Co-Directors Insurance

Structure of a Company

A Company is a legally separate entity from the shareholders that own it. The shareholders appoint Directors to the management board of the Company. Where a shareholder is actively involved in the Company they generally appoint themselves as a Director and in that role make all the important decisions.  The death of a Director who has a significant shareholding in the Company can have serious repercussions for all parties.

Implications of death

The surviving directors now have a new business partner, the deceased’s personal representatives, who may not be familiar with the business.  They may also face loss of control if the deceased director owned more than 50% of the company.  Their ideal solution would be to buy out the shareholding.

The personal representatives of the deceased Director may find themselves with a shareholding for which they have no ready market in a company in which they want no involvement.  The company’s Articles of Association may give the other shareholders the right to block the sale of the shares to an outside party.  They may also be experiencing cash flow difficulties with the loss of the deceased’s salary and potentially a Capital Acquisitions Tax liability.

Co-Directors Insurance is a means of solving these problems for both the surviving directors and the deceased’s personal representatives.  Co-Directors Insurance provides the necessary capital for the surviving directors to buy back the shares of a deceased Director.

Setting up Co-Directors Insurance

Co-Directors Insurance is usually set up using what is known as an “Own Life in Trust” arrangement. It may also be set up by an arrangement known as “ Life of Another” in certain circumstances. Each of these approaches is discussed below.

Own Life in Trust Arrangement

The steps in setting up an ‘Own Life in Trust Arrangement’ are as follows.

  • Each Director effects a life assurance policy on his own life, for a sum assured equivalent to the estimated full market value of his or her shareholding.
  • The Directors pay the premiums. If the company pay the premiums on behalf of the Directors, they are deemed to have received a benefit in kind equal to the amount of the premium paid.  Premiums are not tax deductible in the hands of the Directors.
  • Each policy is arranged under Trust, so that on death the proceeds are payable directly to the trustees for the benefit of the surviving Directors.
  • A legal agreement is put in place between the Directors. This can be either a Buy/Sell Agreement or a Double Option Agreement.
  • A Buy/Sell Agreement obligates the surviving Directors to buy the deceased’s shareholding at a fair open market value and obligates their personal representatives to sell the shareholding back to the surviving partners.
  • A Double Option Agreement is a flexible form of the Buy/Sell Agreement. Each party to the Agreement has an option to trigger the Agreement. It gives the surviving Directors an option to buy out the personal representatives of the deceased Director and it also gives the personal representatives the option to sell their shareholding to the surviving Directors. If both parties mutually agree not to exercise their options this allows the personal representatives to retain their shareholding and come into the business.

Taxation Issues for ‘Own Life in Trust’ Arrangement

Capital Acquisitions Tax on Insurance Policy Proceeds

To ensure that there is no Capital Acquisitions Tax liability in the hands of the surviving Directors certain Revenue Guidelines must be met.  These include the need to show that the policies are clearly effected as part of a commercial arms length arrangement and are part of a reciprocal arrangement between the Directors.  Any surplus not used by the surviving Directors to purchase the deceased partner’s share will be liable to Capital Acquisitions tax.

Capital Gains Tax on Shareholding

There is no Capital Gains Tax liability on the shareholding of the deceased director. The shares are deemed to be acquired by the next of kin at their market value on the date of death.   If the next of kin sell their shares shortly afterwards to the surviving directors, any increase in the value of the shares from the date of acquisition to the date of disposal may be liable to Capital Gains tax.

Capital Acquisitions Tax on Shareholding

 

If the spouse inherits the shares then there is no liability to Capital Acquisitions Tax so this is not relevant.  If someone other than the spouse inherits the normal rules relating to Capital Acquisitions Tax will apply.

If there is a Capital Acquisitions Tax liability, the disposal of shares by the personal representative after inheriting them from the deceased Director would result in the loss of any Capital Acquisitions Tax Business Relief. This may be financially significant and professional advice should be obtained if this scenario is a possibility.

Life of Another Arrangement

  • Under ‘Life of Another’ each Director takes out a policy on the other Director’s lives. This is generally only feasible where there are a small number of Directors and this arrangement is unlikely to change.
  • On the death of one of the Directors each of the others receive the proceeds of their policy which can be used to buy out the deceased’s personal representatives.
  • A legal agreement is put in place to ensure the proceeds are used for the purpose of buying out the deceased’s personal representatives. This can be either a ‘Buy/Sell Agreement’ or a ‘Double Option Agreement’ as set out above.
  • As each Director receives the proceeds of the policy for which they paid the premiums themselves there is no possibility of any liability to Capital Gains Tax or Capital Acquisitions Tax.

Serious Illness and Permanent Total Disability Cover

Before including Serious Illness or Permanent Total Disability Cover in a Co-Directors Insurance arrangement the following issues need to be considered.

  • For serious illness the precise definition of ill health would need to be agreed. A Director who may fully recover from serious heart surgery may not want his shares to be compulsorily purchased by the other Directors.
  • Where a Director is diagnosed as having a critical illness, the Director could face Capital Gains Tax on the disposal of his or her shares, but retirement relief may apply.
  • Where an Own Life in Trust arrangement is used the proceeds paid under a policy due to permanent total disability or a serious illness are also exempt from Capital Acquisitions Tax provided certain Revenue Guidelines are met. These include the need to show that the policies are clearly effected as part of a commercial arms length arrangement and are part of a reciprocal arrangement between the Directors. Any surplus not used by the other Directors for the purchase of shares will be liable to Capital Acquisitions Tax.

Conclusion

Co-Director Insurance gives the directors in a company peace of mind, that there will be funds available to them on death to buy back the shareholding of the deceased from his or her next of kin, thereby maintaining their control of the company.