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1 Errol Gottfried Meyer CFP Professional, Admitted Advocate of the High Court, Master Tax Practitioner (SA) 1 Borrow money Shareholder A Keyman Company Buy and sell agreement Borrow money Borrow money Shareholder B Bank, Supplier, Lease agreement Extracts from the Financial Planning Handbook SARS Reference guide Buy and Sell SARS Reference guide Keyperson Explanatory memorandum - Page 19 to 27 Newsletter Deferred Compensation

2 Borrow money Shareholder A Keyman Company Buy and sell agreement Borrow money Borrow money Shareholder B Bank, Supplier, Lease agreement

3 Borrow money Shareholder A Keyman Company Buy and sell agreement Borrow money Borrow money Shareholder B Bank, Supplier, Lease agreement

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12 Refer to SARS Reference Guide 2008 Know in detail Benefits of a buy and sell arrangement funded with life insurance. It provides liquidity to fund the purchase price upon the happening of an uncertain event, namely death of disability. It is testimony to the agreement between the deceased and the surviving business partner and the content thereof is evidence of the terms after the death of a deceased business partner. A surviving business partner will not drain the capital resources of the business and will have liquidity available to purchase the business interest of the deceased business partner. A surviving business partner will not have to bond personal property, or find alternative means for raising the capital. The interest payments will have a severe negative cash flow for the surviving business partner compared to the cost of affecting life insurance

13 Borrow money Shareholder A Keyman Company Buy and sell agreement Borrow money Borrow money Shareholder B Bank, Supplier, Lease agreement What is a buy-and-sell agreement? A business buy and sell agreement contains, among the other terms and conditions of the partnership, two following essentials: (i) (ii) A definite agreement made by the partners obligating each partner to sell, at death, his or her interest to the surviving partners, and committing the surviving partners to purchase the deceased partner s interest. A method of valuing each partner s interest and an agreement on the price to be paid based upon valuation, this subject to periodic review. Why a Buy-and-Sell Agreement funded by Life Assurance In most cases, the personal assets of the various partners are tied up in the business, as profits are often left in the business to promote expansion and secure stability. Life assurance is the only safe and sure way of creating the necessary funds in terms of the agreement for the following reasons: (i) (ii) (iii) (iv) (v) It provides the ready cash the moment it is needed. It eliminates uncertainty as far as the heirs are concerned by giving them a fair value for their interest at a time when they need it most. It gives the surviving partners complete and unhampered ownership of the business immediately. It eliminates the need to borrow and pay 100cc in the rand plus interest until the debt is cleared. It prevents the business being drained of its capital resources. 13

14 1) The Law - Application of the Estate Duty Act structure of policies 2) Calculations: Share of premium Share of cover Donald, Elroy and Frank are shareholders in DEF (Pty) Ltd. All three are employed by the company A total number of 100 shares have been issued by the company and they each own the following number of those shares: Donald Elroy Frank 40 shares 35 shares 25 shares The total value of all of the company is R The value of each shareholder s shareholding is therefore: Donald R Elroy R Frank R

15 To fund the agreement they must take out three separate life insurance policies They want to enter into a buy-and-sell agreement (i) A policy on the life of Donald The sum assured under the policy should be an amount of R The applicants for this policy should be Elroy and Frank They will own the policy and will be entitled to the proceeds They will also purchase Donald s shareholding in those same proportions An annual premium of R3 500 is assumed (ii) A policy on the life of Elroy for an amount of R The owners of the policy will be Donald and Frank and they will be entitled to the proceeds The premium is assumed to be R2 500 per annum (iii) A policy on the life Frank for an amount of R The owners of the policy will be Donald and Elroy and they will be entitled to the proceeds An annual premium of R3 200 is assumed 15

16 Policy on Donald s life (premium R3 500 per annum) Elroy must pay = x = R2 042 Frank must pay = x = R1 458 R3 500 Policy on Elroy s life (premium R2 500 per annum) Donald must = x = R1 538 pay Frank must pay = x = R 962 R2 500 Policy on Frank s life (premium R3 200 per annum) Donald must pay = x = R1 707 Elroy must pay = x = R1 493 R3 200 Donald Premium in respect of policy on Elroy s life R1 538 Premium in respect of policy on Frank s life R1 707 R3 245 Elroy Premium in respect of policy on Donald s life R2 042 Premium in respect of policy on Frank s life R1 493 R3 535 Frank Premium in respect of policy on Donald s life R1 458 Premium in respect of policy on Frank s life R962 R

17 ABC (Pty) Ltd is a private company with four shareholders: George, Sue, Sello and Paul. The total owner interest in ABC (Pty) Ltd amounts to R5 million, which is divided as follows: George R % Sue R % Sello R % Paul R % TOTAL R % The following slides are based on marketing material from SANLAM 49 George will require funds to buy out a portion of the shares of Sue, Sello or Paul should any of them die or become disabled. As a result, he must take out a policy with Sue, Sello and Paul as the lives insured. In the same way Sue, Sello and Paul must take out a policy with their three fellow shareholders as the lives insured. Therefore in this example four policies are involved, each with one proposer and three lives insured. The following slides are based on marketing material from SANLAM 50 The proposers who have George s life insured on their separate policies are Sue (30%), Sello (20%) and Paul (10%). The total shareholding of this group of proposers in ABC (Pty) Ltd is 60%. Each member s shareholding in relation to the shareholding of the group can therefore be expressed in fractions of sixtieths. Therefore: The cover that Sue must take out on George s life, is 30/60 of R2 million (or R1 million). The cover that Sello must take out on George s life, is 20/60 of R2 million (or R ). The cover that Paul must take out on George s life, is 10/60 of R2 million (or R ). The following slides are based on marketing material from SANLAM

18 In the past such an event created a lot of confusion. There were usually several proposers or owners of a policy on the life of one insured. By means of a cession, each party had to forfeit part of his or her ownership of the policy to the newcomer, so that the newcomer could get coownership of it. At the same time, the existing interest-holding parties had to take out a new policy on the new partner s life. What has to happen now is that each of the existing interest-holding parties adds the new partner as life insured on his or her own separate policy. At the same time, the new business partner must take out a policy on the lives of the existing interest-holding parties. Once again, if the total cover on the life of any interest-holding party is not increased because of the restructuring, some companies will do this without proof of good health. However, should the restructuring result in increased cover on any interest-holding party, proof of good health is required for the difference in cover. The following slides are based on marketing material from SANLAM 52 When the owner of a policy leaves the business, the person is bought out by his or her business partners and he or she can have the policy on their lives fall away. A life insured has the option of transferring, without proof of good health, the cover on his or her life to another policy of which he or she is the owner. In cases where the policy owner leaves the business, those business partners (the lives insured) can then therefore decide whether they wish to have the cover in terms of the policy transferred to policies of which they are the individual owners. The following slides are based on marketing material from SANLAM 53 The interest-holding party will be removed as life insured from the policies of his or her business partners. In such cases, some life companies gives this party the option of transferring the cover on his or her life to a policy of which he or she is the owner without proof of good health

19 Compare the traditional method of life of another basis and the multiple lives assured method in respect of: Income Tax Estate Duty CGT: When a new partner joins When an existing partner leaves/dies The following slides are based on marketing material from SANLAM 55 Refer SARS Reference Guide 2008 Know in detail 56 Study the following facts: ABC Company is worth R A (natural person) and B Trust are the shareholders. B is the trustee of B Trust. A has 60% shares and B Trust has 40%. A signed surety for the liabilities of the company R A has a loan account of R owing in the business. A is the keyperson of the business and his replacement value is calculated to be R after tax. Identify the risk areas and propose solutions. You are required to do a complete Estate Duty calculation for A. Assume that the cost of life cover amounts to R10 per R life cover. (20 marks)

20 Keyperson: Tax deductible route increase R to /.80, therefore premium will also be higher. Discuss 11 (w) (ii) objective and subjective criteria. Value of company increases with R (that is after tax of 28%). Included in par (m) no exemption because premiums qualified ito section 11 (ii). Contingent liability capital - cannot deduct tax. Cost R for R life cover. Discuss 11w(ii), par (m) and exemption so that tax free. Buy and Sell See SARS reference guide. Estate duty exemption for A, but not trust B.- Reasons in reference guide. Note that family company. Premiums = 6% applicable (no value given thus not necessary to calculate premium deduction. Estate duty calculation. Property Shares Note that must insure for higher amount to cater for additional ED. The net value of shares are after ED Life cover keyperson Divide.576 Life cover Additional ED divide.80 Buy and sell for A ( x 60%) = Total amount excluded ito exemption Section 4 (p) deduction To the extent that it increased the value of the shares Calculate CGT CGT is deduction (disposal of shares) ED apportionment / net estate X actual estate duty payable. Will be claim for Estate Duty against the company