With key person protection, a policy is taken out by the business on the life of the key person in order to allow the business to continue trading in the event of the life assured’s death.
Premiums will benefit from relief against corporation tax as a business expense but only where the policy is put in place solely to cover a potential loss of profits. Broadly, if the premiums attract tax relief then the policy proceeds are likely to be taxable as a trading receipt.
Corporation tax relief for premiums paid by the business is normally allowed providing the following all apply:
1. Cover is short term or annual (for example, term assurance usually less than five years, rather than whole of life, annual premiums rather than single).
2. The sole relationship is employer/employee (so tax relief might not apply for significant shareholders). Directors are considered to be employees.
3. The sum assured is paid to the employer to cover loss of profits arising from the key person’s absence.
Corporation tax relief will not be available where the policy has a surrender value because a portion of the premiums are directed towards investment rather than solely to cover loss of profits.
Corporation tax relief may not be available on assurance premiums where the life assured is a significant shareholder (generally holding 5 per cent or more of the company’s shares).
This is because the premiums would fail the ‘wholly and exclusively’ test; the policy is put in place partly for the shareholder’s benefit to protect against a fall in share value, rather than solely to allow the business to continue trading in the event of the loss of a key person.
Its important to note that the tax treatment of both premiums and proceeds will be determined by the company’s inspector of taxes and should be confirmed with them at outset.
Banks lending to the business will often require a policy in place to cover the loan in the event of an individual’s illness or death. This is not strictly key person insurance and will not gain corporation tax relief because the policy is put in place for the benefit of the lender, rather than to replace lost profits.
Renewable term assurance is often used for key person cover. Convertible term assurance premiums may not be tax-relievable because they could potentially become partially used for investment purposes. The term of cover can be adjusted, for example to fall in line with the life assured’s expected retirement date.
If the policy pays out, the benefits are generally taxed as a trading receipt in the year of payment and will be subject to corporation tax. A one-off lump sum payment may artificially increase profits for the year.
The policy may provide the option of receiving benefits in instalments over multiple years which would better reflect the profits lost over time due to the loss of the key person, and stagger the corporation tax liability.