By Louise Misiewicz
Are you looking to pay key man insurance out of your company?
Did you know that the tax considerations are different for employees and director/shareholders?
What is Key Person Protection?
It is a business protecting itself against the financial loss it may suffer as a result of the death, critical illness, or incapacity of a key individual. A key individual is one that provides a significant influence in the running and decision-making of the business.
The insurance company will pay out a sum of money to the company because of the financial risk of losing the key person. The calculations are far and wide of how much premiums needs to be paid and how much will be paid out. This article is not written from a tax rather than insurance perspective.
The Anderson Rules
The following is the Hansard report of the exchange in the Commons on 27th July 1944 regarding insurance by a company on the life of an employee:
‘Sir John Mellor – Asked the Chancellor of the Exchequer whether premiums, paid by a company to insure the life of a director or employee in the company’s interest, are now admitted by the Inland Revenue as a trading expense in the company’s accounts in view of the decision of the House of Lords in the case of DH Williams’s Executors v CIR 26 TC 23, that when such a policy matures by death the sum assured is a revenue receipt in the hands of the company.
‘Sir J. Anderson – 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 by employers 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.’
Tax implications and considerations
It may be argued that the premiums paid are for the benefit of the company and is a cost to mitigate risk. As such this would justify the Whole Exclusive & Necessary test of HMRC.
However, HMRC argues that any premiums paid should not be for the benefit of individual owned businesses. You need to document your reasons for the premium and to ensure that there are no added benefit outside of the company for the shareholders.
Tax relief will not be given if the insurance paid on behalf of a director and who is the majority shareholder.
Premiums would be allowed to be offset against taxable profits provided that:
- Policy is in place for the loss of profits suffered because of the above
- Insurance policy is annual or short term
- The insured is not a major shareholder of the business
In the past, most key person policies have been taken out over a 5 year period in order to fit the criteria.
HMRC have stated: “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.”
From the guidelines, it seems fair to suggest that if tax relief has been allowed on premiums then the proceeds could be taxed.
The safeguard is to speak with your local tax office with the insurance cover details to see if the premiums would be a cost that may be offset against taxable profits.
I also wrote an article recently on how to reduce tax liability in 2017, which can be reviewed in full here.
There’s also useful information here from our FAQ section on the nest way to structure a Limited Company.
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