Shareholder Protection Assurance – a Business Continuity Plan

Ascend Executive work in partnership with the award winning Jarrovian Wealth. Jarrovian were listed as one of the top 100 financial planning businesses in the UK for 2018, by New Model Adviser magazine.

Frank Oxberry, a partner at Jarrovian wealth, provides an overview of what could happen if a director of your business becomes ill or, even worse, dies.

When an owner dies, their share in the business will pass to their beneficiaries; most likely their family members (either under the terms of their will or according to the law of intestacy if they don’t have one). This however might not be what either the continuing owners of the business or the deceased owner’s family wants to happen. The continuing owners may want to buy the deceased owner’s share and the deceased owner’s family (who might not have been involved in the business), might prefer the cash value of the share. A major problem arises when the continuing owners don’t have the funds available to buy the deceased owner’s share. Life assurance policies can be used to provide a solution to this problem.

How does the arrangement work?

Each individual owner takes out a life assurance policy on their own life with the “sum assured” under the policy reflecting the value of their share in the business. Each owner’s policy is held in a business trust from the start, for the benefit of each of the other owners. When an owner dies or becomes critically ill, the claim proceeds are paid to the trustees (keeping the proceeds outside their estate for inheritance tax purposes). The continuing owners can use this cash to buy the deceased owner’s share of the business. While this arrangement provides the funds to buy the deceased owner’s share, there also needs to be an agreement that this is what the continuing owners will use these funds for.

Option agreements

The Agreement required is called a “cross option” agreement. Under this, when an owner dies, the continuing owners have an option to buy their share and the deceased owner’s personal representatives have the option to sell their share. If either party chooses to use their option, the other party must comply.

For critical illness protection, a single option agreement is required. With this type of agreement, only the critically ill owner can apply the option to sell their share – they can’t be forced to sell their share by the continuing owners. This is to protect the critically-ill owner, particularly if it’s likely that they’ll recover and return to work.

Payment and Taxation of life assurance premiums

If the company makes the policy payments, it will receive corporation tax relief provided the payments meet the ‘wholly and exclusively for the purpose of the business’ test. In other words, provided shareholders’ total remuneration (including these payments) are not excessive in relation to the duties they perform for the company. As the company is providing additional remuneration to a shareholder, they will be subject to income tax on the payment.

The owners might decide to make the policy payments themselves – perhaps out of salary and/or dividends received from the company. If they do, no tax relief is available on the policy payments.

Other potential tax implications

There could be other tax implications of the arrangement. However, if it is set up correctly, it is unlikely that such tax charges will arise.