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Key Man Insurance Taxation & HMRC. Our 2022 Ultimate Guide

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We Just Want To Know If Keyman Insurance Is Tax Deductible.

 

There’s no doubt that keyman insurance is important for your business. When you lose an employee due to unforeseen circumstances – such as death or critical illness – your company receives compensation to deal with the financial issues this loss can cause.

We’re not going to dive any deeper into key man insurance within this specific blog. After all, we already have an ultimate guide to top key man insurance here. So, if you’d like to learn more about keyman insurance, click here. But we just want to know if keyman insurance is tax deductible!

Let’s Focus On Key Man Insurance Tax

 

Instead, our focus is firmly on one key thing: key man insurance taxation. It’s a topic that many businesses struggle to understand as it is far from simple. Primarily, your main concern is how this type of insurance is taxed. For instance, is key person insurance tax deductible? We’d love to tell you that there’s a simple yes or no answer here. However, as you can tell from the fact that we’ve created a guide, it is far more complex than this. Don’t worry, throughout this guide we’ll be answering some commonly asked questions relating to key man life insurance tax and the keyman policy tax implications. This will help you know exactly what to do and how to handle the tax side of things when taking out this insurance policy.

How Does HMRC Treat The Taxation Of Key Man Insurance?

 

The good news is that the HMRC does state that key man insurance can be tax deductible. This is because it’s an insurance policy taken out by a company on an individual within the organisation. In essence, this makes you (the company) the beneficiary of any claims made on this policy.

Furthermore, you’ll be required to pay premiums to keep this policy in place. HMRC says that these premiums are technically tax-deductible.

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. Effectively, this means there will be cases when a company takes out key man insurance, yet the premiums can’t be tax deductible as they don’t meet the criteria outlined by the HMRC.

Already, you can see how things become complicated. Part of the reason for this is that the rules surrounding key man insurance taxation are rooted in 1944. There haven’t really been any modern updates to legislation surrounding this. 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.”

Then, he went on to add that if the insurance is used on the lives of employees, 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 tax 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 man 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. They were outlined in 1944 by Sir John Anderson, hence the name.

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?

“The sole relationship is that of an employer and employee”

 

Here, we are referring to the relationship between the company taking out a keyman insurance policy, and the employer that’s being insured. Essentially, the relationship needs to only be an employee/employer connection. The employer being insured (the key person) cannot own a personal interest in the company. If they do, it leads to massive complications. HMRC details that the policy and its premiums must be effected wholly and exclusively for business purposes. You can read more about that here, where there are details and examples of when this isn’t the case. For example, if the key man 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.

“The insurance is intended to meet the loss of profit resulting from the loss of services of the employee”

 

This criterion stipulates that the key man insurance policy MUST cover the expected loss of profits following the loss of a valuable employee. Consequently, there are instances where a keyman insurance policy might not tick this box. For instance, if the policy is used to help cover loan repayments. In this case, it’s very unlikely that the premiums will go down as allowable business expenses, and therefore will not be tax deductible.

“It is an annual or short-term insurance”

 

Lastly, you need to consider how long the policy is taken out. 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. If your policy is a whole-of-life plan, it is unlikely to meet the criteria.

To summarise the Anderson Principles, when all three criteria are met, a company can treat its keyman insurance premiums as allowable business expenses. This means it can be deducted from your profits, reducing your Corporation Tax for the year.

 

Is Key Man Insurance Tax Deductible?

 

This is a big question you all want to ask, and we’ve already pretty much covered it. To reiterate, key man/person insurance is tax deductible under certain circumstances. If your policy meets the Anderson Principles laid out above, then your insurance premiums can be deducted from your business expenses for the fiscal year.

However, it is important to understand the difference between premiums and payouts.

Remember, your premiums are what you pay to keep the key man 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 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.

In short, key person insurance premiums are tax deductible, but any benefits you receive from the policy will need to be taxed like anything else.

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.

Seeing as keyman insurance policies do not provide benefits to employees or directors, they are not considered benefits in kind. This is good news as it means you don’t have to worry about keyman tax policy implications in this regard. You see, some benefits in kind need to be taxed, but given this doesn’t fall under that category, it’s not something you need to think about.

At this point, you should have a more detailed understanding of how keyman insurance is taxed by HMRC. You know that it has the potential to be tax-deductible under specific conditions. In the next few sections of this guide, we’ll answer some key queries most companies have relating to key man insurance taxation. Specifically, what are the rules when certain things are covered?

 

How Does Tax Work When An Employee Is Covered?

 

The right way to take out a key man insurance policy is to cover an employee. When this is the case, it is much easier to figure out how the tax situation will work. In the majority of cases – and we’re talking in the high 90% here – your premiums will be considered tax-deductible business expenses.

Why? Because any benefits you receive from keyman insurance claims will help your business, rather than benefit the employee. You also have the direct employee/employer relationship, meaning you’re ticking two of the Anderson principle boxes already. Provided the policy is a short-term thing covering the employee while they work for you, everything should be fine.

 

How Does Tax Work When A Shareholder Is Covered?

 

Now, this is where things do get a bit complicated. Keyman life insurance tax works differently when it’s used to protect an employee that’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.

Yes, this does make things really complicated. For instance, what constitutes a shareholder? Is an employee with a 5% share in the company – or less – considered a proper shareholder in this regard? Would the policy really benefit them that much? It’s far from an open-and-shut case here. There are possibilities to contact HMRC and negotiate with them if you believe an employee owns such a low stake in the company that they should just be treated as an employee rather than a shareholder.

Regardless of the outcome, payouts from your keyman insurance will still be taxed as well. So, if you use your policy to protect a shareholder and HMRC rules that it fails the wholly and exclusively test, you’ll pay tax on the premiums AND on the benefits.

 

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. The idea is that the benefits paid by the policy can be used to cover loan repayments.

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.

But, 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! You can learn more about keyman insurance taxation when covering business loans by checking out this section of the HMRC’s website.

 

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 business expenses given they meet all three criteria set out in the Anderson Principles. However, the insurance payouts will be considered trading receipts that must be taxed.

  • If your insurance covers shareholders, the premiums and payouts will most likely not be tax deductible.
  • If your insurance covers a business loan, the premiums won’t be tax-deductible but the payouts are.

Hopefully, this clears everything up and helps you understand how keyman insurance is taxed by HMRC. It turns out that Keyman insurance is tax deductible! If you have any other questions, please don’t hesitate to get in touch with our team.

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 regards to 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.

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