his page summarises taxation issues that apply to our business protection products. In all cases, we have based this information on our understanding of current tax laws and HM Revenue & Customs practice, which is subject to change. We therefore strongly recommend that you and your client seek advice from their company’s inspector of taxes before completion of a policy.

Taxation for Key Person Protection

There is no direct legislation on the subject of the taxation of the premiums or proceeds of key person policies. Employers should always consult their local inspector of taxes to confirm how a policy will be treated for tax purposes.

The principles were set out in 1944 by the then Chancellor of the Exchequer, Sir John Anderson, in answer to a Parliamentary question. He made the following statement:

“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 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.”

Therefore, provided that:

i) The sole relationship is between employer/employee;.

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


iii) The insurance policy is annual or short term,

The employer’s tax inspector may allow tax relief on the premium.

HMRC have also provided guidance on the subject in its Business Income Manual (BIM45525). This states:

“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’.”

The premiums on such a policy will be allowable if all the following conditions are met:

The sole purpose of taking out the insurance is the trade purpose of meeting a loss of trading income that may result from loss of the services of the key person, and not a capital loss. Guidance on possible non-trade purposes is at BIM45530.
In the case of life insurance policies, they are term insurance, providing cover only against the risk that one or more of the lives insured dies within the term of the policy, with no other benefits. The insurance term should not extend beyond the period of the employee's usefulness to the company.

Investment Content

The premiums on whole life or endowment policies, or critical illness or accident policies with an investment content - such that premiums contribute to a capital investment - are capital expenditure and will not be deductible, see Earl Howe v CIR [1919] 7TC289, page 300.

Therefore, a whole of life policy would be unlikely to qualify, or any other policy with a term which extends “beyond the period of the employee’s usefulness to the company”. It would be unlikely that a policy covering a director with a significant shareholding in a company would qualify for tax relief. In a partnership, it’s also unlikely that tax relief would be given for a policy on the life of a partner.

Generally speaking, if tax relief has been allowed on the premiums, the proceeds will be taxed as a trading receipt, while, if no tax relief has been received at outset, the proceeds will not be taxed. But this is merely a general statement: the tax treatment of premiums is independent to that of the tax treatment of proceeds. Much will depend on the judgement of the local tax inspector.

Key Person Protection should not necessarily be restricted to policies where corporation tax on the premiums may be available. It may be wise to ensure that an adequate amount of cover is in place, allowing for tax, so that the policy proceeds do not fall short of the amount the business requires to compensate for any losses.

Can Key Person Protection be applied to a controlling director?

Yes, but the company’s tax inspector will probably feel that the policy benefits will be largely for the benefit of the life assured (because he or she owns a majority of the shares), and it is unlikely the tax inspector would grant tax relief on premiums.

Are there any inheritance tax issues?

Cash paid to a company from a policy will boost the value of the shares in that company, so if the key person who dies is also a shareholder, the value of his or her estate would be increased. If the shares pass to someone other than the wife, husband or registered civil partner of the person who dies, and business property relief is not fully available, any inheritance tax liability may increase.

Taxation for Partner/Director Share Protection

a) Inheritance tax

Each protection policy used to support a cross option agreement is usually written in trust for the benefit of the fellow partner(s)/ shareholding director(s). As such, any benefits from the policy will be payable to the trustees and not to the partner/ shareholding director or his estate. In addition, the policy premiums may fall within one or more of the inheritance tax exemptions.

If a partner/ shareholding director dies and the cross option method has been used then any business property relief on their share of the business would be preserved.

b) Capital gains tax

There is no capital gains tax on death but the beneficiaries of the estate may be liable for the increase in value of the share of the business between death and sale, although in practice this would be rare.

However, in the event of the sale of a partner’s or shareholding director’s share due to critical illness, a capital gains tax liability may arise.

For more information on tax and trusts please email our dedicated team: life.technical@landg.com.

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This is not a consumer advertisement. It is intended for professional financial advisers and should not be relied upon by private customers or any other persons.