Business protection - Partnership and membership protection – tax implications

Published  07 March 2024
   5 min read

Do you know what the tax implications are for partnership and membership protection? In this article we discuss the tax relief, tax liability and the uses of a discretionary trust.

Key facts

  • Premiums will be paid directly by each partner out of their taxed income.
  • If the partnership or membership pays the premiums on behalf of the partners they will be shown as drawings from the partners’ or members’ capital accounts.
  • A discretionary business trust can be used. 

Is there any tax relief available on premiums?

The premiums will be paid directly by each partner out of their taxed income. If the partnership or membership pays the premiums on behalf of the partners they will be shown as drawings from the partners’ or members’ capital accounts.


Is there an income tax liability on plan proceeds?

Any gain would be liable to higher rate income tax under normal chargeable event rules.

However, this will probably be of little consequence as the taxable gain is based on the surrender value immediately before death less premiums paid, as opposed to the sum actually paid out on death. In most circumstances the surrender value will be less than the premiums paid. Critical illness is not a chargeable event (section 484 (1) ITTOIA 2005).


What are the implications of using a discretionary business trust?

The trust is subject to the ‘relevant property’ regime applying to discretionary trusts. This regime can result in immediate inheritance tax payable on lifetime transfers into trust plus ‘periodic’ charges at every 10th anniversary and ‘exit’ charges on capital distributed between 10-year anniversaries.

However, in a business context the payment of premiums won’t be treated as gifts or lifetime transfers where they’re made as part of a commercial arrangement. Typically, the 10th anniversary charges won’t apply for life cover given that following a death claim, the funds will normally be paid out of the trust immediately to the other partners or members.

As a result, funds are rarely sitting in trust at a 10th anniversary. In the unlikely event that they are, then the excess (or indeed the surrender value of the life cover should the individual be in very poor health at that time) over the available nil rate band will be subject to inheritance tax at 6% on current rates.

A more common scenario would be a case where a partner with critical illness cover chooses not to sell their business interest and the critical illness proceeds stay in trust beyond the 10th anniversary. If so, periodic and exit charges might well arise unless the trustees decided to release the funds from the trust and for the other partners or members to then hold this money personally.


Is tax payable by the partner’s or member’s estate or family on the sale of the business?

The sale price will usually be made up of two elements. The first will relate to repayment of the partner’s or member’s capital account and the remaining balance will normally relate to goodwill. No tax would be payable on the capital account element as this simply represents the partner’s or member’s share of capital and profits which have already been taxed. However, goodwill is a chargeable asset for capital gains tax (CGT) purposes.

No CGT would normally arise on the death of the partner or member as the interest in the business is usually sold shortly afterwards by the estate and there’s a tax-free uplift in the value of the goodwill at the date of death.

However, if the sale takes place in the event of critical or terminal illness, there could be a CGT liability on a disposal of the interest in the business, subject to any entrepreneurs’ relief which may apply and deduction of any available annual exemption.


Is there any problem in using existing plans?

Partners or members may consider assigning an existing plan into a business trust, but this can have serious tax consequences. HM Revenue & Customs can take the view that at the time of death the original owner didn’t hold the plan and that the current owners (the trustees) have acquired it for consideration.

Though the trustees clearly didn’t pay for the plan, as each partner assigned a plan in return for the others doing the same, the assignment could be claimed to be an arrangement funded on the mutual giving of monies worth. If this view is correct, the plan falls within section 210 of the Taxation of Chargeable Gains Act 1992 and the proceeds would be subject to CGT. Although opinions vary on whether this interpretation of the legislation is right, it’s better to err on the side of caution and avoid assigning existing plans. 



Can the plan be assigned back to the person covered if he leaves the partnership or LLP? As the person covered is a potential beneficiary of the trust, the trustees can assign the plan back to them without any tax implications if they decide to leave the partnership or LLP and if they want the plan to continue as personal cover. We can provide specimen documentation to assign the plan out of trust back to the person covered.

The trust provides that if the partner leaves the business, the trustees must hold the trust benefits for the partner or member, even if the plan isn’t assigned out of trust.


The information provided is based on our current understanding of the relevant legislation and regulations and may be subject to alteration as a result of changes in legislation or practice. Also it may not reflect the options available under a specific product which may not be as wide as legislations and regulations allow.

All references to taxation are based on our understanding of current taxation law and practice and may be affected by future changes in legislation and the individual circumstances of the investor.