This article is part of our guide to insurance for business owners, alongside keyman insurance and the employer-employee scheme. Keyman cover protects the business’s cash flow. This piece is about the other problem a death creates in a jointly owned business: who buys the deceased owner’s share, and with what money.
The Short Answer
A buy-sell agreement is a written arrangement between the co-owners of a business that decides, in advance, what happens to an owner’s stake if they die: who will buy it, how its price will be worked out, and when it will be paid. Insurance funds it. A life policy on each owner, sized to the value of their stake, pays out at the moment the money is needed, so the surviving owners can buy the share and the family receives fair value in cash.
Without one, a death in a partnership or a closely held company tends to produce the worst of both worlds. The family is left holding a stake in a business they do not run and cannot easily sell. The surviving owners are left negotiating a price under pressure, with no cash to pay it.
Keyman insurance keeps the business running. A buy-sell agreement decides who owns it afterwards.
What Goes Wrong
What happens when a partner dies without a plan
- The firm may legally dissolve. Under section 42(c) of the Indian Partnership Act, 1932, a firm is dissolved by the death of a partner, unless the partners have agreed otherwise. A deed without a continuation clause turns a death into a winding-up.
- The family wants cash, not a business. Heirs are usually not equipped to run the business, and an unlisted stake has no ready buyer.
- The survivors have no money to pay. Buying out a share worth crores from working capital is rarely possible without borrowing at the worst possible time.
- Nobody agrees on the price. Without a valuation method fixed in advance, the family and the surviving partners negotiate against each other while grieving, and disputes can run for years.
How It Works
The three parts of a funded buy-sell arrangement
1. The agreement
In a partnership or LLP, the terms belong in the partnership deed or LLP agreement: that the firm continues after a death, that the deceased partner’s share will be bought out, and on what terms. In a private company, they belong in the shareholders’ agreement and the articles of association, which commonly give surviving shareholders the right to buy a deceased shareholder’s shares first.
2. The valuation method
Fix how the stake will be valued, not a rupee figure that goes stale. Common methods are a multiple of average profits over the last few years, a formula based on net assets, or a value the owners agree and re-sign every year. The agreement should also say when payment is due and whether it can be made in instalments.
3. The insurance
A life policy on each owner, with cover roughly equal to the value of their stake. For this purpose a pure term plan is the natural fit: the need is a large sum on death, at the lowest cost. When the policy pays, the money is used to buy the deceased owner’s share at the agreed value.
Who Owns The Policies
Two ways to hold the insurance
| Business-owned (entity) route | Owner-to-owner (cross) route | |
|---|---|---|
| Who buys the policies | The firm, LLP or company, one on each owner | Each owner buys a policy on each of the others |
| Who pays the premium | The business | The owners personally |
| Who receives the claim | The business, which then pays the family for the share | The surviving owners, who buy the share directly |
| Number of policies | One per owner | Rises quickly: three owners need six policies |
| Best suited to | Most Indian partnerships and closely held companies | Two or three owners with very different ages or stakes |
Most Indian businesses use the business-owned route because it is simpler to administer. The tax consequences differ between the two, and that is where advice is essential.
The Tax Position
How a buy-sell arrangement is taxed
When the business owns a policy on an owner’s life, the policy falls within the tax law’s definition of a keyman insurance policy, which covers anyone connected with the business, not only employees. The consequences are the same as in our keyman insurance guide:
- Premium: deductible as business expenditure. For partnership firms, CBDT Circular No. 38/2016 accepts that premium paid by a firm on a keyman policy on a partner’s life is allowable, following several High Court rulings. Under the Income-tax Act, 2025 this is the general deduction in section 34 (formerly section 37).
- Claim received by the business: taxable as business income (section 26(2)(i) of the 2025 Act; formerly 28(vi)). The life insurance exemption does not apply to keyman policies.
- Payment to the family for the share: since 2021, when a firm pays a departing partner more than the balance in their capital account, the excess can be taxed as the firm’s capital gains (now section 67(10) of the 2025 Act; formerly 45(4)). If the firm hands over assets rather than money, section 8 (formerly 9B) can also apply. Whether these rules apply when the payment is to a deceased partner’s heirs is still debated.
Two practical consequences follow. First, because the claim is taxable in the firm’s hands, cover sized exactly to the stake’s value may leave a shortfall after tax, so it may need to be grossed up. Second, the timing and form of the payout to the family matter for tax, so they should be designed with a chartered accountant, not improvised after a death.
In the owner-to-owner route, the premium is a personal expense and not deductible. Whether a policy one owner takes on a co-owner’s life is also caught by the keyman definition depends on the facts. Take advice before choosing that structure for tax reasons.
The one rule that matters most: the agreement and the insurance must match. A deed that promises a buy-out with no money to fund it, or a policy with no agreement saying what its proceeds are for, each solves half the problem. Put both in place together, and review them together every year.
A Worked Example
Sizing the cover: three partners
A trading firm in Ranchi has three equal partners. They agree to value the firm at four times its average annual profit over the last three years. On that basis the firm is worth ₹3 crore, so each partner’s stake is worth ₹1 crore.
| Step | Illustrative figure |
|---|---|
| Value of each partner’s stake | ₹1 crore |
| Policies needed (business-owned route) | One on each partner: three policies |
| Starting point for cover per partner | ₹1 crore |
| Allowance for tax on the claim in the firm’s hands | Cover rounded up after a CA’s estimate of the tax |
| Review | Every year, when the valuation is re-signed |
The figures are illustrative only. Each partner should also keep separate personal term insurance for their family. The buy-sell policy pays for the share; it does not replace the household’s own cover.
Avoid These
Common buy-sell mistakes
1. A fixed price that is years out of date
A deed that values a share at a figure agreed a decade ago will be unfair to someone. Agree a formula, or re-sign the value every year.
2. Cover that never grows with the business
If the firm doubles in value and the cover stays the same, the survivors are back to borrowing to fund the gap. Review the sum assured when the valuation is updated.
3. Only planning for death
Retirement, long illness and a partner simply wanting to leave all trigger the same question of price. A good agreement covers each exit, even though only death is funded by life insurance.
4. A two-partner firm relying on a continuation clause
A partnership needs at least two partners, so a continuation clause alone cannot keep a two-partner firm going after one dies. These firms need a plan for bringing in a new partner, converting to an LLP or company, or winding up in an orderly way.
Talk It Through
Planning succession for a partnership or family company?
Tell us how the business is owned and roughly what it is worth. We will help you size the cover for each owner, explain how the policies can be held, and arrange them through a licensed insurance agency. For businesses in Ranchi, Deoghar and across India online. No cost to talk.
Key takeaways
→ A buy-sell agreement fixes, in advance, who buys a co-owner’s stake on death and how it is valued. Life insurance on each owner provides the money.
→ Under the Indian Partnership Act, a partner’s death dissolves the firm unless the deed says otherwise, so the deed needs a continuation and buy-out clause.
→ Fix a valuation method, not a stale figure, and review it and the cover every year.
→ Business-owned policies on owners are keyman policies in tax law: the premium is generally deductible, but the claim is taxable business income.
→ Payments to a departing partner above their capital balance can attract tax in the firm’s hands, so design the payout with a chartered accountant.
Questions
Frequently asked questions
What is a buy-sell agreement in a partnership?
It is a clause in the partnership deed, or a separate agreement, that says what happens to a partner’s share when they die or leave: that the firm will continue, that the share will be bought, how it will be valued, and when it will be paid.
Why is insurance needed for a buy-sell agreement?
Because the buy-out has to be paid at the moment the business is weakest. A life policy on each partner, sized to their stake, provides that cash without borrowing or selling assets.
Does a partnership firm dissolve when a partner dies?
By default, yes: section 42(c) of the Indian Partnership Act, 1932 dissolves a firm on a partner’s death, subject to any contract between the partners. A continuation clause in the deed changes that, except in a two-partner firm.
Is the premium paid by the firm on a partner’s life tax deductible?
Generally yes. CBDT Circular No. 38/2016 accepts that premium paid by a firm on a keyman policy on a partner’s life is allowable business expenditure, now under section 34 of the Income-tax Act, 2025.
Is the insurance claim taxable for the firm?
Yes. A policy taken by the firm on a partner’s life is a keyman policy, so the claim is business income and the life insurance exemption does not apply.
Can this work for a private limited company?
Yes. The terms go into the shareholders’ agreement and articles of association, typically giving surviving shareholders the right to buy a deceased shareholder’s shares at an agreed valuation, funded by insurance.
Keep Learning
Next steps: Keyman insurance · Employer-employee insurance scheme · What is term insurance
The bigger picture: The business insurance guide · The complete guide to insurance in India
About the author
Ujjwal Tiwary
ARN-144500 · NISM Series V-A certified since 2018 · Ranchi & Deoghar, Jharkhand
Ujjwal Tiwary is an AMFI-registered mutual fund distributor (ARN-144500) based in Ranchi and Deoghar, Jharkhand, and has held the NISM Series V-A certification since 2018. He works with families on mutual funds, insurance and income tax returns, and writes or personally reviews every article on FactFinances. He is not a SEBI-registered investment adviser; nothing on this site is personalised advice.
Disclaimer: FactFinances provides educational content only. This article is for general information and is not insurance, tax, financial or legal advice, and does not recommend any specific product or insurer. Disclosure: Insurance is the subject matter of solicitation. Insurance products are arranged through a licensed insurance agency; the policy is issued and underwritten by the respective insurer, and claims are settled by the insurer as per the policy terms. The agency receives commission from insurers, included in the premium. Read the sales brochure and policy wording carefully before concluding a sale. This article is not legal advice on partnership deeds, shareholders’ agreements or company law. The tax treatment described here is based on the Income-tax Act, 2025 (in force from 1 April 2026), the corresponding provisions of the Income-tax Act, 1961 and CBDT Circular No. 38/2016, as understood at the time of writing. The application of the reconstitution rules on a partner’s death is unsettled, and tax law can change; have the agreement drafted by a lawyer and the structure reviewed by a chartered accountant. ARN-144500. Regulatory information: IRDAI.