A Tale Between Key-man & Business Buy Sell Arrangement
Key-man insurance is an insurance policy paid by the company (Company = Sdn Bhd ), to cover the company in the event of losing its key-man/men. The company is the proposer and beneficiary of the insurance plan. The company has insurable interest over the key-man because if it loses the key-man, the business will be significantly affected. The key-man can be any persons employed in the business and one who gives a significant contribution to the business. The key-man can be the managing director, the general manager or any staff with specialised skills, knowledge or business network.
The Business Buy-Sell Agreement is an arrangement between the shareholders of the company, whereby if a specified event is triggered such as death of a partner, the shares of the company which belongs to the demised partner will be transferred to the other surviving partners and a sum of money predetermined in the Business Buy-Sell Agreement will be paid to the family/beneficiaries as consideration for the shares. The sum of money mentioned is usually financed through an insurance paid out. The insurance was bought by the partners on each other’s lives. The specified events are usually those covered in the life insurance policy ie. death, disability or diagnosis of critical illnesses.
The toughest part of Business Buy-Sell Agreement is looking for a basis to value the company’s shares. Since these shares are not quoted in the Stocks Exchange, there is no ready market for the shares. Ultimately the most important factor is , the price must be acceptable by all the shareholders concerned.
Eight years ago, when I first did my research on the subject of Business Buy Sell Agreement, I was being informed that it is a good idea to use the company’s funds to purchase the insurance because it can be claimed as an expense for tax purposes. This will reduce the tax payable of the company. However, this is not such a great idea after all. Why ?
Reason 1
Section 67 of the Companies Act 1967 concerns dealing by a company in its own shares. Section 67(1) states that a company cannot give money to anyone to purchase the company’s own shares This means that, if the company that is the one paying for the premium, the insurance pay out should belong to the company. Effectively it is a key-man policy. The act of taking out money from the company for the purpose of buying the shares is an offence.
Reason 2
The only amount allowable for tax purposes is the insurance expense portion within the premium. The portion with savings/investment element will be added back and taxed as part of the profit of the company. How do we then to determine the portion within the life insurance premium that qualifies for tax deduction? It is indeed very difficult. Thus, a term policy may be considered as the most suitable type of plan for the purpose of key-man insurance, as its premium may be fully deductible for tax purposes.
Please refer to the IRD Public Ruling relating to the deductibility of Keyman insurance premium and the taxability of the proceeds from the Keyman insurance policy. http://www.hasil.org.my/english/pdf/ruling(2)2003.pdf
Under the Business Buy-Sell Agreement, the premiums are paid by the shareholders. Usually in the following methods :
1) declare dividend to the shareholders. The dividend will first be considered as the income of the shareholder (prior to Budget 2008) and the cash will be used to pay for the premium;
2) pay directors’ fees to the shareholders (if they are also the directors). The director fee will also be considered as income of the shareholder/director and is subjected to personal tax. (will be stated in the EA form) and the cash will be used to pay for the premium
The types of policies which are usually used for Business Buy-Sell Agreement are term and wholelife/Investment linked policies. If term policies are being used, there will not be any ‘cash value’ in the policies at the end of the pre-determined term cover period. If wholelife/investment linked policies are being used, then the shareholders can expect some cash/investment value when they surrender the policies in the future.
I hope I have manage to clear some confusion over the 2 different arrangements and their legal and tax pitfalls.
For reference only : Companies Act 1965
Section 67. Dealing by a company in its own shares, etc.
Section 67(1) Except as is otherwise expressly provided by this Act no company shall give, whether directly or indirectly and whether by means of a loan, guarantee or the provision of security or otherwise, any financial assistance for the purpose of or in connection with a purchase or subscription made or to be made by any person of or for any shares in the company or, where the company is a subsidiary, in its holding company or in any way purchase, deal in or lend money on its own shares.
Section 67(3) If there is any contravention of this section, the company is, notwithstanding section 369, not guilty of an offence but each officer who is in default shall be guilty of an offence against this Act.
Penalty: Imprisonment for five years or one hundred thousand ringgit or both.
The Malaysian Companies Act 1965 can be found in its entirety in the Ministry of Domestic Trade and Consumers Affairs.
http://www.kpdnhep.gov.my/index.cgi?action=pub&pub=akta_syarikat_1965