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Tax implications of business protection

This article is part of
Guide to Business Protection

There are various elements to consider when setting up business protection, including how premiums will be treated for tax purposes and how benefits will be paid.

Emma Davies, market development manager of Legal & General, says the reason for the policy will play a big factor in deciding the tax bill.

It is wise to consider each case on its merits and to seek advice from their company’s inspector of taxes before completion of a policy, according to Dougy Grant, protection director of Aegon.

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Generally Mr Grant says tax relief will be granted where the premiums meet the “wholly and exclusively for the purpose of the business” test. He says there is no direct legislation on the subject of the taxation of the premiums or proceeds of key person policies.

According to Mr Grant the principles governing tax relief on business protection premiums were set out in Parliament by the then chancellor, Sir John Anderson, in 1944 and are known as the Anderson rules.

A relevant life policy is defined in S393B(4) of the Income Tax (Earnings and Pensions) Act 2003 (ITEPA).

This makes clear who is eligible to apply for cover and that cover can only be for life and terminal illness.

Mr Grant says the proceeds from a key person policy will be taxable if they are used for revenue purposes and won’t be taxable if they are used for a capital purpose.

Employers should always consult their local inspector of taxes to confirm how a policy will be treated for tax purposes, he adds, but tax relief is generally available providing:

1) The sole relationship is between employer/employee.

2) The cover is for loss of profits; and resulting from the loss of service of that employee, and

3) The insurance policy is annual or short term.

With key person cover, Ian Smart, head of product development and technical support for Bright Grey, says it is unlikely that the business will get tax relief on the premiums where the life assured is a significant owner of the business.

But Mr Smart says tax relief is possible if the life assured is an employee and the policy is for a short term (less than five years).

Plan proceeds paid to a limited company or limited liability partnership are likely to be taxed as a trading receipt, he adds

If the plan has been taken out by a partner on the life of a key employee and written in trust, Mr Smart says the plan proceeds will, generally be paid free of tax.

Who pays?

With business succession protection, Mr Grant says the business owners will generally pay the premiums from their post-tax income.

If the business pays the premiums, then Mr Grant says the premiums will usually be treated as drawings in the case of a partnership and they will form part of a shareholder director’s remuneration package where the business is a limited company.