Maintaining control and stability of the company in the event of death and/or terminal illness of a key director/shareholder is vital to the continued success of the company. By taking the appropriate legal and financial steps, directors and shareholders can be confident that the business is financially secure.
Death of a director
The articles of association are important as they govern what will happen to the shares on death, the rights of each class of share, and whether the company is allowed to purchase its own shares (usually this will be the case).
Company share protection schemes - the legal framework
There are a number of share protection plans that can be used and the particular one that is recommended will depend upon the individual circumstances of the business. The suitability of a share protection plan should be assessed with reference to the following criteria:
A share protection plan consists of:
Buy and sell agreement - death cover
Under the agreement, each director agrees that on death, the personal representatives of the deceased director are required to sell his shares in the business to the surviving directors, and on the death of a director, the surviving directors are required to buy the deceased’s shares.
Double option agreement - death cover
Each director completes a double option agreement, under which the following is agreed:
Taxation implications of double option and buy and sell arrangements in detail.
The following summary relates to most term, critical illness and whole life policies (excluding term assurance under a personal pension plan) using a standard business protection trust
Inheritance tax (IHT)
The proceeds arising from the trust policy will be free of IHT. Assuming that the underlying agreement to purchase shares from co-directors relates to their fair value, the transaction should be regarded as commercial and no element of ‘gift should attach to the premiums for IHT purposes.
Assuming the policies used are ‘qualifying’ policies having run the appropriate number of years where required, or provide critical illness benefits no liability will arise on the proceeds. There is no relief available on premium payments.
Capital gains tax (CGT)
CGT should not arise on the policy proceeds where the policies have been held under the terms of the trust from inception. Where existing policies are placed under trust for the respective benefit of the other directors this may represent an assignment for money or money’s worth. Such a ‘cross assignment’ would make the proceeds potentially liable to capital gains tax.
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