How Is Keyman Insurance Taxed?

Keyman Insurance protects your business from the loss of a key employee due to death or critical illness. It pays out a cash lump sum into the business so the company can cope with any turbulence such a loss causes. For example, it can help with:

• Hiring replacement staff
• Providing a buffer against loss of profits
• Repay outstanding loans
• Make up for difficulties securing funding
• Provide general financial support to the business in various other ways.

The below is a general guide to how HMRC taxes Key Person Cover. However, if there’s any doubt you should always check with your accountant and / or your local tax office.

HMRC, Keyman Insurance and Tax

How HMRC taxes Key Man Insurance is complicated. It’s governed largely by a set of guidelines laid out more than 70 years ago known as the Anderson Rules.

One of these guidelines is the ‘wholly and exclusively test‘. This represents one of the major factors that decides whether or not you pay tax on Keyman Insurance premiums.

The test examines whether the payout from the policy will be ‘wholly and exclusively for the purposes of the company’s trade’, i.e. solely for the benefit of the business. If so, premiums are typically a tax-deductible business expense against the company’s corporation tax bill.

Taxation When Protecting a Shareholder…

However, where a policy benefits the company shareholder, the purpose of the policy fails the ‘wholly and exclusively’ test. Premiums are therefore unlikely to be eligible for corporation tax relief.

According to HMRC’s Business Income Manual at BIM45530:

“Where the key person is a director whose death would significantly affect the value of shares in the company, one of the purposes for taking out the policy may be a non-trade purpose of protecting the value of the director’s shares and therefore the value of their estate … [and are] not paid wholly and exclusively for the purposes of the company’s trade.”

There may be some ‘wiggle room’ for minority shareholders who own around 5% or less of the company. This limit isn’t statutory —it’s more of a guideline. It may therefore be open to negotiation with HMRC on a case-by-case basis.

Payouts on plans that cover company shareholders usually count as a trading receipt, which means HMRC also taxes the payout. So it’s worth remembering that policies that benefit shareholders could be taxed on the way in and on the way out.

Tax When Covering an Employee…

When a business takes out Keyman Insurance to cover an employee, premiums are typically a tax-deductible business expense eligible for corporation tax relief. This is because the payout is not for the benefit of the employee but for the business to make up for the loss of that key person.

However, the benefit usually counts as a trading receipt and will therefore be taxable. As such, you’ll need to gross up the payout to ensure that the net figure you receive post-tax still meets your needs.

Tax When Covering a Business Loan…

When you take out a Key Person policy specifically to protect a business loan, premiums again fail the ‘wholly and exclusively’ test. This is because the payout isn’t for the business — it’s for the benefit of the lender. You’ll therefore need to pay tax on premiums covering business loans.

However, given the payout is intended to rebalance the company’s capital account, it’s not usually classed as a trading receipt. The payout is therefore usually tax-free. This means that there’s no need to gross up the value of such policies, which naturally reduces the premium.

As a general rule of thumb, where you get tax relief on premiums, the benefit will be taxable and vice versa. However, this isn’t always the case, such as where the policy covers a shareholder, so it’s always best to check the ins and outs with your accountant and HMRC.

Sam Barr-Worsfold
Business Protection Expert at Drewberry

Get Keyman Insurance Quotes and Expert Advice

While the above offers a rough guide to the tax position of Keyman Insurance, it’s a complicated area.

That’s why it’s always best to get professional advice, we have a team of experts on hand to compare the UK market and make sure your business protection is cost-effective and set-up correctly.

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