The tax treatment of key man insurance is not absolute and straight forward for every company. First off it’s always a good idea to check with your local tax office for the latest information. It’s also a good idea to check with your accountant as there are lots of reasons why companies and their key man insurance policies will be treated different by the tax man.
Key man insurance is taken out by a company on an individual within the company. The company therefore owns the policy and will be the beneficiary of and claim. The premiums are paid from the company and are tax deductible as long as the reasons for cover fit certain criteria which in most circumstances it will.
The main principles of key person taxation were set by the then Chancellor of the Exchequer in 1944. In answer to a parliamentary question Sir John Anderson made the following statement:
“Treatment for taxation purposes would depend upon the facts of the particular case and it rests with the assessing authorities and the Commissioners on appeal, if necessary, to determine the liability by reference to these facts. I am, however, advised that the general practice in dealing with insurances on the lives of employees is to treat the premiums as admissible deductions, and any sums received under a policy as trading receipts, if (i) the sole relationship is that of employer and employee; (ii) the insurance is intended to meet loss of profit resulting from the loss of services of the employee; and (iii) it is an annual or short term insurance. Cases of premiums paid by companies to insure the lives of Directors are dealt with on similar lines.”
So provided that the company is taking out a policy on its employee, the insurance is for loss of profits resulting from the loss of that key employee and the insurance policy is annual or short term, then the company may be allowed tax relief on the premium. In the past most key person polices have been taken out over a 5 year period in order to fit this criteria, but is believed that this is no longer the case and 10 and 15 year policies are also now allowable.
HMRC also stated the below:
“An employer may take out in his own favour a policy insuring against loss of profits resulting from the death, critical illness, sickness, accident or injury of an employee, director or other ‘key person’.”
Premiums on a key person policy will be allowable if all the following conditions are met:
- The only reason of the key person insurance is the purpose of replacing a loss of income resulting from a loss of works from the key person. But not including a capital loss to the company.
- Insurance must be term insurance providing cover for their person or person’s only during the term of the policy and only while the person is working for the employer.
Therefore a whole of life insurance would probably not qualify as tax deductible as the policy will likely out last the person’s usefulness to the company. It’s possible that whole of life insurance maybe suitable to shareholder protection policy as the person will possibly hold on to the shares even after they have left the company. It’s unlikely though from the guidelines that this will qualify for tax relief.
From the guidelines it seems fair to suggest that if tax relief has been allowed on premiums then the proceeds could be taxed. But it’s also fair to suggest that tax treatment of proceeds of benefit will be treated differently depending on the judgement of the local tax inspector. It’s a suggestion that a certain amount of benefit be accounted for to cover any tax liability from a pay-out so as not to fall short of company requirements.
Can you take out Key Person protection on a majority holding director?
It’s possible to take out this insurance but as the director is the majority shareholder it may be seen that he or she will benefit most from any pay-out (especially if critical illness is included) and therefore not necessarily be given tax relief.
Inheritance tax problems
Any cash paid to a company will increase the value of that company and of course the shares. This will in turn increase the value of the shareholders estate. If shares are passed to anyone other than the wife or husband of the person who dies inheritance tax could increase.
A cross option agreement is normally written in trust for the benefit of partners or shareholding directors when setting up a shareholder protection. Therefore benefits from a policy pay-out are to the trustee and not to the shareholder. It’s possible that premiums may fall within inheritance tax exemptions.
As mentioned above this information should only be used as a rough guide for tax treatment. We strongly recommend that you speak to a tax advisor or tax expert to find out what your liabilities are. Of course you can always check out the HMRC website for the latest information key man insurance taxation.
For those people who are looking for a personal tax efficient life insurance you may want to consider a relevant life policy or just give us a call on 020 7112 8844.
Information regards to taxation levels and basis of reliefs are dependent on current legislation. Individual circumstances are not guaranteed and may be subject to change. The Financial Conduct Authority do not regulate trusts.