more, the legal fiction does not apply. The new policyholder (child/beneficiary) could also opt to register the bought-off capital and pay 3% gift tax. In the latter case, no inheritance tax will be due.
A second technique to work around the legal fiction is to designate a new beneficiary for the life insurance. This could be, for example, the spouse of the policyholder or the policyholder's own children. In such a case, there is no longer a clause for the benefit of a third person drafted by the original policyholder. Therefore, the legal fiction does not apply.
Of course, the decision discussed above represents a point of view that is held by the Flemish tax administration. It is not certain that the Belgian courts will support this new point of view, however.