Will you be taxed on your Keyman Policy?

Newsletter issue - January 09.

Many small businesses take out keyman insurance policies designed to pay out on the death or incapacity of a key member of the team, such as a lead director. The premiums paid for such insurance policies are only tax deductible as a business expense if all of the following conditions apply:

• the purpose of taking out the policy is to cover the drop in profits that would result from the loss of the key person;
• the policy only applies for the time that the employee is useful to the company; and
• the policy has no investment element such as a surrender value.

If the purpose of the policy is to pay off a business mortgage or loan, like an endowment policy, then that would be a capital related purpose, and the premiums would not be tax deductible. Endowment policies also tend to have an investment element.

Generally where the premiums paid for a keyman policy have been correctly deducted as a business expense, if that policy pays out the proceeds are treated as part of the trading income of the business. The converse also generally applies that if the premiums paid were not tax deductible, the receipts from that policy are not treated as trading income of the business.

Unfortunately there is no law that lays down this clear principle, and there have been several cases that have been decided either way. Even where the premiums have not been deducted from profits, the Taxman may argue that the payout of the policy allows the business to continue, and the proceeds should be taxed as business profits.

Whether there is tax on the payout may affect the amount you need to be insured for, so please contact us if you need advice on whether the receipt of any payout would be taxable.