The use of insurance for business succession planning [CPD Quiz]

01 May 2019

Crissy Demanuele

Crissy Demanuele is a member of the BT Product Technical, Life Insurance Team. She has a strong background in insurance, taxation, superannuation (including SMSFs), social security, estate planning and aged care.

This article explains what is meant by a buy/sell agreement and how it works, as well as how insurance can help businesses meet the requirements set out in a buy/sell agreement.

If your client owns a business with other people, it’s important for them to agree on how ownership of the business will be transferred, should one of the owners (or principals) pass away, become disabled, or leave the business for another reason, such as resignation or retirement. This is known as business succession planning.

Business succession planning is a formal process that enables the business principal(s) to develop preferred exit options, whilst they are still in a position of control. As part of that process, the business principals should establish a legal agreement, such as a buy/sell agreement to provide more certainty in this situation.

Insurance can provide the surviving business principals with the funding to purchase the departing principal’s value of the business.

This article explains what is meant by a buy/sell agreement and how it works, as well as how insurance can help businesses meet the requirements set out in a buy/sell agreement.

What is a buy/sell agreement?

A buy/sell agreement is a legal agreement between business principals that stipulates what must happen to a departing principal’s interest in the business or partnership, should a particular trigger event occur.

A buy/sell agreement can be structured to give the remaining principals the legal right to buy their interest in the business, for a specified amount. The agreement may also give the departing principal (or their beneficiaries) the right to sell their interest in the business to the other principals (or another interested party), should one of these events happen to them. The purchase can be funded by life insurance policies, taken out on the lives of each principal.

A solicitor will generally need to draft the buy/sell agreement. When drafting the buy/sell agreement, it’s important for the business principals to agree on what outcomes they would like to achieve. The buy/sell agreement should also take into account each of the business principals’ wills, and the solicitor may suggest amending their wills to align with the buy/sell agreement.

Example 1

John, Brad and Michael are all equal partners of a transport business called ‘Transport to You’, which is currently valued at $6.2 million. They have decided that if any of them leave the business, they expect to receive an amount equal to their proportion of the partnership. If they pass away, they want their spouses to receive the same amount.

 They have also all agreed they do not wish for any of their spouses to become a partner in the partnership if they were to pass away, and the remaining partners will absorb the departing partner’s equity.

 They meet with a solicitor who suggests that they each sign a buy/sell agreement. The buy/sell agreement legally enforces that, if due to certain trigger events, one of the partners leaves the partnership, the value of their proportion of the partnership will be paid to them (or their spouse) upon their departure.

 The trigger events include:

  • Death;
  • Total and permanent disability (TPD);
  • Critical illness (also known as trauma or Living Insurance), where they are inactive from the business for at least six months; and

Types of buy/sell agreements

There are generally two types of buy/sell agreements used. These are:

  • mandatory agreements; and
  • put and call options.

Mandatory agreements are also known as ‘must buy/must sell’ agreements. With these types of agreements, the relevant parties must agree to buy and sell the business interest if certain trigger events occur.

With put and call options, if a trigger event occurs, the departing principal (or their beneficiaries or estate upon death) can exercise the put option (their right to sell), so the remaining principals can purchase the interest in the business. Alternatively, the remaining principals can exercise the call option (their right to purchase), so the departing principal (or their beneficiaries or estate upon death) must sell their interest in the business.

Put and call options can provide more flexibility because if both parties decide not to exercise their put or call options, the sale of the interest in the business does not have to occur. However, if either party exercises their option, the transfer of ownership must occur.

How can insurance assist with business succession?

Not all trigger events, such as resignation, can be insured for. However, insurance may be taken out on each of the principals for insurable events, such as death, TPD or critical illness.

The insurance benefit can provide the funding, so that the remaining principals can purchase the departing principal’s value of the business (either indirectly or directly) if one of these events occur.

If the business principals decide not to take out insurance or where there is a gap between the insured amount and the value of the departing principal’s share of the business, the remaining principals may have to:

  • Sell business assets;
  • Sell their own personal assets;
  • Gradually buy out the share in the business or interest in the partnership; and/or
  • Borrow money or obtain vendor finance to provide them with the necessary funding.

If a new principal enters the business, they may be able to provide the capital needed to purchase the departing principal’s interest in the business. However, this could take some time and the departing principal or their estate/dependants may require the proceeds during this time.

Valuing the business

Valuing the business is an essential part of business succession planning. A proper valuation can reduce the likelihood of potentially awkward or unfair negotiations on price, or even disputes with a departing principal or their beneficiaries. A proper valuation can also give the parties to the agreement, and their beneficiaries, much greater clarity about what their interest in the business is worth and how much they would need to pay to purchase an outgoing principal’s share.

This can provide guidance as to how much each of the principals should be insured for.

It is generally a good idea for the valuation to be updated each year, or when the circumstances of the business change. A regularly updated valuation may reduce the risk of disagreements and help enable a smooth transfer.

Without this adjustment, there may be a gap between the value of the business to be transferred and the amount of insurance cover to pay for it.

Who should own the insurance if the purpose is for business succession planning?

Where insurance is taken out for the purpose of funding a departing principal’s business value, the insurance can be:

  • Self-owned by each business principal;
  • Cross-owned by the business principals on each of the other principal’s lives;
  • Owned within a trust (trust ownership);
  • Owned by the company; or
  • Held within superannuation.

When advising clients on the policy ownership, consider:

  • The legal requirements and wording of the buy/sell agreement structured;
  • The ability to transfer the insurance, if needed in the future;
  • The structure of the business and potential ownership changes in the future;
  • Who will pay the premiums and how to ensure that the policies don’t lapse; and
  • The taxation treatment of the insurance benefits.

Each type of ownership structure is explained in further detail as follows:

  • Self-ownership

Self-ownership involves each principal holding an insurance policy over their own life. The premium expense can either be shared, or each principal can pay their own premium. If a principal dies, the insurance benefit can be paid directly to their beneficiaries or estate. If they become disabled or suffer critical illness, they can receive the proceeds. The buy/sell agreement can be structured so as to reduce or eliminate the amount that the surviving principal/s must pay to acquire the departing principal’s share, by the insurance proceeds paid from the departing principal’s policy. This helps the surviving principal/s, as the insurance proceeds will represent some or all of the purchase value.

  •   Cross-ownership

 Cross-ownership involves the business principals holding an insurance policy over each of the other principals’ lives. The buy/sell agreement can be structured so that the insurance proceeds are used to help fund the transfer of business ownership.

  •  Trust ownership

The insurance policy may also be owned by a discretionary trust. Where this is the case, the trustee will distribute any insurance proceeds in accordance with the trust deed. Trust ownership may be useful when policies for other purposes are owned in the same trust, or where proceeds from a single policy are to be used for multiple purposes. Trust ownership is complex and therefore professional taxation and legal advice is essential.

  • Company ownership

When the insurance policy is owned by a company, the proceeds from a death, TPD or critical illness insurance claim may be used by the company to buy back the departing principal’s

share(s). The result is that the remaining principals will hold a greater percentage of equity in the business without actually purchasing additional shares. This may create a greater tax liability upon the eventual sale of their existing shares.

  • Super ownership

It can be tax-effective to fund a life insurance policy inside superannuation. The super fund can claim tax deductions for the cost of providing Term Life and TPD cover. Contributions made into the fund to cover the premium costs will also generally be tax-deductible, however, contributions tax will apply to those contributions. Division 293 tax may also apply to those contributions, depending on the partner’s income.

Holding insurance within super for a buy/sell purpose can also create complexity, due to contribution caps, and restrictions on the types of insurance and features that can be held within super. For example, trauma insurance cannot be taken out within super.

There may also be tax consequences at the time of claim, especially where death benefits are paid to non-tax dependants. Nominated beneficiaries are restricted to dependants as defined under the Superannuation Industry (Supervision) (SIS) Act; and, if a death benefit is paid, this might be paid to someone other than the intended beneficiary.

More importantly, the Australian Taxation Office (ATO) has previously expressed the view in ATO ID 2015/10 that holding insurance within a self-managed super fund (SMSF) for a buy/sell purpose is likely to result in a breach of the sole purpose test. Therefore, clients considering holding insurance within an SMSF for this purpose should seek legal advice or obtain a private ruling before setting up the insurance.

Matching the insurance ownership to the buy/sell agreement

If the ownership structure doesn’t match up with the buy/sell agreement, or if insurance is taken out and a buy/sell agreement is not entered into, problems can arise. In some instances, a departing principal (or their dependants) may end up with the insurance proceeds, as well as the departing principal’s share of the business. Conversely, if the agreement and insurance are not set up correctly, the departing principal (or their dependants) could wind up receiving nothing when they depart the business.

Example 2

Marie and Janice are both married and co-principals of an accountancy business. The business is currently valued at $2.5 million. They have set up a buy/sell agreement in which they have agreed that if either of them passes away, becomes totally and permanently disabled or suffers critical illness, they will exit the business and the departing principal (or their spouse) will receive a lump sum payment of $1.25 million (plus indexation), to be funded by insurance.

 The agreement also states that the remaining principal can exercise their put option to purchase the departing principal’s share of the business for no cost.

 Marie and Janice cross-own Term Life, TPD and critical illness cover on each other’s life.      

 In January 2019, Janice passed away. As per the buy/sell agreement, Marie exercised her put option and forced Janice’s husband to relinquish Janice’s share of the business for no consideration. However, the intention was that Janice’s husband should receive the death benefit from the Term Life insurance policy. However, because Marie owned the policy on Janice’s life, she also received the insurance proceeds.

 Marie now owns the entire business and also received the insurance proceeds.

What is that tax treatment of holding insurance for buy/sell purposes?

 Where insurance is held for a buy/sell purpose, the premiums will not be tax-deductible except if the insurance is held within superannuation. Furthermore, if an insurance benefit is received, it will not be included in the assessable income of the recipient. However, there may be capital gains tax (CGT) payable on the benefit or superannuation lump sum tax (if held inside superannuation).

Table 1 summarises the CGT treatment of insurance benefits when they are owned outside superannuation, and have been held for the purposes of meeting a buy/sell agreement.

Table 1

Type of insurance Is CGT payable on the benefit?
Term Life No, unless paid to an entity other than the original principal, and the policy was transferred for some consideration.


Trauma or TPD No, if paid to the life insured, a relative^, or trust; and the proceeds are paid to a beneficiary of the trust that is the insured person, or a relative^ of the person.


Yes, if paid to anyone other than the life insured, a relative^, or trust, where the proceeds are paid to a beneficiary of the trust that is not the insured person nor a relative^ of the person.


^ A ‘relative’ is defined in section 995-1 of the Income Tax Assessment Act 1997 as:

  • the person’s spouse (includes de facto and same sex);
  • the parent, grandparent, brother, sister, uncle, aunt, nephew, niece, lineal descendent or adopted child of that person, or of that person’s spouse; or
  • the spouse of a person referred to in paragraph (b).

Strategies to transfer business ownership can be complex and the needs of each business and its owners will be different. Buy/sell arrangements can be structured in many different ways. It is important that clients seek advice from a solicitor, accountant and financial planner to ensure the rights and obligations contained in the buy/sell agreement reflects the wishes of all parties.

Crissy De Manuele, Senior Manager – Product Technical, Life Insurance, BT.



Take the quiz here

  1. Which of the following statements about put and call options is correct?
    1. With put and call options, a departing principal (or their estate) must in all cases sell their interest in the business if a trigger event occurs.
    2. Put and call options provide flexibility because if both parties choose to not go ahead with the conditions in the agreement, they don’t have to.
    3. A call option means the departing principal (or their estate) can sell their share of the business to the remaining principals.
    4. Under a put option, the remaining principals of the business (or other interested parties) can purchase the departing principal’s interest in the business. 
  1. Where insurance is taken out to cover business owners for the purpose of meeting a buy/sell agreement:
    1. It must be owned by the company.
    2. It must be owned by each owner or partner (of a partnership) on their own life.
    3. It can be self-owned, cross-owned, owned by a company or owned within a trust.
    4. It must be owned within a trust. 
  1. It is generally a good idea to revalue a business or a partnership:
    1. Every year or when circumstances change.
    2. Only when a new owner or partner joins the business.
    3. Only when one of the owners or partners leaves the business.
    4. Only when the business or partnership is set up initially. 
  1. Holding insurance within superannuation for business succession planning purposes:
    1. Allows the business owners to be insured for Term Life, TPD and trauma cover.
    2. Is the most tax-effective way to hold insurance and receive insurance payouts.
    3. Reduces complexity.
    4. May increase complexity, due to limits on contributions, the types of cover which are allowed to be held in super, and restrictions on beneficiaries. 
  1. If a TPD or trauma policy is self-owned and it is held for business succession purposes:
    1. The premiums will not be tax-deductible, the insurance benefit (if paid) will not have to be included in assessable income, and CGT will not be payable on the benefit.
    2. The premiums will be tax-deductible.
    3. There will be CGT payable on the benefit, if it is paid.
    4. The benefit paid must be included in the recipient’s assessable income in the year they receive the payment.