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What is Keyman Insurance and how does HMRC tax it?

For many companies, Keyman Insurance offers vital business protection against the death of a key person. You can also add Critical Illness Cover, which provides an extra layer of protection if the key person becomes critically ill. The most common critical illness claims are for cancer, heart attacks and strokes.

Keyman Insurance and how does HMRC tax it

Why Keyman Insurance?

Most companies have at least one key individual they rely on and simply couldn’t do without and whose absence would have a major impact on the company’s prosperous future.

Small businesses are particularly vulnerable. Many such companies rely heavily on input from one or two key people and would therefore struggle in their absence.

If a key individual fell critically ill or even sadly died, how would your business cope without their vision, drive and talent? Would it simply be another statistic, among the 52% of companies which expected to fold within a year if a key person exited the business, as found in research from Legal & General?

Key Man Insurance steps into this breach by protecting your company. It pays out a cash lump sum into the business in the event of the death or critical illness of a key person. Your organisation can use the funds however it sees fit to survive.

Keyman Insurance, Tax and HMRC

Your business owns and pays for a Key Person Insurance policy regardless of how you ultimately use any payout you receive. However, despite this, HMRC taxes Keyman Insurance differently depending on who it deems the ultimate beneficiary of the payout.

There are many rules surrounding how Key Man Insurance is taxed. Perhaps the most important of these guidelines is the ‘wholly and exclusively’ test, one of the major factors which decides whether you pay tax on Keyman Insurance.

It examines how you’ll use the policy’s payout and if that will be ‘wholly and exclusively for the purposes of the company’s trade’, i.e. for the business’ benefit only. If so, premiums are typically a business expense against your company’s corporation tax bill.

Tax when protecting a shareholder…

If you’re protecting a shareholder with a considerable stake in the business, HMRC typically sees the payout as not wholly and exclusively for the business. This is because, were a major shareholder to die, their death would have a significant impact in the value of the company’s shares.

Given this, HMRC typically declares such a policy to be at least partly for the non-trade purpose of protecting the value of the director’s shares and therefore the value of their estate.

In this case, premiums would fail the wholly and exclusively test. Moreover, any payout from such a plan generally counts as a trading receipt, so HMRC also taxes the payout. Any policy protecting shareholders is therefore generally taxed on the way in as well as on the way out.

Tax when covering employees…

Where you’re covering an employee, however, premiums are typically a tax-deductible business expense eligible for corporation tax relief. This is because the payout benefits not the employee personally but the business.

However, HMRC still usually sees the payout as a trading receipt and will therefore take a chunk in tax accordingly. It’s therefore important to discuss grossing up the benefit with your adviser to ensure you get the correct payout net of taxation.

Taxation when covering business loans…

Again, when you’re looking to protect a business loan, premiums fail the ‘wholly and exclusively’ test. This is because the payout isn’t for your company — it’s for the lender. HMRC therefore requires you to pay tax on premiums for a policy protecting a business loan.

However, the taxman sees the payout as a rebalancing of the company’s capital account and therefore doesn’t typically class it as a trading receipt. As such, a payout is usually free from tax.

Getting expert advice

As you can see, just how Keyman Insurance is taxed is complicated, which is why we recommend discussing the ins and outs with your accountant. It’s also essential you get independent financial advice. This not only ensures you get the best deal on premiums but also helps make sure you understand the tax position you’ll be in regarding premiums and payouts.

With this in mind, we’ve partnered with independent protection experts Drewberry to help companies seeking Keyman Insurance. Drewberry compares the whole UK market for you and has arranged business protection for companies just like yours across the country. Drewberry’s experts are therefore well-placed to find you the best policy for your needs and set it up correctly. With around 2,700 5-star reviews, they’re also dedicated to providing you with the best client service and advice.

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