Key person policies and tax relief

Many businesses take out key person policies to protect against the financial impact of losing a vital individual. These individuals may include directors, senior employees or anyone central to the business’s success. As a result, key person policies can provide essential cover for death, critical illness, sickness, accident or injury.

However, the tax treatment of these policies is not always straightforward. Understanding the rules can help your business claim relief where it is available.

When are premiums allowable as a business expense?

Whether tax relief applies depends on the nature and purpose of the policy. HMRC guidance confirms that premiums are generally allowable as a business expense in certain cases. Specifically, the sole purpose of the policy must be to protect the business against a loss of the individual’s services. Importantly, this means the policy should not cover a capital loss.

In addition, for life cover, relief is normally only available for term insurance policies. These must provide pure risk cover with no investment element. Furthermore, the policy term should not extend beyond the individual’s expected usefulness to the business.

Policies that do not qualify for tax relief

On the other hand, policies with an investment or capital element are generally treated differently. For example, whole life or endowment policies usually fall into this category. In these cases, HMRC treats the premiums as capital expenditure, so tax relief is usually not available. Similarly, restrictions can apply where key person policies are linked to long-term loan finance.

How are insurance proceeds treated?

Where premiums qualify for tax relief, any insurance proceeds received are generally taxable as trading income. Conversely, where premiums are not deductible, the receipts are often not taxed. Nevertheless, the exact treatment depends on the specific circumstances of each case. Therefore, businesses should review the terms of their key person policies carefully.

Additional considerations for employers

Separate rules may also apply in certain situations. For instance, employers who insure against liabilities to compensate employees may face different treatment. Likewise, where benefits are paid directly to employees under sickness or life insurance arrangements, additional rules can come into play. As a result, it is wise to seek professional advice when setting up or reviewing key person policies.

Take the right steps to protect your business

Ultimately, key person policies offer valuable protection for businesses that rely on specific individuals. However, the tax implications can vary significantly depending on the type of policy and its purpose. By understanding the rules around allowable expenses and taxable proceeds, you can make informed decisions. Moreover, regular reviews of your key person policies ensure they remain fit for purpose.

If you would like more information about key person policies or would like to speak to one of our tax experts, please contact our team today.