Key person insurance and tax
Getting key person insurance - sometimes referred to as key man insurance - can be an important failsafe for a key individual.
But how does HMRC tax 'key man insurance' and is it considered a taxable benefit? We cover all that and more in this guide.
Key person insurance and taxation for company and limited liability partnerships (LLP)
When the policy is on the life of an employee, the tax treatment of premiums is likely to largely depend on what have become known as the 'Anderson Principles'. This is based on comments made by the format chancellor, Sir John Anderson, in 1944, along with other related legislation and HMRC guidance.
Essentially, if certain criteria is met, the tax treatment of a key person should be:
- The company can treat the premiums it pays as allowable business expenses, deductible from the company's profits (potentially reducing its Corporation Tax Liability every year it has a policy).
- The company will have to account for any proceeds from the policy as a trading receipt (potentially increasing its Corporation Tax Liability in the year or receipt).
One benefit of taking out a key person insurance policy is that businesses can sometimes qualify for tax relief on their policy premiums, and in some cases, pay no tax on the pay-out.
Historically, 'key man' insurance has generally been viewed as tax deductible, and in 1944, when Sir John Anderson made the changes, he stated that premiums can be treated as "admissible deductions" in certain situations.
It's worth noting that there is no clear legislation on this topic, and there is no guarantee that a business can claim tax relief on their key person policy.
Is key person insurance tax deductible today?
The short answer is that ‘key man’ insurance is sometimes, but not always, considered tax deductible. When outlining the ‘Anderson rules’, the Chancellor at the time stated that “treatment for taxation purposes would depend upon the facts of the particular case”. In order to have a chance of being eligible for tax relief on a key person policy, a business would need to meet the following criteria set out by Anderson:
While the above forms an overview as to whether key person insurance has any taxable benefit, it will ultimately be between HMRC and local task inspectors - in conversation with a company's tax advisers - to determine whether the Anderson rules have been met and what, if any, tax is owed.
Does a key person pay out cover shareholders?
If a key person owns an interest in the company often considered 5% or more, this can lead to complications. Then it’s unlikely the proceeds on a claim would be tax-free, and the company may not receive tax relief on the policy premiums. This is because HMRC treats revenue as different to capital for taxation purposes, and a shareholding in a company is not solely for the benefit of the business, as it has a personal benefit for their estate and family too.
However, the law doesn’t specify what percentage constitutes a major shareholding, so your tax advisers may wish to negotiate with HMRC if they believe the company’s ‘key man’ insurance policy should have greater tax benefits.
For an LLP, premiums may be allowable as a business expense if the key person is an employee of the business.
Key person insurance and your employees
In theory, if an employee is covered by key person insurance then the premiums should be tax deductible when assessing your company’s Corporation Tax liability, as the policy benefits the business rather than the individual. This assumes that the employee in question is not a major shareholder in the company. In terms of any tax owed on a key person insurance pay out following the loss of an employee, HMRC may seek to determine whether the money is used for revenue or capital purposes before deciding whether it can be classed as tax-free.
Is a key person pay out tax-free for a business loan?
If you’ve taken out a ‘key man’ insurance policy to cover a business loan, you may not need to pay tax on any payout, given that the money would be for capital purposes and therefore not classed as a trading receipt by HMRC. However, the policy’s premiums are unlikely to be tax deductible, as the value of the policy benefits the lender rather than the business.
When are key person insurance proceeds taxable?
Ultimately, whether a key person insurance policy has any taxable benefit is down to HMRC’s interpretation of the Anderson rules, and whether the proceeds are used for capital purposes (which should be tax-free) or revenue purposes (which should be taxable). You might find that if you received tax relief on your policy premiums then you may be less likely to claim a tax-free payout, and vice versa. Tax interpretations aren’t always crystal clear, so having a trusted accountant or tax advisers on hand could help you understand your liabilities.
Key person and partnerships
A partnership in England, Wales and Northern Ireland cannot be the owner of a policy because it does not have a separate legal identity.
If the key person is one of the partners, that partner could take out an own life plan, and write it in trust at outset for the other partners.
What is a trustee?
A trustee is someone appointed to look after the asset(s) they are putting in trust the trustees are the legal owners of the trust assets and must act for the benefit of the beneficiaries of the trust. In the event of the key person’s death, the trustees will need to make a claim for the proceeds and ensure that these are passed to the beneficiaries of the trust.
Taxation of a partnership
There will be no tax relief on the premiums and the amount of cover will not be taxed.
Inheritance tax - issues for policies placed in trust
Whilst a policy in the Partnership Protection Trust will not form part of the key person’s estate for Inheritance Tax, there are some occasions where there is a potential for an Inheritance Tax charge to arise. For example, on each 10-year anniversary of the trust (periodic charge) and when payments are made out of the trust (exit charge).
If a life insurance policy with no surrender value is placed in trust, then provided that the life insured is in good health the value of the policy for Inheritance Tax is likely to be negligible. The maximum 10-year anniversary charge is 6% of the value of the trust fund in excess of the nil rate band.
Understanding taxation on your key person insurance policy doesn’t have to be such a head-scratcher with the right help and guidance.
When you contact us, you’ll be speaking to a qualified financial adviser who can help explain ‘key man’ insurance taxation, with no obligation to proceed.