Protecting the Interest of the Business When Life Takes a Turn

We don’t often cover topics for the CII J03 and AF2 exams, so in this article, we thought we’d look at a topic that will usually form part of both exams and that’s business protection.

This article is relevant to examinable tax year 2016/17.

What is often tested in J03 and AF2 are the different types of option agreement used to cover the death of one of the business owners.

The main options are the:

• Buy and sell agreement 
• Double option (or cross-option) agreement 

Buy and Sell Agreement

All the owners enter into a buy and sell agreement which states that the deceased owner’s estate MUST sell their shares to the surviving owners and the surviving owners MUST buy.  This ensures that the remaining owners can keep full control of the business as well as make sure the deceased’s family are adequately compensated.  The value of the business share would have to be agreed by the owners and written into the agreement to avoid any problems at the point of sale.  If a fixed price is used, then this should be reviewed regularly.

The big advantage is that buy and sell agreements provide security because all parties know exactly what will happen on death.  The big disadvantage is that because it is a binding contract for sale, business relief for IHT is lost.

Double Option Agreement

With a double option agreement, instead of a binding contract for sale, the business owner has the option to buy the share from the deceased’s estate and the deceased’s estate also has the option to sell.  This means that business relief is not lost for IHT even though where one of the parties exercises their option, the other party is obliged to comply.

There is usually a time limit attached to the agreement; for example, the option should be exercised within 6 months.  It could be less or more than this, but too long could mean delays for the deceased’s estate.

You should note that to provide for critical illness cover, a single option agreement should be put in place, not a double option. The option is given to the business owner who is critically ill; if (s)he decides to sell his/her share in the business, the other owners must buy.  This gives the business owner protection should (s)he believe (s)he can return to the business at some point in the future

In both cases, funds will need to be provided by taking out life insurance (term insurance is usually the simplest and least expensive option), and this would normally be placed under a business trust.  (Life of another could be used, but this can be unwieldy if there are several business owners involved).   Upon death, the sum insured is paid to the trustees who would normally be the other business owners, who can then use those monies to buy from the deceased’s estate.

Grab the resources you need!

If you’re studying for your CII AF2 exam, and you want to do everything you can to secure a good result, grab our free taster to try out one of Brand Financial Training’s resources for yourself.  Click the link to download the AF2 calculation workbook taster now!

Alternatively, you can download taster resources for J03 if that is your exam of focus.

Over to You…

Are you preparing for either of the J03 or AF2 exams? If so, what topics are you finding most challenging?