There are various forms of protection available to businesses in case they lose a key person, and these have different tax implications.
A director’s priorities are likely to be two-fold: to cover their personal income needs in the event of being unable to work, and to fairly compensate both their family and the remaining shareholders in the event of their death.
Key person assurance is widely used to cover the costs incurred by a company where a key person is unable to work.
Corporation tax relief
Corporation tax relief for premiums paid by the business is normally allowed, provided the so-called ‘Anderson rules’ apply. See Box One.
Typically, if the premiums attracted corporation tax relief, then any policy proceeds would be taxable as a trading receipt. Most companies would prefer to gain tax relief on premiums (a certainty) rather than on any policy payout (a, hopefully remote, possibility). There are several scenarios where corporation tax relief will not be available. See Box Two.
On the death of a shareholder, typically the remaining shareholders would want to retain control of the company while the deceased’s family would prefer the cash value of the shares. In the absence of share protection arrangements, shares may pass to the deceased shareholder’s family by will or intestacy.
The family may not have the desire or ability to be involved in the company, and profits would likely suffer as a result.
The family may wish to sell the shares, but they are likely to be illiquid or of little interest to those not already involved in the company. The remaining shareholders may lack sufficient cash to purchase the shares from the deceased shareholder’s family.
Whole of life policies can solve these various issues. A policy can be used to direct the shares to the remaining shareholders and provide the family with a cash lump sum.
The company cannot obtain tax relief on whole of life premiums because the policy is for the benefit of the individuals and their families, rather than for the purposes of ongoing trade. Therefore, the directors will pay the premiums themselves out of their taxed income. The policy proceeds are then usually paid tax-free to the nominated beneficiaries.
A company’s articles of association may restrict how shares can be transferred in the event of a shareholder’s death, so legal and tax advice is imperative.
Partnership holdings and shareholdings in unlisted incorporated trading companies generally qualify for 100 per cent BR. However, a binding requirement for a deceased shareholder’s shares to be sold is a contract. This will result in loss of BR as at the date of death, because at that point the asset will effectively be in the form of cash rather than shares.
Cross-option agreements are often used to circumvent this issue. If one party exercises their option to buy/sell, the other party is obliged to comply. These arrangements are not binding contracts for sale which means BR is still available.