Key man / key person insurance is a specially designed type of life insurance intended to protect businesses from the loss of one of the key people in the organisation. In many smaller companies much of their success rides on the shoulders of one or two critical people, and if that person was suddenly lost, it could spell disaster for the business. Key person insurance will provide much needed capital at such a time, so that the company can fill holes in its profits, recruit a replacement or buy out a director without creating a crisis.
Companies investing in key person protection may be wondering whether this investment is tax deductible. Indeed, the treatment of tax on both the premiums paid and on the insurance pay out can be somewhat confusing, and legislation on the subject is decidedly grey. However, referring back to case law and general principles of taxation, here’s what you need to know.
Let’s Talk About Tax
When it comes to taxation, the defining factor as to what and whether key person insurance is deductible is who the beneficiary is going to be. To even be considered for tax relief, the policy needs to be owned by the company and the premiums paid by the company itself. Any policy that is given as part of an employment package and ends up becoming the property of the insured party is not strictly company profit and therefore cannot be tax deductible.
However, in cases where the company is going to benefit directly from the policy, there are two common scenarios to consider:
- If the company is to be the only beneficiary
In the case where the company is ‘wholly and exclusively’ the beneficiary of the insurance, then the premiums may be tax deductible. This could apply, for instance, in the case where the insurance has been taken out to cover the hole in the company income that the person would leave. However, in this case the insurance pay-out will be considered a part of the company profits, and therefore would be taxed accordingly.
- If the company and an individual are to be beneficiaries
If you are insuring a shareholder so that the company is in the position to pay a fair, market price for those shares if the person dies, then it is not only the company who will benefit from the insurance pay-out. Although the company will certainly benefit by being able to buy the shares, the shareholders’ estate and subsequent beneficiaries will also be benefitting. In this case, the premiums paid cannot be claimed as a business expense, but on the other hand, the pay out of the policy is not a taxable receipt in the hands of the company.
These are two very simplified examples of how taxation can work when it comes to key man insurance. Every case is unique, however, and although HMRC largely agree with the principles here, they also stress that every situation should be looked at on an individual basis. If you’re in any doubt over whether your key person insurance is taxable, we recommend getting professional advice on your individual circumstances.
If you would like to talk this through in more detail, contact me on 01252 757 277 or request a callback here.