business men shaking hands

Business Protection

09/05/2019
business men shaking hands
Whether you are a sole trader, SME or larger business, no matter how much you would prefer not to think about the possibilities of things going wrong, something inevitably does.

Having the right protection in place can ensure that when things take a turn for the worst, your business is able to work through the disruption and remain financially stable.

Every business is different and therefore your business's insurance needs will typically be dependent on what it does, it's structure, location and whether or not you have any employees.

Key Person Protection (profit protection)

Key Person Protection (profit protection) helps safeguard a business against the financial effects of death, terminal illness, or critical illness of a key person during the policy term.

The loss of a key person may result in: reduced sales, loss of profit/turnover, wasted time, recruitment costs, and the disruption of development plans or increased workloads for the remaining staff.  It may even cause loss of confidence in a business.

Who is a 'Key Person'?

A key person is any employee whose death or continued absence could affect the profitability or growth of the business. Key people are individuals whose skills, knowledge, experience or leadership are important to a business’ continued financial success.

Examples of a key person include, but are not limited to:

  • Sales director
  • IT specialist
  • Managing director
  • Head of product development
  • Technicians and R&D personnel

How does it work?

Key Person Protection (profit protection) is life assurance with – or without – critical illness cover, written on the life of the key person but owned by the business so that any money due as a result of a successful claim on the policy is payable directly to the business. This financial pay-out can help ensure that the business remains viable, continues to trade, and has the opportunity to find a suitable replacement.  With this insurance, the business pays the premiums.

Key person protection may apply to sole traders as well as corporate entities such as limited companies, limited partnerships, limited liability partnerships, joint ventures or other such organisations or associations. With partnerships, the policy is written on an own life basis and may be placed in trust for the benefit of the other partners.

It is worth noting that (a) the calculation of the level of insurance cover required, (b) the duration of the policy and (c) the taxation treatment of policy premiums and monies received will all depend on a variety of factors – so there is not a ‘one size fits all’ approach.  Please speak to one of our Crowe Financial Planning Consultants for further guidance.

Example

Kingswood Wedded Bliss (KWB) is a wedding planning company with a renowned reputation for offering a complete service to meet their clients' wedding needs. Miss Cotton designs all their wedding dresses and is famous for her designs and creativity.

After recent discussions, the shareholders have realised that their business relies heavily on the reputation of Miss Cotton’s designs. If she were to become critically ill or die, their business would suffer and they could potentially lose up to 70% of their profits. In addition, they may have to recruit and train a replacement, which could take at least three years.

They decide to take out a Key Person Protection plan, which would provide the funds to help mitigate these problems, should anything happen to Miss Cotton.

With Key Person Protection in place (KWB own the policy on Miss Cotton)

business protection flowchart 1

Without Key Person Protection in place

business protection flowchart 3

It would be a good idea for KWB to contact their local tax inspector. This will help them to understand tax relief on the policy premiums and the tax liability on any monies received in the event of a claim.

On a typical ‘qualifying’ Key Person Protection policy, the benefit paid to KWB would be treated as a trading receipt. This means it would be subject to corporation tax at the company’s rate for that financial year. It would therefore, make sense if the sum assured was based on gross profits so any tax liability at point of claim will be accounted for.

Relevant Life Plan

A Relevant Life Plan is a term assurance plan available to employers to provide an individual death in service benefit for an employee. It is designed to pay a lump sum if the employee dies whilst employed during the length of the policy. It will also pay out if the employee, whilst employed, is diagnosed with a terminal illness and meets the provider’s definition at any time during cover.

A Relevant Life Plan is paid for by the employer and if the insured person dies, it is the family that receives the pay-out, not the business itself.

It's important to note that a Relevant Life Plan will only cover those who receive a salary from a business. A sole trader or a Partner (within a Partnership), are not eligible for this type of insurance policy. However, this does not prevent them from buying regular life insurance out of their own income in the normal way.

Where can it add value?

In many cases, ‘Death in Service’ group life schemes are subject to the rules of Registered Pension Schemes and the maximum benefit that can be paid without incurring a tax charge is equal to the Lifetime Allowance.

One of the lesser known issues that can arise is that this benefit must also take into consideration the value of all pension scheme held by the individual. Therefore, if the total value of your Death in Service benefit and your pensions exceed the Lifetime Allowance, the excess could be subject to tax at a rate of 55%*.

Furthermore, where an individual has applied for and secured Fixed (or Enhanced) Protection, where the Lifetime Allowance was fixed at a higher level than currently available, a greater issue may raise its head.

Fixed Protection is granted on the basis that an individual makes no further contributions to a pension scheme. Should they do so, they will lose this valuable benefit which cannot be replaced and there may be other, perhaps significant, consequences.

As Death in Service benefits are often subject to the rules of Registered Pension schemes, entering into a new or re-brokered Death in Service policy could be deemed as making a pension contribution. This could cause the individual to forfeit the previously secured Fixed Protection and result in their next of kin facing a sizeable tax charge instead of any legacy planned for.

A Relevant Life Plan is deemed to be an ‘Excepted’ Life Policy and therefore does not fall under the rules of a Registered Pension Scheme. However, to ensure that this is the case, a Relevant Life Plan should be written into a Discretionary Trust with the individual’s family and dependants named as the beneficiaries.

*Any chargeable amount used to provide pension income for a dependent or nominee of the deceased will be subject to a Lifetime Allowance tax charge of 25%.

Partner/Director/Limited Liability Partnership Share Protection

The loss of a business owner may destabilise the business and can quickly lead to financial difficulties. For example, when a business owner, Director or Partner dies, then their stake (or shares) in the business are likely to pass directly to their family. If this was a majority stakeholder (or shareholder), this could mean that the remaining owners lose control of some – or all – of the business, and have to work with the spouse, child or sibling of a former owner.  This may present a variety of unwanted complications (such as active involvement with an inheriting party, who may have different ideas on what the business should be doing, or even a potential ‘second-hand’ sale to a competitor).

Partner/Director/LLP Share Protection means if the worst were to happen, the remaining Partners/Directors/members could potentially stay in control of the business.

How does it work?

In the event of a business owner dying or becoming terminally or critically ill during the policy term, Partner/Director/LLP Share Protection can provide an appropriate sum of money to the remaining business owners in the event of a valid claim.  The policy proceeds could help to purchase the insured’s interest in the business, thereby helping to stabilise the business and potentially help to ensure that it is kept in the remaining owners’ hands and not someone else’s.

There are typically three parts to this insurance protection:

  • a life insurance policy: This will pay out on the death of one of the owners
  • a Trust document: The life assurance policy should be written into Trust at the outset
  • a legal agreement: This sets out when and how these shares will be bought back and at what price

However, unlike ‘key person protection’, each owner pays the premiums on his or her policy; the cost may vary between owners, depending on their age, health and other factors. Obviously, if one owner holds a greater stake in the business – say a 66% holding – they will pay a larger slice of the premiums unless a premium equalisation consideration is put in place.

As with ‘key person protection’: It is worth noting that (a) the calculation of the level of insurance cover required, (b) the duration of the policy, (c) the choice of legal agreement, and (d) any ‘premium equalisation’ considerations will all depend on a variety of factors – so there is not a ‘one size fits all’ approach.  Please speak to one of our Crowe Financial Planning Consultants for further guidance.

Example (Partners’ Share Protection)

Glowing Electrical Services (GES) is a partnership of Clive Sparks, Alan Cable, Richard Power and Dave Current. GES is currently worth £100,000 and has equal partners. GES wants to have protection in place should any of the partners die unexpectedly.

Each partner takes out a £25,000 term assurance to retirement age. The policies are written under Trust for the other partners, with all four of them as Trustees. Each has signed a Cross Option Agreement (COA). So, if Clive Sparks were to die, the life office would pay £25,000 to Alan, Richard and Dave as Trustees. They would split the money between themselves as surviving Partners and beneficiaries and each use their money to buy Clive’s share from his wife.

Clive's estate ends up with £25,000 cash for the value of his share. Alan, Richard and Dave can continue with GES as equal partners with arguably, little or no further obligation to Clive’s wife.

As an aside: The remaining Partners may then need to revisit the adequacy of the Partner’s Share Protection in place.

business protection flowchart 5

 

Example (Directors’ Share Protection)

Kingswood Wedded Bliss (KWB) is a wedding planning company. There are three shareholding directors, Mrs Bliss with 51%, Mr White with 39%, and Miss Cake with 10%. KWB is currently worth £1 million. KWB has an efficient succession plan in place should any of the directors die unexpectedly. They have signed a cross option agreement and each director has a term assurance policy to retirement age for the value of their shareholding. The policies are held under Trust for the other directors, with all three acting as Trustees.

If Mrs Bliss dies suddenly

The life office pays out the claim value of £510,000 to both Miss Cake and Mr. White as Trustees.They would split the money between themselves as surviving directors and beneficiaries and each use their money to buy Mrs Bliss’ share from her estate.

Mrs Bliss’ estate then has £510,000 cash, for the value of her shares. The surviving shareholders continue with KWB business, with no further obligations to Mrs Bliss’ heirs.

Protection premiums can differ, according to age, personal health and other circumstances. In this example, let us assume that Mr White’s premium was the highest. The directors were able to benefit from ‘premium equalisation’ which ensured the cost of protection was divided fairly. Premium equalisation reflects the business interest being protected, and establishes that the policies are purely commercial in nature. This ensures there’s no adverse IHT treatment on the arrangements.

If we assume that the premiums are paid by KWB, then it will be treated as taxable remuneration for each remaining shareholding director.

business protection flowchart 4

Business Loan Protection

The loss of the person(s) who have guaranteed a loan is particularly serious for a business. Business Loan Protection helps a business pay an outstanding overdraft, loan (including Director’s loans) or commercial mortgage, should the guarantor die or become terminally or critically ill during the policy term.

How does it work?

Business Loan Protection is life assurance (sometimes life assurance with critical illness cover) written on the life of an individual or individuals. When a valid Business Loan Protection claim is made, a sum equal to the outstanding debt could be paid to either the business or directly to the lender.

This is important as some businesses can struggle to get finance. Banks and other commercial lenders may be unwilling to advance credit to firms, or may charge prohibitively high interest rates. As a result, many people can end up investing their own money in their business, often by taking out a mortgage on their own home.

Protecting a business can be particularly important if it is run with other Directors. Individual Directors can safeguard their own investments in the business by setting up a Directors’ Loan account. This is a loan to the business that has to be declared via the company’s accounts.

There are many business owners who are unaware that these loans have to be repaid in the event of the Director’s death. If neither the Director nor the business have life insurance, it may be difficult to repay these loans. This could leave companies with a black hole in their accounts, and put a severe financial strain on the business at an already difficult time.

Moreover, if a business fails, due to the death of the owner, or a partner, and there aren’t sufficient assets to cover any outstanding debts, then a lender (such as a bank) could seek repayment from the guarantor, or their estate. This could mean a guarantor’s personal assets, including his/her home might be at risk, and could leave a business owner’s family struggling to repay any business debts.

It is worth noting that typically the cost of Business Loan Protection varies with (a) the size of the debt/loan to be insured, (b) the duration of the policy, and (c) the age of the insured.

Example

Oraganos Limited is an Italian restaurant in central London with an outstanding reputation for its menu and ambience. Managing Director, Guiseppe Verdi, plans to expand the Oraganos empire by opening a deli and bakery. The shop next door has just become vacant and presented Guiseppe with an ideal opportunity to grow the company.

To achieve this the company needs to borrow £1.5 million from the bank

The bank insists on an insurance policy of £1.5 million on Giuseppe’s life, as he is the key person, to protect the loan should he die. Oraganos Limited takes out a £1.5 million term assurance policy on Guiseppe. This policy is designed to pay out £1.5 million if Guiseppe dies during the policy term. The policy can be paid direct to Oraganos Limited or it can be assigned to the bank.

business protection flowchart 1

Because Oraganos Limited owns the life policy on a ‘life of another’ basis, there’s no need for Trust documentation to be completed. In the event of a claim, the benefit would be paid direct to Oraganos Limited or the bank, therefore it’s not treated as a benefit in kind for Guiseppe Verdi. The premiums would not attract tax relief and the proceeds received at the point of a valid claim would not be taxed.

Important notes and risk warnings

This notice cannot disclose all the risks associated with the protection issues outlined earlier. You should not effect any financial product unless you understand its nature and the extent of your exposure to risk. You should also be satisfied that it is suitable for you in the light of your circumstances and financial position. Different products have varied levels of exposure to risks and to different combinations of risks.

  • The information provided is based on our understanding of current taxation law and HMRC practice, which may be subject to change.
  • Reference has been made to information available on the Legal & General website
  • Before a company (or other entity) takes out an insurance policy, it may be important for the entity to know whether the policy payments will qualify for tax relief or if the proceeds on a claim will be tax-free (or as trading income). These principles have come to be known as the ‘Anderson rules’ and are covered within the HMRC’s Business Income Manual.
  • Whether or not tax relief is given on the premiums should typically not be a priority when putting cover in place.
  • The tax treatment – and associated implications – for setting up a policy to cover 'Key Person Protection', 'Share Protection', 'Relevant Life Policy' or 'Business Loan Protection' can be very different. Therefore, it’s important that these are always set up as separate policies.
  • Additionally, there may be a number of different (and significant) taxation issues – and other associated factors and implications – to be aware of.  For example, there may be impacts upon: Inheritance Tax (IHT), pre-owned asset tax charge (POAT), Capital Gains Tax (CGT), Business Property Relief.  Appropriate professional advice should be sought before proceeding further.
  • The level – and cost – of protection required will depend on individual circumstances and various other associated factors.  This would be particularly true for: company – and shareholder – valuations for shareholder protection; and the attributable contribution to profits of key persons.
How to contact us
Phil Smithyes
0118 959 7222
Thames Valley
Miles Clarke
0118 959 7222
Thames Valley
Adrian Crowe 
020 7842 7187
London
Richard Dean
01242 284421
Cheltenham
Stuart Elder 
0118 959 7222
Thames Valley
Aron-Gunningham
0118 959 7222
Thames Valley
Julian Hanrahan
01622 767676
Maidstone
Cammas-MacCormick 
01892 700200
Tunbridge Wells
Dharmesh-Upadhyaya 
020 7842 7325
London

Please note that this article is aimed at challenging your thoughts on protecting the financial stability of your business and does not constitute financial advice. You should not rely on this information to make or refrain from making any decisions. You should always obtain independent professional advice in respect of your own situation and we would urge you to contact your Crowe Financial Planning Consultant who will provide you with specialist advice tailored to your specific needs.

Crowe Financial Planning UK Limited is authorised and regulated by the Financial Conduct Authority (‘FCA’)

The FCA does not regulate National Savings or some forms of mortgage, tax planning, taxation and trust advice, offshore investments or school fees planning.

The Financial Ombudsman Service (‘FOS’) is an agency for arbitrating on unresolved complaints between regulated firms and their clients. Full details can be found on its website www.financial-ombudsman.org.uk.
Please also refer to our internal complaints policy which can be made available on request.

The information contained within this document is subject to the UK regulatory regime and is therefore targeted primarily at consumers based in the UK. 

 


Contact us

Phil Smithyes
Phil Smithyes
Partner, Head of Financial Planning
Thames Valley