BLOG
Key Man Insurance Taxation. Our 2024 Ultimate Guide
- Jody
Start saving money on Life insurance today
How Does HMRC Treat The Taxation Of Key Man Insurance?
The taxation of key man insurance is a topic that many businesses struggle to understand and it can be a bit of a minefield.
“We’d love to tell you that there’s a simple yes, but unfortunately, that’s just not the case”
The good news is that the HMRC does state that key person insurance can be tax deductible. This is because essentially it is a company insurance policy similar to any other business insurance. The company owns the policy, pays the premiums and is the beneficiary of any claims.
However, there’s a pretty big BUT coming up. The premiums you pay are classed as “tax-deductible” but only if they fit specific criteria.
This means there will be cases when the premiums can’t be offset against tax as they don’t meet HMRC’s criteria.
Already, you can see how things become complicated!
The rules surrounding key man insurance taxation were rooted in 1944 and there haven’t been any updates since.
Currently, the guidelines still follow what was set by the Chancellor of the Exchequer at that time. His name was Sir John Anderson and he made the following statement when in parliament:
“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.”
He added that if the insurance is used on employees’ lives, the premiums can be treated as admissible deductions and any sums received under a policy can be seen as trading receipts. But, he outlined a set of conditions that must be met for this to be the case, which has come to be known as the Anderson Principles.
So Key man insurance is deductible, as long as it adheres to the Anderson Principles.
What Are The Anderson Principles?
As mentioned above, the Anderson Principles are crucial in understanding how key person insurance is taxed.
In simple terms, it’s a set of criteria that must be met for keyman insurance to become a tax-deductible benefit.
In total, there are three Anderson Principles. Please note, all three MUST be met:
- The sole relationship is that of employer and employee
- The insurance is intended to meet the loss of profit resulting from the loss of services of the employee
- It is an annual or short-term insurance
These are direct quotes from Anderson when he was speaking to parliament in 1944. So, what exactly do they mean in more detailed terms?
1. “The sole relationship is that of an employer and employee”
Here, we are referring to the relationship between the company taking out insurance on a key employee.
Essentially, the relationship needs to only be an employee/employer connection. The employee being insured (the key person) cannot own a personal interest in the company. If they do, it leads to complications.
HMRC details that the policy and its premiums paid must be effected wholly and exclusively for the benefit of the company’s trade.
For example, if the key person insurance insures a director whose death severely impacts the share price of the company, it could be argued that the reason for taking out key man insurance is to protect the value of other directors’ shares in the business.
This would not be wholly and exclusively for business purposes.
2. “The insurance is intended to meet the loss of profit resulting from the loss of services of the employee”
This criteria stipulates that the key man insurance MUST cover the expected loss of profits arising from the loss of a valuable employee and therefore the loss of trading income and not a capital loss.
Consequently, there are instances where a keyman insurance policy might not tick this box. For instance, if the policy is used to help cover business loan repayments. In this case, it’s very unlikely that the premiums will go down as allowable business expenses, and therefore will not be deductible.
3. “It is an annual or short-term insurance”
Lastly, you need to consider how long the policy is taken out for. Or the “term of the policy”.
Annoyingly, there isn’t a period that’s strictly defined as “short-term”. So, it can be hard to know whether or not your policy meets this requirement. Nevertheless, the policy will only be tax-deductible if it is in place for as long as the employee is useful to the company. In essence, it covers them while they are working for you.
You cannot take out life insurance plans that cover the entirety of an employee’s life beyond when they work for you. So for example a whole-of-life plan, would not meet the criteria.
Are Key Man Insurance Premiums Deductible?
If your policy meets the Anderson Principles laid out above, then your insurance premiums can be deducted from your business expenses, just like any other business insurance.
However, it is important to understand the difference between premiums and payouts.
Remember, your premiums are what you pay to keep the insurance live. This is what you can deduct from your business expenses to reduce Corporation Tax. The payouts are what your insurance policy pays you as compensation if you lose the key person. This will be paid as a cash lump sum tax-free benefit to your company. Consequently, this will mean it is liable to tax like any other amount of money within a company.
Is Key Person Insurance A Benefit In Kind?
What is a benefit in kind? The technical definition is that benefits in kind are: Benefits that employees or directors receive directly from the company that aren’t included in salary or wages.
Keyman insurance policies do not provide benefits to employees or directors, so are therefore not considered a benefit in kind.
How Does Tax Treatment Work When An Employee Is Covered?
Covering an employee is the correct approach to obtaining a key man policy. It is considerably simpler to predict how the tax situation will unfold when this is the case. In the vast majority of the time your premium payments will therefore be written off as a business cost for tax purposes.
Why? Because any compensation you get from filing keyman insurance claims would benefit your company rather than the worker.
Additionally, you have a direct employee/employer relationship, therefore you’ve already met two requirements of the Anderson principles.
How Does Tax Treatment Work When A Shareholder Is Covered?
Now, this is where things do get a bit complicated!
Keyman insurance tax works differently when it’s used to protect an employee who’s also a shareholder in the company. If you read further up this guide, you’ll remember we briefly touched upon this when discussing point one of the Anderson Principles.
The argument is that a keyman life insurance policy would technically benefit the company shareholder, as well as the business. If this shareholder were to die or suffer a critical illness, it could have a direct impact on the share price of the business. Thus, any payouts taken from the policy could be used to protect the value of these shares and the value of the individual’s estate. As such, HMRC argues that this violates the wholly and exclusively test we mentioned earlier.
In short, the purpose of the policy is not wholly and exclusively to protect the business. Therefore, it is unlikely that premiums will qualify for corporation tax relief.
How Does Tax Work When Covering A Business Loan?
Again, we very slightly touched upon this earlier in the guide. Some businesses will take out a key person policy with the intention of protecting a business loan called “business loan protection“. The idea is that the proceeds paid by the policy can be used to cover loan debt.
In this scenario, you open up some interesting taxation rules. Your premiums will NOT be tax-deductible as the policy fails the wholly and exclusively test yet again. Here, your business is not the one benefiting from a payout; it’ll be the lender that’s the key beneficiary.
The interesting twist is that the payout from the insurance is not technically classified as a trading receipt because you’re rebalancing your business’s account. Thus, it is tax-free!
Key Person Insurance Taxation: A Summary
We will finish this guide by summarising everything as concisely as possible.
Key person insurance premiums are tax-deductible if they meet all three criteria set out in the Anderson Principles. However, any claims and payouts will be considered trading receipts that must be taxed.
- If your insurance covers shareholders, the premiums and payouts will most likely not be deductible.
- If your insurance covers a business loan, the premiums won’t be deductible but the payouts are.
If you have any other questions, please don’t hesitate to get in touch with our team. You can also read more by checking out this section of the HMRC’s website.
For those people who are looking for 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 regarding taxation levels and the basis of reliefs are dependent on current legislation. Individual circumstances are not guaranteed and may be subject to change. The Financial Conduct Authority does not regulate trusts. We always recommend that you speak to it’s always best to speak to your local tax office or your accountant for the latest up to date information.
Jody is the Managing Director and founder of My Key Finance Ltd. He has over 22 years of experience as a mortgage & protection adviser. He is an authority within the UK business protection market & specialises in key man insurance, relevant life cover and shareholder protection. Jody has written articles for Business Matters, Business Directory and has been featured in Forbes. He is Authorised & Regulated by the Financial Conduct Authority and is CeMAP qualified.
As editor and author of our blog, Jody hopes to educate and advise people with more in-depth information & guidance on life insurance and business protection.
Jody & his wife Lori featured in the BBC programme “The House £100k Built” He is also a keen Arsenal fan and loves nothing more than watching his son & nephews play football at the weekend.
