Insurance
of Key Directors and Employees |
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 Insurance
of Key Directors and EmployeesSUMMARY
OF GUIDANCE Introduction The purpose of the report is to give guidance about the protection needs of a companys Key Directors and Employees; Death The protection by insurance cover for the company against the death of a key director or employee. Disablement Cover for the company against the financial consequences of a key person being disabled. Critical illness Cover for the company against the financial consequences of a key person suffering from a critical illness. Tax Use of the most tax-efficient arrangement to provide the cover. Guidance The guidance in this report is restricted to the area of financial protection through life and health insurance. It is not intended to provide you with a tailored comprehensive planning review. We may be able to answer queries by contacting us at enquiries@goforcustomer.co.uk .If you are in any doubt about your individual or company requirements then you should seek professional advice. NEED FOR COVER Dependence on key person The continuing profitability and possibly even the survival of some company businesses are highly dependent on certain key employees and directors. The death or disablement of any one of these key people could have very serious effects: Consequence of death
Most companies should therefore take out cover to provide against the event of death or disability of Key Directors and Employees. Schedule of cover In determining the schedule of cover there are many facets to take into consideration. You should also seek advice from your Company Accountant and Auditors. A suitable schedule of cover can be constructed as follows:
THE TAX POSITION Conditions for tax relief on premium paid by company The premiums paid under policies taken out by a company may be allowed as a deduction against profits for corporation tax. The expenditure must have been incurred 'wholly and exclusively' for business purposes and must be an expense of a revenue nature as opposed to a capital expense. HMRC generally interprets these requirements as meaning that the premiums will be deductible if: Employee only relationship The sole relationship is that of employer/employee and the cover is intended to meet the loss of profits arising from the loss of the employee's service rather than to cover a capital loss such as goodwill. Term assurance policy The policy is a short term temporary assurance which does not have a cash value. Premiums are not deductible for a whole of life or endowment assurance policy. Proceeds of policy taxable As long as these conditions are satisfied and the premiums are allowable as a deduction, the policy proceeds would normally be regarded as a trading receipt and would be taxable accordingly. TERM
ASSURANCE TO COVER LOSS OF PROFITS Typically Term Assurance is used to cover loss of profits. This Temporary Insurance can also be on an increasable basis or on a renewable basis. Increasing Term Assurance is of particular benefit if the company projects increasing reliability on a Key director or Employee and thus potentially increasing profits. Read quotation and key features carefully You should read the quotation and key features and key facts carefully; they contain important information about your rights and benefits under the policy. Reduced cost to company This policy structure should ensure that the premiums are allowed as an expense for corporation tax purposes, thus significantly reducing the costs to the company. However, the policy proceeds would be treated as a trading receipt in the year (if) they become payable. Payment of sum assured by instalments The sums assured could therefore be payable in equal annual instalments over, say, five years. This should prevent the whole amount being payable in one year, which could push your company profits into a higher marginal rate of corporation tax. Under current legislation, only the value of the instalment becoming due should be added to the relevant year's profits. Level term Level term assurance provides the same amount of cover over the period of the contract. Renewable term Renewable term assurance provides the same amount of cover over the period of the contract. In addition you have the added flexibility that you can renew the policy for a maximum of years at the policy's expiry, regardless of the policyholder's state of health. At each renewal though the cost will increase. Term assurance - choice of company At www.GoForCustomer.co.uk we make available the key financially secure and competitive Life Assurance Providers in an easy to use on-line quotation tool. Quotations are listed in competitive order and all documents are provided to apply for the cover required. TERM ASSURANCE TO COVER CAPITAL LOSS Guidance - term assurance for loss of goodwill Typically Term Assurance is used to cover loss of goodwill. This Temporary Insurance can also be on an increasable basis or on a renewable basis. Increasing Term Assurance is of particular benefit if the company projects increasing reliability on a Key director or Employee and thus potentially increasing goodwill. Schedule of cover
Non-allowable premiums tax-free proceeds The premiums should not be allowed as an expense for corporation tax purposes, because they should be treated as capital expenditure. The policy proceeds are not normally taxable, because they should be capital receipts. CONFIRMATION FROM HMRC HMRC clearance HMRC normally considers each case on its own merits. It does not follow that because premiums are not claimed as an expense, the proceeds would not be treated as a trading receipt. Therefore, to be certain of the tax treatment of the policies, clearance should be obtained from HMRC. If required your Accountant or Tax adviser will draft a suitable letter to HMRC. NO COVER FOR SHAREHOLDERS Guidance - personal policies Care should be taken when insuring a key director who is a shareholder. Here it may be advisable to take out policies on the shareholders own life outside the company for the benefit of the shareholders family. This fund could then be lent back to the company if necessary. Not company policies for shareholders If there is material shareholding in the company; it is may not be advisable for the company to take out the policies on the shareholders life. The value of the policy would increase the value of the company for tax purposes and may prejudice business tax reliefs. Tax position on premiums - policies for shareholders Moreover, the premiums paid by the company are unlikely to be allowed as an expense. HMRC will argue that the company's expenditure is at least partly for the shareholders own advantage and therefore has not been incurred 'wholly and exclusively' for business purposes. KEY EMPLOYEE'S INCOME PROTECTION Need for key person PHI Many businesses would experience very serious financial problems if some key individuals were unable to work because of serious ill-health. In fact, the costs could be as great as if the employee had died and the chances of a disability occurring are greater than the chances of a premature death. Details of cover The benefit, which should be the estimate of the loss of profits as a result of the loss of the employee's services, could be payable after a deferred period of between a few weeks and 12 months and for a period of years. Schedule of cover A summary of the cover that should be provided could be as follows:
Tax
position on claim The premiums paid by the company would normally be allowable as an expense for corporation tax purposes. However, if the benefits become payable to the company, they would be treated as a trading receipt. It is suggested that confirmation of the position should be sought from the local Inspector of Taxes. CRITICAL ILLNESS COVER Need for the cover If a key Director or employee were to suffer a critical illness such as a stroke or heart attack, the company could experience very serious financial problems. In fact, the costs could be as great as if the employee had died, and the chances of a key person suffering a critical illness are even greater than the likelihood of a premature death. Benefits of critical illness cover Critical illness insurance can be used to provide this lump sum if the insured person has a critical illness or dies. Extent of the cover Critical illness insurance will pay out a capital sum if the key Director or Employee suffers any of the key critical illnesses or events defined in the plan. These normally include diagnosis of heart attack, stroke, kidney failure, almost all serious forms of cancer, multiple sclerosis or a coronary artery bypass surgical operation or transplant of a major organ. The pay-out under the policy could also be made if the key person is permanently totally disabled or dies. If combines Critical Illness or death is chosen the plan pays out on the earliest of one of these events, so that it is only possible to claim once under each policy. Thus, if a claim is paid out for a heart attack and the key Director or Employee subsequently dies, there will not be a further payment of the cover under the plan Tax position The premiums paid by the company are unlikely to be allowed by HMRC as a deduction as a trade expense for corporation tax purposes. The proceeds should not be taxable as a trading receipt. Schedule of Cover Critical illness cover could be taken out by the company on the lives of all the key employees and directors. The following is a schedule of cover that could be provided:
Read quotation and key features carefully You should read the quotation and key [features and key facts carefully; they contain important information about your rights and benefits under the policy. Affordability The premiums should be readily affordable by the business, based on your own assessment. ASSUMPTIONS ABOUT TAX POSITION Tax position The assumptions about the tax position of the plans and recommendations made in the guidance are based on current law and HMRC practice which may be subject to alteration in the future. In particular, what assets, gains or income are taxed and the levels of taxation on them are all subject to change. Tax reliefs may also change and their value to you will depend on your individual circumstances. SUMMARY OF RECOMMENDATIONS Life cover by business The business should consider taking out insurance cover on the lives of key employees and directors. Life cover by key directors Shareholder directors should take out cover on their own lives and could increase their net remuneration to cover the premiums. Disability cover The business should consider taking out cover against loss of profits caused by the disability of key employees and directors. Critical illness cover The business should consider taking out cover against the loss of profits that would be caused by the critical illness of key employees and directors. Directors'/Shareholders'
Insurance Guidance The purpose of the report is to give guidance about the protection needs of company Directors and Shareholders in the following; Shareholders' agreement Most companies should have the establishment of an appropriate shareholders' agreement to cover the event of a shareholder director's death or critical illness and in fact retirement. Professional legal advice should be sought. Company purchase The main conditions under which a company may buy its own shares. Insurance Arrangements for sufficient funds to be available to finance the purchase of shares from a deceased director's personal representatives or from a critically ill director. Family provision The provision of funds for each director's family on death or on suffering critical illness. Guidance The guidance in this report is restricted to the area of financial protection through life and health insurance. It is not intended to provide you with a tailored comprehensive planning review. We may be able to answer queries by contacting us at enquiries@goforcustomer.co.uk. If you are in any doubt about your individual or company requirements then you should seek professional advice. THE NEED FOR SHAREHOLDERS' AGREEMENT Position as director/ shareholder Directors of a company who own a percentage of the share capital, should consider the question of share purchase on the death or retirement of a director or if a director becomes critically ill. Consequences of death if no shareholders' agreement If there is no shareholder agreement and if a director were to die, their shareholding would pass under the terms of their will, probably to other members of the family. This clearly may not be in the best interests of the remaining directors or even the deceased director's family. The future of the company depends upon the people who exercise control through their shareholdings and such a change could adversely affect the company. If 'buy and sell' agreement in force If a buy an sell agreement is in force, this means that if a director dies, the other directors are under an obligation to buy the shares. Providing finance for surviving directors Arrangements should be considered so that the surviving directors can buy the shareholding of the deceased director. This can be achieved by providing the personal representatives with a fair value for that shareholding, which can then be distributed to the deceased directors dependants. Family security Financial security can thus be provided for members of the deceased director's family, completely outside the company. Control Control of the company would be retained by the surviving shareholders/ directors, without the possibility of interference in the running of the business by the deceased person's family. Disability of a director The same considerations arise if a director were to become severely disabled and critical illness Cover (CIC) is considered. OPTION AGREEMENTS IHT consequences of 'buy and sell' Under a normal 'buy and sell' agreement, the deceased shareholder's personal representatives have to sell and the other shareholders are forced to buy the shares. Although this relatively simple agreement provides the deceased directors family with money and the other shareholders with shares, it effectively destroys valuable inheritance tax relief. If the shares were left to the deceased shareholder's children or an appropriate trust before being disposed of, they would qualify for business property relief but not if they are subject to a 'buy and sell' agreement. Double option However, it is possible to establish an agreement which has broadly the same practical consequences as a 'buy and sell' agreement, but does not involve losing the inheritance tax relief. This is normally known as a 'double option agreement'. Structure The structure of a double option agreement is as follows:
The business property relief would be available if needed, because there would be no binding obligation on the parties, but the agreement would achieve exactly the same objectives as a 'buy and sell' agreement. For if one party to such an agreement exercised the option, then the other party would be bound to buy or sell, as the case may be. Tax implications The main capital gains tax and inheritance tax implications of such a 'double option' agreement on the death of a director would be as follows: CGT implications For capital gains tax purposes, the deceased person's interest would pass to the personal representatives and would be revalued at the date of death. This means that a subsequent sale by the personal representatives under the agreement to the surviving shareholders soon after death should not give rise to a capital gains tax liability. IHT implications For inheritance tax purposes, if the person entitled to the interest is the spouse of the deceased, the transfer from the deceased would be exempt. Where the person is not the spouse, business property relief would be available because the double option agreement has been used. The subsequent sale under the agreement would be a commercial transaction on full open market terms and it would therefore not involve any further liability to inheritance tax. Single option agreements A single option agreement is more appropriate if shareholder insurance is based on critical illness cover. Structure Under a single option agreement the insured shareholder (or the personal representative) has an option for, say, six months after a claim on the critical illness insurance, to sell the shares to the other directors. There is no corresponding option for the other directors to buy shares. Consequences
As there is no binding obligation to sell, business property relief would be available, if it is needed. An insured shareholder can force the other shareholders to buy, if circumstances make this advisable. Tax consequences If a director becomes critically ill, the main capital gains tax and inheritance tax implications of a single option agreement would be as follows: CGT implications For capital gains tax purposes, any sale of shares during the shareholder's lifetime could give rise to tax. However, taper relief could reduce the amount of gain taxable by up to 75%, if the shares have been owned for two or more years. If the serious illness quickly leads to the shareholder's death, then the normal revaluation on death will occur and any capital gains tax problems should be minimal. IHT implications For inheritance tax purposes, the single option agreement gives the shareholder a very important flexibility. If the illness is likely to lead to an early death, the shareholder can choose not to exercise the option; in this case, the shares will remain in his or her estate at death and qualify for the appropriate level of inheritance tax relief and capital gains tax uplift. On the other hand, if the shareholder is likely to recover but not resume work, the option can be used to convert the shares into cash for retirement. However, the cash proceeds of sale will not benefit from any inheritance tax reliefs and there could be a capital gains tax liability. PROVIDING THE CASH FOR A SHARE PURCHASE Introduction It is essential to provide adequate cash resources to allow the purchase of a deceased or critically ill director's shareholding. A life assurance policy is, and a critical illness plan are appropriate for this purpose, because they can provide the necessary cash at the exact time it is needed. Term assurance To keep the cost of the plan to the minimum in the short term, term assurance policies can be used to give the necessary cover. Types of term plan A term assurance policy for a level amount of cover for a number of years or a renewable policy which can be renewed at the end of the term for another period, regardless of the insured person's state of health at the time. These tend to be the most appropriate contracts for share purchase. The policy should contain the right to increase the amount of cover every year in line with inflation. For this reason an Increasing or Indexed Level Term Aassurance is widely used. Importance of increase option The option to increase the level of insurance under the policy is important, because it will allow any annual increase in share values to be covered - at least to some extent. Basis for levels of cover The life assurance quotations available at www.goforcustomer.co.uk should be for levels of cover which reflect the current value of the shareholdings. In determining the value you may need to seek advice from your Accountant. Schedule of quotations A summary of the required cover could be established as follows:
Read quotation and key features carefully You should read the quotation and key features and key facts carefully; they contain important information about your rights and benefits under the policy. Affordability The premiums should be readily affordable by the company, based on your assessment. Critical illness policy If a shareholder were to fall ill because he or she had contracted a critical illness, both the shareholder's family and the company could suffer. Benefits of critical illness cover Critical illness cover can be used to provide this lump sum shortfall. The cover should be taken out by all the shareholders for the benefit of their families and the company.
Critical illness insurance would pay out a capital sum if a shareholder suffered any of the key critical illnesses or events defined in the terms of the plan. These normally include diagnosis of heart attack, stroke, kidney failure, almost all serious forms of cancer, multiple sclerosis or a coronary artery bypass surgical operation or transplant of a major organ. The pay-out under the policy could also be made if the shareholder is permanently totally disabled or dies. The plan pays out on the earliest of one of these events, so that it is possible to claim only once under the policy. Thus if a claim is paid out for having a heart attack and the shareholder subsequently dies, there will not be a further payment of the cover under the plan. HOW THE POLICIES SHOULD BE WRITTEN Policies written in trust Each director should take out a policy on their own life and it should be subject to a trust for the benefit of the other shareholder directors. The trust should be written so that if the director dies or becomes critically ill, the proceeds of the policy would be paid to the other directors free of inheritance tax. Flexibility of trust provisions A flexible power of appointment trust would be particularly useful in this context. This would ensure that the funds will be available to the right people at the right time to enable them to buy the shares. It would also mean that the beneficiaries could be changed if the company were sold or went public, or if a director left the company. For example, the policy could subsequently be used for inheritance tax planning and the premium payments could be continued. Critical illness The flexible power of appointment trust could allow the critically ill director to benefit from the policy, if this were appropriate, eg, because it was agreed that they would return to work with reduced responsibilities and income. Increase directors' salaries The company could increase the directors' salaries to enable them to make the premium payments or pay the premiums on their behalf. In this way, the cost of the policy would be effectively met by the company, although the income tax and national insurance implications for both the company and the directors must be considered. Importance of increase option The option to increase the level of insurance under the policy is important because it will allow any annual increase in share values to be covered - at least to some extent. Basis for levels of cover The critical illness insurance quotations available at www.goforcustomer.co.uk should be for levels of cover which reflect the current value of the shareholdings. In determining the value you may need to seek advice from your Accountant. Schedule of quotations A summary of the required cover could be established as follows :
Read quotation and key features carefully You should read the quotation and key features and key facts carefully; they contain important information about your rights and benefits under the policy. Equalisation
of costs (alternative approach) Each director should take out a policy on their own life for the same amount of premium to ensure an equitable distribution of costs. Any balance of cover required on the life of the older directors should be taken out by the younger directors as grantees. IHT implications Each premium paid by each life assured would technically be a transfer of value for inheritance tax purposes, but is likely to be within each director's annual £3,000 and normal expenditure exemptions (see appendix on home page). Any excess would be a potentially exempt transfer. If the whole arrangement was fully commercial, no transfers of value would be involved. However, if the director who arranges the policy is a potential beneficiary under the policy trust, there could be a liability to pre-owned assets tax. Professional advise from your Accountant should be sought. IHT implications of alternative approach Any premiums paid by the grantee under the policies on the lives of other directors would not be taxable transfers for inheritance tax purposes because the policy would be the absolute property of the grantee. COMPANIES BUYING THEIR OWN SHARES Company buying its own shares The company itself could buy the shares of any retiring or deceased director. This would provide an alternative to the remaining directors buying the shares. Companies Act powers Companies can buy their own shares, provided they have the necessary powers in their Articles of Association. If your company's Articles do not already give sufficient power, it may be worth altering before the purchase takes place. Tax provisions For tax purposes, payment by the company for the shares will be treated as a capital payment and not a distribution of profits, provided certain conditions are met. Thus, the shareholder whose shares are bought will be liable only to capital gains tax. The capital gains tax treatment will normally be more beneficial if the vendor qualifies for capital gains tax business taper relief, or the sale takes place following the vendor's death. The main conditions for CGT treatment are: Unlisted trading company The company must be an unlisted trading company. Purpose of purchase The purchase must be wholly or mainly for the purpose of the trade or to meet an inheritance tax liability which could not be met without undue hardship. Not for tax avoidance The purchase must not form part of a scheme or arrangement where one of the main purposes is tax avoidance. Conditions on the vendor The shareholder must be UK resident and must have owned the shares for five years (three years if the sale is by the deceased's personal representatives). Following the sale, the shareholder must have substantially reduced his or her holding and must no longer be connected with the company. Clearance from HMRC Before the company makes the purchase, a joint application for clearance should be made to HMRC Technical Division (Company Taxation). This is to ensure that the favourable tax treatment is allowed and to confirm that the purchase is not a transaction in securities within s703 ICTA 1988. Single option A single option agreement giving the company the option to buy the shareholding is an effective way. Life cover on directors by company An effective way of providing the company with enough cash to make the share purchase is for the company to take out life assurance cover on the life of each director. The premium payments should not qualify as an allowable expense against taxable profits, but the company should not normally be liable to corporation tax as a trading receipt on the death benefit, or if the policy is cashed. However, the excess would be liable to corporation tax if the cash value of the policy is more than the premiums paid when the proceeds become payable. Critical illness cover on directors by company Critical illness insurance could be taken out by the company. This would provide the company with enough cash to make the share purchase possible if a director became critically ill. The premiums should not qualify as an allowable expense against taxable profits, but the company should not normally be liable to corporation tax as a trading receipt on payment of the policy benefit. Policies taken out by directors (alternative) Policies could be taken out by each director on their own life written in trust for the survivor(s). If a director dies, the funds could then be lent to the company so it can make the purchase. Critical illness policies taken out by directors (alternative) Policies could be taken out by each director on their own life in trust for the fellow directors. If a director becomes critically ill, the funds could be lent to the company so that it can make a purchase of the shares. ASSUMPTIONS ABOUT TAX POSITION Tax position The assumptions about the tax position of the plans and recommendations made in this guidance are based on current law and HMRC practice which may be subject to alteration in the future. In particular, what assets, gains or income are taxed and the levels of taxation on them are all subject to change. Tax reliefs may also change and their value to you will depend on your individual circumstances. SUMMARY OF GUIDANCE Shareholder's agreement A shareholder's agreement should be established to ensure that the surviving directors can buy a critically ill or a deceased director's shares. Double option The shareholders' arrangement should be a 'double option agreement'. Company share purchase In the event of a director's critical illness or death, their shares could be bought by the company itself. Life policies To provide enough funds for the purchase, life assurance policies for appropriate amounts should be taken out on the life of each director. |