How is Key Person Insurance Taxed?
Key person insurance premiums can be a tax-deductible business expense against a corporation tax bill, but only if the pay-outs meet certain criteria.
This is a complicated area, however, although the advice below is factually and legally correct at the time of publishing, it is always advisable to discuss with a financial advisor or accountant.
HMRC largely follow guidelines set out nearly 80 years ago, known as the Anderson Rules. In terms of how key person insurance is taxed, the Anderson Rules state that the pay-outs must be “wholly and exclusively” for the benefit of the company.
Using this as a baseline, these days premiums can be tax deductible providing that the policy is there to cover loss of profit that may occur from the death of the employee with pay-out set at a reasonable level, that it is not to cover a loan and the sum assured is in line with the loss of profits that may arise in replacing the employee.
The policy is generally short term, at around a 5 year duration. Longer policies are now accepted but they shouldn’t exceed the realistic duration of employment.
Providing all the above is met, then the insurance premiums should be tax-deductible – the key part here is the “wholly and exclusively” for the benefit of the company aspect.
There are further complications when it comes to protecting a shareholder as this can be seen to be of benefit to people other than the company and is therefore not “wholly and exclusively” for the benefit of the company. Premiums in this scenario are unlikely to be eligible for corporation tax relief. There is some room for manoeuvre with minority shareholders though, with possible negotiations with HMRC on a case by case basis.
HMRC’s Business Income Manual at BIM45530 states the following:
“Where the key person is a director whose death would significantly affect the value of shares in the company, one of the purposes for taking out the policy may be a non-trade purpose of protecting the value of the director’s shares and therefore the value of their estate … [and are] not paid wholly and exclusively for the purposes of the company’s trade.”
What Happens When a Loan is Taken Out?
Another grey area is when a insurance policy is taken out to cover a loan against the death of a key employee. In this instance it is not “wholly and exclusively” for the benefit of the business (as the lender will also benefit) and the premiums will not be eligible for Corporation Tax relief. But – as the pay-out is seen as for the benefit of the lender, the pay-out will not normally be classed as a tax receipt and will not be subject to taxation.
As we have said, key person insurance policies and the taxation involved can be a complicated area. HMRC do offer some very good resources and in particular HMRC’s Business Income Manual, sections BIM45525 and BIM45530, list some useful information.
Working with a qualified tax advisor or financial advisor can help to ensure that your key person insurance policy is structured in the most tax-efficient manner possible.
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