Key person insurance
The profitability of a business may depend on one person or a small number of people. If that’s the case, the business may be seriously compromised if that/those persons, fall seriously ill or have an accident.
To protect against financial loss, it’s possible to take out a policy insuring against the loss of profits arising from the death, critical illness, sickness, accident or injury of a director, employee or other key person. This is known as the key person insurance.
The key person insurance & deductibility of premiums
As with any business expense, premiums paid in respect of key person insurance are deductible if they are incurred wholly and exclusively for the purposes of the business.
This will be the case if the sole purpose in taking out the insurance is the trade purpose of meeting a loss of trading income that may result from the loss of service of the key person.
The extent to which the sole purpose test is met is a question of fact which is determined by taking into account of what the company directors or, in the case of an unincorporated business, the proprietors, were aiming to achieve as a result of taking out the policy.
If the underlying purpose is not a trade purpose, the premiums can’t be deducted as a business expense. There are various scenarios in which a policy may be taken out for a purpose other than a trade purpose. This would be the case, if a policy is taken out in respect of only those directors who are also major shareholders with a view to protecting the value of the shares and, in the event of the insured’s death, his or her estate.
Where the policy is a life assurance policy, the premiums are deductible only if the policy is a term policy providing cover only against the eventuality of the insured dies within the term of the policy, and no other benefits. The insurance term should not extend beyond the period of the insured’s usefulness to the company.
To qualify for a deduction in the computation of taxable profits, the premiums must be a revenue expense rather than a capital expenditure. No deduction is given for a policy that provides against a capital loss. Further, no deduction is available for premiums to the extent that they contribute to a capital investment. This will be the case where a policy, whether a whole life, endowment, critical illness or accident policy, has an investment element.
Key person policies associated with loan finance
Care must be taken where such a policy is taken out as a condition of the provision of long-term finance. HMRC have confirmed that for an unincorporated business, the key person insurance policy premiums are not an incidental cost of the loan finance and as such are not deductible.
The premiums are a cost of the life policy itself. For a company, the loan relationship rules apply and, as the premium is not considered to be an incidental cost of the loan finance, a loan relationship debit is not available.
Where the premium is deductible, any payout from the policy is taxable as a trading receipt. However, if a deduction was not available for the premium (for example, where it is a condition of the provision of loan finance), any payout is similarly left out of the account.
For more information about the key person insurance and associated deductions, please visit the official government website.