Shareholder Protection Insurance

How Does Shareholder Protection Work?

By arranging Share Protection, you are able to ensure the remaining partners have the option and the financial backing to buy back company shares belonging to the deceased should the worst happen. The absent shareholder or their family also gets the option to sell their shares to a willing and able buyer (the company).

Shareholder Protection Life Insurance protects against a policyholder dying or developing a terminal illness by triggering a payout if one of these two scenarios comes to pass. Adding Critical Illness Cover means the policy will also pay out if the individual insured develops one of a set of critical illnesses outlined in the policy documents.

Why Include Shareholder Critical Illness Cover?

Critical Illness Cover pays out should one of a list of critical illnesses or injuries strike. This can include anywhere from 40 to 100+ conditions. Each insurer will define serious illnesses differently, so it’s important to get advice to ensure you get the best policy terms.

Often it’s obvious that there might be severe disruption to a business should a shareholder pass away, but people tend to forget that the same could be true if an individual was rendered out of the business long-term or even indefinitely with a critical illness.

Adding Critical Illness Cover ensures a Shareholders Insurance Policy would cover both disruptive eventualities.

Samantha Haffenden-Angear, Cert CII
Independent Protection Expert at Drewberry

The two most common ways you can set up Shareholder Protection Insurance are:

• Own life under business trust
• Company share purchase

Setting Up Own Life Shareholder Protection Under Business Trust

With this option, each individual to be insured takes out a policy on their own life. This will generally run up to retirement age. These policies are taken out to reflect the value of that individual’s shareholding within the business. Each policy is then written into trust for the benefit if the other shareholder.

Where the company pays for the individual Shareholder Protection premiums on behalf of the shareholders, it’s usually treated as a deductible business expense for corporation tax purposes but the premiums will be considered a P11D or benefit in kind for the shareholders and taxed accordingly.

For both options, the individual remains the owner of the policy, hence the need to write the policy into trust to keep the payout separate from the individual’s estate.

If the insured individual dies, or becomes terminally or critically ill, the benefit is paid to the trustees (i.e. the other shareholders), keeping the cash completely separate from their estate.

The remaining shareholders can then use the payout to buy the outgoing owner’s shares in the business, either from the personal representative of the deceased’s estate or from the shareholder themselves if the payout has been triggered by critical illness.

Why Premium Equalisation is important…

Where the individuals pay for the premiums themselves, to avoid potential tax implications it’s usually important to equalise the premiums between the individuals paying for cover.

With Life Insurance there will naturally be variations in the cost of cover between the individuals based on factors such as their age and state of health. Equalisation prevents HMRC viewing vastly unequal premiums as conveying a gift between the participants, given that younger shareholder(s) are far more likely to benefit from the higher premiums for a policy paid for by the older shareholders.

Without equalisation the commerciality of the agreement to could come into question and potentially result in unnecessary inheritance tax issues.

There’s a specific formula for calculating premium equalisation that your adviser will be familiar with, so ask them how to equalise the arrangements to ensure your shareholder protection premiums are paid correctly.

Sam Barr-Worsfold, DipFA
Business Protection Expert at Drewberry

Setting Up Company Share Purchase Shareholder Protection

In this example, the company purchases a life insurance policy for each individual shareholder and will usually be set-up to provide cover up to their expected retirement date. No trust is necessary as the money will be paid into the business, where it is typically treated as capital rather than as a revenue receipt for corporation tax purposes.

Should a shareholder die or become critically ill, the payout from the policy goes into the company, providing the necessary funds to buy the shares of the outgoing shareholder. These shares are then bought out and cancelled, effectively increasing the proportionate shareholding of the remaining shareholders.

While this is a similar approach to own life under business trust, there are a few points that must be considered before writing your Shareholder Protection Cover in this way:

• There must be the capability for the company to purchase its own shares under its articles of association. Some older companies, particularly those incorporated before 1982, may not have this right and changing the articles of association to include this right could increase the value of the company’s shares
• Before a company can purchase its own shares, the directors must give a statutory declaration of solvency that will be valid after the outgoing shareholder exits, backed by a favourable report from the company’s auditor
• There are stipulations to be met under the Companies Act to allow a company to legally purchase its own shares
• Rewriting your articles of association to include the right for the company to purchase the deceased’s shares may have the effect of increasing the value of those shares, so it’s vital you account for this in terms of the sum assured
• However, the death of a shareholder could also negatively impact the value of the business and will likely lead to any loans the outgoing shareholder made on behalf of the business having to be repaid, also reducing the value of the company.

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How is Shareholder Protection Insurance Taxed?

The taxation of Shareholder Protection Insurance depends on a variety of factors. Premiums and the payout may be subject to a range of taxes depending on the individual circumstances of you and your company, so it’s always best to seek specialist advice.

Where the individual pays the premiums themselves the premiums are paid from post-tax income and no tax relief is available. The benefit is written into trust for the benefit of the other shareholders, and in the most part protecting the payout from inheritance tax.

Taxation of a own life policy under a business trust…
Where the company pays the premiums on behalf of the shareholder on an own life basis which is set-up under business trust, the company is typically able to deduct this payment as a business expense for corporation tax purposes. However, the shareholders would have to pay tax on the premiums, as these would be a P11D or benefit in kind.

Taxation of a company share purchase arrangement…
Where the premiums are paid under a company share purchase arrangement, these premiums are not typically considered a business expense as they wouldn’t meet the ‘wholly and exclusively for the purposes of trade’ rule, given that the policy isn’t designed to meet loss of profits when the outgoing shareholder dies or becomes critically ill.

As the company owns the policy and makes the policy payments, as well as receives the benefits, there aren’t usually tax implications for the shareholders.

Ask your accountant for specialist advice on the tax position of Shareholder Protection Insurance as they will be in the best position to advise you with regards to potential capital gains tax, income tax and inheritance tax liabilities.

Victoria Slade
Business Protection Expert at Drewberry

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