Buy-Sell Agreements – What are they and what are the benefits?

Current as of October 2016

 

A buy-sell agreement is a legally binding document between the key persons in a business (i.e. the business partners).

It acts as a succession planning tool to protect the business interest for each of the key persons in the business, and provides legal certainty for the families or estates of each of the key persons.

It allows executors access to the business interest in a timely manner, as well as insurance proceeds without causing delay and disruption to the existing owners and the business.

The agreement is usually connected with the relevant life insurance policy of a key person.

The ‘triggering event’ is the most important aspect of the agreement, as it represents the timing in which the insurance policy gets claimed. Examples of ‘triggering events’ include bankruptcy, divorce and retirement or death of a key person.

The agreement can be written for all forms of business structures including trusts, companies and partnerships.

Types of agreement:

  1. Cross-purchase agreement – this involves the existing/remaining business owner(s) buying out the key person’s business interest. The agreement will legally require the estate/executor of the deceased to sell, and the existing owner(s) to buy the interest.
  2. Share buy-back agreement – this involves the company legally requiring to buy back the shares in the company from the key person or their estate/executor using the insurance proceeds. The buy-back will probably have a component of franked dividend included in the total.

Owner of the insurance policy – it can be in the name of the following entities:

  1. The key person holding the policy;
  2. The business partners holding each other’s policy (cross-purchase option);
  3. The Trustee of the Discretionary Trust being the equity holder of the business interest;
  4. The company holding the policy (Share buy-back option).

Tax on insurance proceeds

The tax implication associated with cashing in the insurance policy will depend on issues such as the entity holding the policy and whether the policy covers trauma and total permanent disability (‘TPD’).

The Capital Gains Tax (‘CGT’) provisions usually apply here as the income tax rules are excluded due to the fact that no deduction is claimed or allowed to be claimed on the insurance premium.

Below is a summary of the key tax issues:

Owner of the Policy and Type Tax Implications
Individual (Life, Trauma & TPD) Tax Free
Policy held by cross owner (Life only) Tax-free if paid to existing owners
May be taxable if paid to new owner or partner
Policy held by cross owner (Trauma & TPD) Taxable (50% CGT discount may be available)
Company (Life only) Tax-free to the company but will become taxable in shareholders’ hands as an unfranked dividend on liquidation
Company (Trauma & TPD) Taxable
Trust May be tax-free (with careful planning and proper agreement in place)
Trust (Trauma & TPD) Taxable (50% CGT discount may be available)

As always, if you have questions relating to Buy-Sell Agreements or would like us to refer you to a solicitor to assist you with putting together the agreement, please do not hesitate to contact us.

 

DISCLAIMER
This newsletter has been produced by Stanley & Williamson as a service to its clients and associates. The information contained in the newsletter is of general comment only and is not intended to be advice on any particular matter. Before acting on any areas contained in this newsletter, it is imperative you seek specific advice relating to your particular circumstances. Liability limited by a scheme approved under Professional Standards legislation.