Partnership / Membership Protection
INSTRUCTION TO USER – The following section has been designed for inclusion within a report
generated by the PPOL suitability report writing solution. You will need to use the PPOL
software to create a report containing an Introduction section and a standard Protection
Recommendation for the underlying product you are recommending (e.g. level term assurance,
whole of life etc) in the usual way. Once you have downloaded the report created via PPOL to
Word, insert the protection recommendation within the text at the point indicated below and
simply edit the resultant section to reflect your individual requirements.
The text has been colour coded to aid with your understanding. Where the text is highlighted in
blue this tends to suggest that the text may not be appropriate in all instances, and you may
need to delete some or all of it. Where the text is highlighted in red, this will require your input.
Most businesses will have implemented arrangements to cater for the retirement of their key
individuals, and some may also have considered their business succession. Fewer will have
considered the effects of the loss of a partner of the business (known as member if an LLP)
through illness or death.
A Partnership
A partnership is defined in section 1 of the Partnership Act 1890 as ‘the relationship which exists
between persons carrying on business in common with a view of profit, other than by way of
membership of a body corporate.’ There is no longer any limit as to the number of partners a
business can have. Within a partnership, each partner has an interest in the business rather than
the ownership of ordinary shares, as would be the case in a limited company structure.
A Limited Liability Partnership (LLP)
An LLP is a form of legal entity, which is a corporate body formed in accordance with the Limited
Liability Partnership Act 2000. Each member (as opposed to partner) has an interest in the
business, rather than ownership of ordinary shares.
The death of a business partner / member can have far-reaching consequences for the future of
a business. The business would lose a valuable revenue generator but also, the remaining
partners / members may end up having to work with the deceased partner’s / member’s
beneficiaries who may not have the necessary skills experience or interest to continue in the
business. Additionally, the partners’ / members’ interest may need to be turned into cash to pay
death duties or provide for his or her dependents on death. For a partnership, in the worst case
scenario the partnership can end up having to be automatically dissolved on death if there is no
Partnership Agreement in place. Equally, if a partner became seriously ill, they might well want
to leave the business. In this case, the remaining partners / members would need to have
sufficient funds available to buy out their interest in the business.
A surprisingly large number of partnerships and LLPs have no partnership or membership
agreement in place. This is a crucial document that not only sets out how the profits and capital
of the business should be shared, it also states what should happen in the event of dissolution of
the partnership or LLP, retirement, death or ill health of any of the partners or members. Any
existing partnership or membership agreement must be reviewed before recommending
insurance solutions to ensure there is no conflict.
Raising the finance to buy a partner’s / members’ interest may involve the sale of assets or
finding someone who can afford to buy-in to the company. Finding a suitable replacement and
raising the money can be difficult and time consuming. To this end, it is clear that the remaining
partners / members need to retain continuity, stability and control of the business whatever the
eventuality. This can be achieved by making adequate legal and financial provision. These steps
are outlined below.
Legal Solutions
A Partner’s / Member’s Share Purchase Agreement is required to enable the surviving partners
to purchase the interests of the business from the deceased partner’s estate and to provide the
deceased partner’s / member’s dependents with a willing buyer and cash instead of an interest
in a business. They are usually designed to ensure that funds are available in the right hands for
the purchase of a partner’s / member’s interest on death. An effective Partner’s / Member’s
Share Purchase Agreement should provide:
1. Flexibility.
2. Capital that is available in the right hands at the right time.
3. Tax efficiency.
There are three ways in which the Partner’s / Member’s Share Purchase Agreement can be set
up. These are:
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A Buy and Sell Agreement
Double Option / Single Option Agreements
Automatic Accrual Method
It is important to consider the circumstances in which these agreements are to operate. For
further information concerning each agreement, I refer you to the technical notes section in the
Appendix of this report.
For example, the partners / members may not wish them to take effect on a sale of an interest
at any time, and may prefer instead to have the right of pre-emption i.e. a partner wishing to
dispose of his interest must offer them for sale to the other partners first.
Having considered the options, I have suggested that you proceed with a <INSERT> Share
Purchase Agreement. Many life companies can provide specimen wording for this type of
agreement. However, I do stress that it is beyond my scope to advise on the suitability of the
agreement or its wording. To this end, I would strongly advise that you consult with your
solicitor to ensure that the recommended agreement, and its wording, is suitable and sits
comfortably with your Partnership / Membership Agreement.
Financial Solutions
Having decided which Share Purchase agreement to use, the next step involves the
establishment of a suitable life insurance vehicle that can be used to fund the purchase of the
deceased partner’s / members interest. An insurance policy aims to provide protection against
the financial effects of death or earlier critical illness, and will provide the surviving partners /
members of the business with a cash lump sum to purchase the deceased’s interest / interest of
the individual who is critically ill, while ensuring that the partner / member who is critically ill is /
deceased’s beneficiaries are compensated financially.
Each partner / member should be insured to reflect their respective percentage interest of the
partnership / LLP Partnership. It is difficult to value an unquoted company. As a rough guide, it is
generally accepted that the value of a business can be calculated by multiplying its average
annual net profit after tax for the last three years by a multiple of between three and six.
However, if you are in doubt of the value of your business, I would suggest that you contact your
accountant. Please note a shortfall in cover will mean the surviving partners / members will
have to make up the difference out of their personal funds. But an excess of cover could call into
question the “commerciality” of the arrangement.
The partners / members and their interests are currently valued as follows:
Name of Partner / Member
% Interest
Value (£)
<INSERT> one of the following 3 options>
1. PARTNERSHIP / MEMBERSHIP PURCHASE IN TRUST
A Trust Deed is designed for use where a partner / member of a partnership / LLP partnership
intends to effect a policy or a cover on his/her own life in trust to provide funds on his/her death
or a diagnosed critical illness, terminal illness or total and permanent disability for the other
partners / members, on the basis that the other partners / members will likewise effect
policies/covers on corresponding trusts.
Who Can Benefit from this Trust?
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A Trust Deed can ensure your policy/cover is placed in trust from the outset.
A Trust is created for the benefit of those people who are partners / members in your
partnership / LLP partnership
The Trustees should ensure that none of the policy/cover moneys are paid to anyone
who ceases to be a partner / member or does not meet the conditions specified in the
Trust Deed.
Once the policy/cover is placed in Trust, it is not possible for you or the Trustees to
change the Beneficiaries, unless you cease to be a partner / member of the partnership
/ LLP partnership (see below).
Reverter to Settlor Provision
It is important to note that the policy/cover will revert automatically to you if you cease to be a
partner / member prior to a claim arising under the policy/cover. If this happens, this Trust will
effectively come to an end. A simple assignment should then be made by the Trustees in favour
of yourself. You could then place the policy/cover subject to a new trust. You may, for example,
want to place the policy/cover in trust for the benefit of your children to assist with inheritance
tax planning.
The life company will be able to provide a specimen trust. However, I do stress that it is beyond
the scope of <INSERT> to provide advice on the suitability of trusts and their wording. To this
end, I would advise that you consult your solicitor on this matter.
2. PARTNERSHIP / MEMBERSHIP PURCHASE LIFE OF ANOTHER
I have recommended that each partner / member effects a life insurance policy on the life of the
other partner(s) / member(s). This should be for the amount that they would expect to have to
contribute towards the purchase of a deceased or retiring colleague’s share. Should one of the
partners / members die, the survivor will be paid the sum assured under the policy. Each owner
is paying an equitable cost of the protection being provided and so equalisation of the
premiums is not an issue.
However I do stress that this is relatively inflexible if the business expands and new partners /
members are brought into the business. If there are more than two business partners /
members a number of contracts may be required leading to excessive cover levels and costs.
Life Insurance Recommendation
INSTRUCTION TO USER - INSERT APPROPRIATE PROTECTION PRODUCT RECOMMENDATION
HERE
I strongly recommend that we review your business protection on a regular basis to ensure your
business protection marries your needs and objectives.
Technical Notes – Share Purchase Agreements
It is vitally important that the partners or members or shareholders of a business establish a
formal agreement which deals with what may happen to their interest or share of the business
on their death, and increasingly, in the event of them becoming terminally or critically ill. There
are various Share Purchase Agreements available for consideration, a summary of which can be
found below.
Buy and Sell Agreement
A Buy and Sell Agreement can be thought of as a prenuptial contract for businesses, specifying
what happens if things go wrong. The buy/sell triggers are agreed and defined by shareholders
or business partners or business members with legally binding clauses, declaring who may buy
and at what price an interest in the business will be sold.
If death is the trigger, the deceased’s estate then sells and the surviving shareholders or
business partners or business members are obliged to buy the deceased’s share of the business,
using a pre-agreed method of valuation. For example Bob and James are equal shareholders /
partners / members in a business. If Bob dies, his share would form part of his estate. With a
Buy and Sell agreement in place, the estate would be reimbursed for the agreed value of Bob’s
shares or interest (avoiding the lengthy issues associated with probate), and the actual shares or
interest would revert to James.
HM Revenue & Customs treats this as a contract for sale. This means the loss of Business
Property Relief (BPR) for IHT purposes, but this agreement can operate on retirement as well as
death. The buy sell method is simple and easy to understand. However, it may increase
Inheritance Tax liabilities because of the loss of business property relief.
Double Option / Single Option Agreement
Double Option Agreements are also known as ‘cross-option’ agreements. The surviving
shareholders or partners or members have an option to purchase and the estate to sell shares
or an interest within a pre-determined time, during which the estate is bound not to sell them
to anyone else.
For example, Vicky, Diane and Sarah are sisters – and equal shareholders or partners or
members in a business. On Sarah’s demise, Vicky and Diane are in two minds as to whether they
want the family business to continue. For six months – giving them time to make up their minds
– Sarah’s estate (her husband and family), must keep the shares or business interest. If the
surviving sisters choose to buy the shares or interest, Sarah's estate will have to sell the shares
or business interest to the other two sisters, the value of the shares or business interest being
calculated in accordance with the terms of the Double Option Agreement.
Most Double Option Agreements provide only for death, not serious illness (although this
agreement can operate on retirement). To provide cover against critical illness, a Single Option
during a lifetime agreement may be preferable. This offers a shareholder or partner or member
the freedom to decide whether to stay in the business or simply be reassured that the other
shareholders or partners or members are bound to buy the shares / business interest.
In both cases, Business Property Relief is not lost as HM Revenue & Customs do not view these
agreements as contracts for sale.
The double option agreement has the benefit of allowing the surviving shareholders partners or
members an enforceable option to buy the deceased’s share, but with the added advantage that
the agreement does not disqualify the value of that share for business property relief.
Automatic Accrual Method
This method is mainly used by partnerships / LLP partnerships. It does not involve the purchase
or sale of shares or a business interest, instead, the deceased’s shares or interest pass
automatically to the remaining shareholders or business partners / members.
All shareholders or business partners or members take out life policies to compensate the
estate, and these policies can be put into trust to ensure benefits go to chosen beneficiaries.
For example, Peter, Nick and Wendy are all partners in an estate agents’ business. On Peter’s
demise, Nick and Wendy automatically receive his share of the business and it is divided equally
between them.
Automatic accrual is flexible but relies upon each shareholder / partner / member maintaining
their own policy for the current value of their company / partnership / LLP partnership interest.
Taxation Implications
Taxation of Premiums
Premiums paid on policies taken out for the purposes of share or partnership or membership
protection are usually paid for by each director partner or member, and therefore do not
benefit from tax relief. As general rule if the company partnership LLP partnership pays the
premium, they will not receive tax relief on the premium, as the purpose is share purchase
rather than replacement of profits. However, the balancing premise is that the proceeds of any
policy should then not be taxable.
Please note that the tax treatment of the premiums cannot be assumed, and can vary
depending upon individual circumstances. To this end, I strongly recommend that you contact
your local Inspector of Taxes for further clarification on the tax treatment of this arrangement
before the policy comes into force.
Inheritance Tax (IHT)
Provided the arrangement is classed as ‘commercial’ there will be no IHT consequences for the
settlors of the life policies in trust. The deceased owner’s interest in the business will fall into
their estate for IHT purposes. However, depending on the nature of the business, i.e. Company,
Partnership, LLP Partnership, Business Property Relief would normally be available.
Trusts effected on or after 22 March 2006 and earlier trusts brought under the new regime as a
consequence of, for example, a change in beneficial interests could potentially incur a periodic
charge at each 10 anniversary and exit charges on the basis applicable to discretionary trusts.
However, provided the life assured is in reasonable health the term assurance will have little
value. The event likely to cause greatest concern is a claim arising just before a 10-year
anniversary leaving the trustee’s insufficient time to distribute the benefit before the
anniversary date.
Capital Gains Tax
Life policies are usually exempt from Capital Gains Tax in the hands of the original owner. No
CGT liability should arise unless the value of the deceased’s interest in the business increases
between the dates of death and sale by more than the sellers’ available exemptions.
Income Tax
There should be no Income Tax on the proceeds of the term assurance policy as there are no
investment gains. However, if a trust (existing or new) allows the settlor to benefit, it will fall
within the scope of the pre-owned assets tax legislation, effective from 6 April 2005. Care
should be taken on the use of non-term assurance policies.
Wills
All the shareholders involved in the shareholder protection arrangement should execute wills to
ensure their intended beneficiaries receive the proceeds free of any intestacy delays.