Key Man Insurance Taxation
The tax treatment of Key Man Insurance is not absolute or straight forward for every company. There are numerous reasons why individual companies are treated differently by HM revenue and customs. Your accountant will be able to give you a clear picture of how your business will be affected. It's also important to make sure that you are using the most up to date tax legislation.
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 any claim. If the companies reason for insurance sits within the designated reason below, it is a deductible business expense, and is therefore tax deductible. However if there is any reason why the insurance is not solely for the businesses benefit, it is no longer deductible.
The main principles of Key Person taxation were set by the 1944 Chancellor of the Exchequer, John Anderson. In answer to a parliamentary question he 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.”
If the company is taking out a policy on its employee, to protect the business from a loss of profits resulting from the loss of that key employee and the insurance policy is annual or short term, the company may be allowed tax relief on the premium. However if the key employee owns more than a 10% share in the company, it is no longer an allowable expense. This is because the insurance policy is no longer seen as being solely for the business.
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 not qualify as tax deductible as the policy will last longer than the person’s usefulness to the company. A whole of life insurance policy is more suitable as shareholder protection because the person may hold on to the shares even after leaving the company. However this is unlikely to qualify for tax relief.
If tax relief has been allowed on premiums then the proceeds, the pay out amount, can be taxed. But it is important to note that tax treatment of proceeds of benefit will be treated differently depending on the judgement of the local tax inspector. When taking out a policy it may be wise to include a certain amount or percentage of benefit, to cover any tax liability from the pay-out. This is to guarantee that the pay out meets the company needs.