A note about the information
This 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 for a company
Each case is treated individually so it's highly recommended that a business liaises with the local inspector of taxes to discuss how a policy will be treated for tax purposes.
Often the premiums for key person insurance will be allowed as a business expense for corporation tax purposes, but only if three conditions are met:
- The sole relationship is between employer/employee(less than 5% shareholding).
- The cover is for loss of profits resulting from the loss of service of that employee.
- The insurance policy is annual or short term (typically 5-10 years maximum considered as short term).
Whole of life insurance would not therefore qualify, nor would the premiums covering a director with a significant shareholding (in excess of 5%) in a company, as it would be considered that the cover was primarily for his or her own benefit. In a partnership, it's also unlikely that tax relief would be given on the life of a partner.
Whether or not the proceeds of the policy are taxed will depend largely on how the premiums have been treated for tax purposes. Generally speaking, if tax relief has been allowed on the premiums, the proceeds will be taxed as a trading receipt, while, if no tax has been received at outset, the proceeds will not be taxed. But there are no hard and fast rules. Much will depend on the judgement of the local tax inspector.
Where the policy proceeds are taxable, the tax payable will be linked to the type of underlying policy. Payments under a key person term assurance policy will be treated as a trading receipt and subject to corporation tax. Bearing in mind this policy has been taken out to replace lost profits and those profits would have been liable to tax, this approach makes sense.
However, the payout from a whole of life policy is treated differently as it's considered a capital item. As these policies are deemed "non qualifying" for life assurance purposes, they will be treated as the company's income. The taxable amount is the difference between the premiums paid and the surrender value of the policy immediately before the claim, and will be taxed as the company's income. As we've already covered in the conditions above, a whole of life policy would not qualify for tax relief on the premiums anyway.
Key Person Protection should not necessarily be restricted to policies where corporation tax on the premiums may be available. It's more advisable 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
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.
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.
Your questions answered
You can contact our protection sales team on 0845 273 0010.
Phone lines are open Monday to Friday, 9am to 5pm. Call charges will vary and we may record and monitor calls.
