If you’re a business owner, the unexpected loss of a co-shareholder (due to death or diagnosis of a critical illness) could have a devastating impact on your company’s profitability – and future prospects. But there is a way to limit the financial impact of such a loss, and enable you to create a succession plan for the surviving shareholders.

Unexpected loss of control is a potential nightmare scenario for anyone who runs a business. But if a co-owner or key shareholder died, it could be a very real prospect. Without shareholder protection in place, the deceased’s shares usually form part of their estate, and therefore automatically pass to their named beneficiaries.

In this situation, a (potentially) significant portion of the business could now be owned by someone with little or no concern for the long-term success of the company. They may even choose to sell their inherited shares to an unknown third party – or worse, a competitor.

The surviving shareholders may want to buy the shares back, but this can be a time-consuming and costly exercise. It may even add an unwelcome debt to the business at a time when it may struggle to afford to repay it. But there’s another option for business owners that would enable them to retain control over their company on the death, or serious illness, of a co-owner or keyperson – shareholder protection insurance.

Shareholder protection is an important and practical way of ensuring shares remain in the business

What is shareholder protection?

Shareholder protection is an insurance policy. It gives business owners the means to buy back shares from a co-shareholder who dies, or has to leave the business due to a critical or terminal illness. It’s an important and practical way of ensuring shares remain in the business, control of the company stays in the right hands, and any disruption caused is minimised.

Setting up shareholder protection

There are a number of ways to set up shareholder protection, each of which can be set up to cover death and / or critical illness:

  • Company share purchase – The company takes out a policy for each shareholder covering the value of their individual shares. In this case the company becomes the beneficiary, and the surviving shareholders can use the payout to buy back the shares.
  • Own life policy – Each shareholder takes out an individual insurance policy covering the value of the shares they hold. The policies are held under a business trust and pays a lump sum on death for the surviving owners to buy back the shares and divide them equally.
  • Life of another – Suitable for businesses with two shareholders, who will take a policy out on the life of the other.
    In all cases, business owners must agree the value of the shares and each shareholder’s stake when setting up what is a legally-binding agreement. It can be complex, and it is advisable to work with an accountant to get an accurate estimation.

The most effective way of minimising potential IHT liability is to write the shareholder protection policy in trust

Managing tax implications of a shareholder protection agreement

There are also a number of tax considerations when purchasing shareholder protection, including income tax, capital gains tax, inheritance tax and corporation tax. It’s also worth remembering that the rules relating to tax are complex and can change at short notice, and you should consult a financial planned who’ll be able to advise you on your individual position.

Income tax

If the business pays the policy premiums on behalf of its owners, this may result in a small income tax liability for the shareholders. However, there’s no personal income tax liability on the proceeds paid out following the shareholder’s death.

Capital gains tax

The cash lump sum paid out by a shareholder protection policy would typically be free from any capital gains tax (CGT) liability. However, if the value of the shares increases between the death of the share owner and the date they’re sold back, the beneficiary could theoretically incur a CGT liability.

However, as most shareholder protection agreements include a specific valuation of the shares in advance, this kind of CGT liability is considered rare. In any case, it is essential that any shareholder agreement outlines the specific approach used to calculate the value of the shares, and that this valuation forms part of the agreement.

Inheritance tax

Because the shares will be treated as part of the deceased’s taxable estate, the surviving business owners could face a significant inheritance tax (IHT) bill.

The most effective way of minimising any potential IHT liability is for the business owners to write the shareholder protection policy in trust. This means any proceeds from the policy would be paid directly to the trustees, instead of forming part of the deceased’s estate, or being passed on to the surviving co-owners.

One other important area to consider involves claiming Business Relief. This is an exemption that reduces the value of a business (and its assets) when calculating the IHT due on an estate. It can be a complex area, so it’s important to talk to a tax planning specialist who can help to work out the most tax-efficient route on your behalf.

Corporation tax

If the business pays the shareholder protection policy premiums on behalf of the shareholders, it can claim these as legitimate business expenses, and therefore won’t be subject to corporation tax. And should the policy payout upon the death of a shareholder, the business would not be required to pay corporation tax on the policy proceeds

Shareholder protection gives business owners certainty, both in terms of succession planning and therefore control

The benefits of shareholder protection

Shareholder protection gives business owners certainty, both in terms of succession planning and therefore control. It also provides the financial means for the business to buy back shares.

For the deceased’s family members and named beneficiaries of their estate, it helps ensure they’ll receive fair financial recompense and the confidence that the wishes of the deceased are being carried out.

How an Amber River financial planner can help

Putting a shareholder protection policy in place involves the preparation of legally-binding documents and trust arrangements, as well as assessing the tax implications for the co-owners and the business. It’s therefore, essential to seek professional advice before making any arrangements.

Get in touch

At Amber River, we help business owners take the important decisions that secure the future of their business and their families. To speak to one of our team, arrange an appointment or find out more, call 0800 915 0000, or alternatively use our contact form here.