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Take your partners

Choosing keyperson insurance to cover partnerships

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Last week, I looked at business contin-uation cover in relation to sole traders. What if the business is a partnership? Well, first there is likely to be, almost by definition, the need for cover on more than one individual.

When the keyperson is a partner, the fact that the partnership is not a separate legal entity (but see later) needs to be factored into the design of the solution. This means that, when partners are “key”, strategy is normally that each individual partner effects a policy on their own life subject to a business trust for their co-partners.

The policy proceeds would typically be paid to the trustees to use for the benefit of the beneficiaries – the surviving or continuing partners. For example, in the XYZ partnership, partner X dies or becomes critically ill so the policy proceeds are paid to Y and Z who then lend these funds to the partnership. These funds, in effect, remain the assets of the lenders but are constituted as a debt rather than an interest in the partnership. The debts would, as a result, constitute an asset in the estate of each partner to whom the money was owed.

Tax is secondary in all this but it is, nevertheless, impor-tant. How does it work? Well, when the keyperson is a partner and the policies are effected on an “own life in business trust” basis, as just described, the expenditure will be a personal capital (non-revenue) expense. This means there will be no tax relief on the premiums. The corollary is there will be no tax on the sum assured.

Provided, as it usually will be, the arrangement is a com- mercial one at arm’s length, there will be no donative intent. Ensuring the only beneficiaries under the trust are business members is thus essential. This means there will be no gift and if there is no gift, there can be no gift with reservation – always a good thing to avoid.

This (the absence of a gift) would mean that the settlor/ life assured could be a poten-tial beneficiary. Under the trust, the benefit could auto-matically revert to them if the beneficiary, say, leaves the partnership or retires. Most would see this as valuable flexibility. One would need to consider the IHT-relevant property regime but, where the underlying investment is a term policy, this should not cause a problem.

A Scots partnership and an LLP are separate legal entities and can effect policies as a contracting party in their own right. This can avoid the need for a trust with the policy being held, effectively, as a capital asset on the balance sheet.

Alternatively, the Scots partnership or the LLP could proceed on the “own life in business trust” basis outlined above. I suspect that in most cases where the person to be insured is a partner (Scots law partnership) or a member (LLP) the “own life in business trust” route would be used. This is especially so, given that whether this or the life of ano-ther route is used, the tax treat- ment of the premiums and the sum assured would be the same – no relief on the premiums and no tax on the sum assured.

Another reason for pursuing this solution may be that the partners want to put in place a composite own-life/in-trust solution for the provision of funds to meet the needs of business continuation and business succession, that is, keyperson and share purchase.

In this case, for each partner, a business trust would host a policy, the sum assured under which would be suffi-cient to meet the business continuation needs and the business succession needs.

The amount needed by the business would, typically, be loaned to the business and the sum to be used in partnership/LLP business interest purchase used directly by the partners for that purpose.

It is important to remember that if this composite solution is adopted, the sum assured needs to be sufficient to deal with all the purposes for which it is intended, that is, delivering financial comp-ensation to the business via a partner’s loan to the partnership and a sum big enough to satisfy the need to pay the requisite sum in relation to the need to purchase or provide compensation in relation to the deceased or critically ill partner’s interest in the business.

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