Keyman Insurance - To Tax or Not to Tax?

Has your company taken out any keyman or other life assurance to protect the company in the event of the unexpected or untimely death of your key person or people?

In the unfortunate event of a payout under the policy, tax is unlikely to be the first thing on your mind. But the proceeds could be very significant and the question of whether or not they are liable to corporation tax therefore an important one.

The tax treatment of such policies has long been the subject of some uncertainty. There is a generally held view that if no tax deduction is claimed for the premiums then the proceeds are not taxable. However it is not quite as simple as that.

It all hinges on the reason for taking out the policy in the first place says the Inland Revenue. If the purpose is to plug a hole in profits resulting from the death of a key employee then the premiums are tax deductible because they relate to the trade but any proceeds are taxable being income in nature. You may feel that losing say 30% of any proceeds to the Inland Revenue makes a bit of a mockery of having taken out the insurance in the first place.

However all may not be lost. There may be something you can do to improve the position (where no tax relief is due on the premiums) and ensure any proceeds are treated as capital rather than income and hence not taxed. Additional comfort is given by a recent tax case on this point which the Inland Revenue lost.

Taking out a keyman policy is often linked to agreements with banks or other lenders. It is often the case that such a policy is a prerequisite to an injection of funds into the business. Therefore the primary purpose of taking out the policy, as noted in a Board minute, may be to obtain the funding from the prospective investor. Alternatively the primary purpose may be to provide a means of repurchasing the company’s shares from the deceased’s estate in the event of death. Any proceeds should therefore be treated as capital and not taxed.

It is the purpose for which such policies are taken out that is of crucial importance as is any documentation evidencing that purpose. It is possible to clarify the tax treatment when the policy is taken out which given the long term nature of such policies may be desirable. We would be pleased to talk to you if this is an area of interest to you.