UK: Keyman Insurance Policies

INTRODUCTION

Keyman insurance policies are very commonplace. In many instances they will be implemented without any reference to the company's tax advisers and without any thought being given to the tax position. The premium is then included with all other insurance premiums and the total is claimed as a tax deduction. However whether or not tax relief is due and the taxability of any subsequent capital receipts is not straightforward.

LEGISLATION AND REVENUE PRACTICE

Parliamentary statements

On 27 July 1944 the Rt Hon Sir John Anderson gave a Parliamentary Statement setting out the Revenue's interpretation of the law as follows:

On 1 August 1944 Sir John Anderson confirmed that, as a general rule, if the premiums are not admissible, policy monies do not constitute taxable receipts but it was not possible to give an assurance which would cover every case.

Although these statements were made in 1944 they are still regarded as current.

HMRC Business Income Manual

BIM 45525 and BIM 45530 of the Business Income Manual indicate that the premiums are allowable if all of the following tests are satisfied:

• The sole purpose of taking out the insurance is the trade purpose of meeting a loss of trading income that may result from loss of the services of the key person, and not a capital loss;
• In the case of life insurance policies, they are term insurance, providing cover only against the risk that one or more of the lives insured dies within the term of the policy, with no other benefits. The insurance term should not extend beyond the period of the employee's usefulness to the company.

Whole life and endowment policies

HMRC take the view that the premiums on whole life or endowment policies, or critical illness or accident policies with an investment content (such that premiums contribute to a capital investment) are capital expenditure and will not be deductible, in accordance with Earl Howe v CIR [1919] 7TC289, page 300.

Non-trade purposes

Whether the sole purpose condition above is met is a question of fact, to be determined by evidence of what the directors of the company concerned, or the proprietors of an unincorporated business, were seeking to achieve by taking out the insurance policy and paying the premiums.

HMRC set out the following circumstances in which there may be non-trade purposes for taking out a 'key person' policy:

• Where the policy is in respect of directors who are major shareholders but not other employees;
• If benefits under the policy exceed sick pay arrangements – or other employee benefits – typically offered to employees of equivalent status in similar concerns.

For example, 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.

Group Policies

Where there is a non-trade or personal purpose in paying premiums in the case of some members of a group policy but not others, a reasonable apportionment may be made.

Policy associated with loan finance

Endowment policies on the life of a key person may be taken out as a condition of the provision of long-term finance.

For an unincorporated business the premiums on such policies are not regarded as 'incidental' to obtaining the finance within the meaning of ITTOIA 2005/S58(2), so are not deductible. 'Incidental costs' are defined in ITTOIA 2005/S58(2) as 'fees, commissions, advertising, printing and other incidental matters' and which are incurred wholly and exclusively for the purpose of obtaining the finance, providing security for it, or repaying it. The expenses listed form a class that would include any incidental costs of taking out a life insurance policy, but not the premiums, which are the cost of the policy itself.

For companies, the premiums on such policies might be considered as falling within CTA2009 s307(3) and s307(4) and therefore deductible in line with the loan relationship rules under this heading. For this purpose credits or debits to be brought into account in respect of loan relationships would include '...all charges and expenses incurred by the company under or for the purposes of its loan relationships and related transactions.' However, HMRC manuals at CFM33060 and CTM53540 indicate that premiums for key person insurance may not be regarded as directly incurred for the purpose of a loan relationship. Premiums would not therefore be regarded as deductible as incidental costs of taking out loan finance under the loan relationship rules. If such a policy has no investment element, the principles set out at 2.2.1 above could apply to permit a deduction for Corporation Tax. Where the policy has some investment element then for accounting periods beginning on or after 1 April 2008 these are within the loan relationship regime for companies anyway (see 4 below).

The HMRC view of the deductibility of keyperson insurance remains as described in HMRC manuals CFM33060 and CTM53540. If the policy includes an investment element as suggested in paragraph 2.2.5, HMRC would not consider that policy to be a true 'key person' policy, as this provides for protection only.

Key person insurance receipts – where premiums allowable

As a general rule, where both conditions outlined at 2.2.1 are satisfied and the premiums are deductible then any sums received will be income of the employer's trade (CIR v Williams' Executors (1944 26TC23, page 37).

Key person insurance receipts – where premiums disallowable

As a general rule, where a policy does not comply with both of the conditions at 2.2.1 above:

• the premiums cannot be deducted, and
• receipts under that policy are not taxed as trading income.

However, whether particular receipts are part of trading income is a separate matter of law to the deductibility of expenditure. No assurance can be given that any future receipt will be excluded from Case I income even though the premiums are not allowable (Simpson v John Reynolds & Co (1975) 49TC693 and McGowan v Brown & Cousins (1977) 52TC8).

COUNSEL'S OPINION

We have a copy of Counsel's Opinion for a case where the agents had been unaware that insurance premiums included a Keyman insurance policy and consequently no adjustments had been made in the corporation tax computation. The policy had been set up 10 years previously and the premiums had been claimed for all years since.

The background was as follows:

• 1989 Company took out mortgage with bank to buy premises.
• March 1990 Company took out insurance policy on life of two directors (brothers owning 40% shareholdings each) on recommendation of bank manager.
• 1996 One brother died. Insurance proceeds of £500,000 were paid to company. Counsel was very clear that the £500,000 policy proceeds were a Schedule D Case I receipt of the Company and he referred to the cases of CIR v Williams' Executors (26 TC 23) and Keir & Cawder Ltd v IRC (38TC23) in support of his view.

In the Williams Executors case an accident policy was taken out by a company on the life of a director who was a 35% shareholder. Evidence was given to the Commissioners that a factor in the decision to take out the insurance was that in the event of the director's death, the company's business would suffer and his family would not get much for his shares. It was also stated that the object of the insurance was not to cover any temporary loss. Unfortunately that evidence did not help and the Revenue won the case. This was a unanimous decision of the House of Lords and therefore carries substantial weight. This case was followed in the Kier and Cawder case which concerned a life insurance policy on the life of a consultant.

Notwithstanding what the Manual said, Counsel did not consider that the fact that the deceased director was a shareholder was determinative of the main issue which was essentially whether the premiums were paid to protect the company from loss of profits. He considered that the fact that the shareholders might also benefit was not relevant unless the real reason for taking out the policy was to protect them rather than the company.

LIFE INSURANCE INVESTMENT PRODUCTS

Introduction

Where a keyman insurance policy is purely a term assurance policy and has no investment element, then it will have no surrender value prior to death. Where a keyman policy is tied to an investment product, however, it may have a surrender value (though HMRC's view is that Keyman Insurance policies cannot have an investment element, and so any such policy which does is not a Keyman Insurance policy in their eyes).

Application of the Loan Relationship Rules

Life insurance contracts with a surrender value or other investment element, held by companies may (for accounting periods beginning on or after 1 April 2008) be treated as though they were loan relationships (FA2008, Sch13 and CTA2009 Part 6 Ch11). Some investment life insurance contracts are excluded from these new rules, however, and include those held for the purpose of a registered pension scheme and those issued in respect of an insurance made before 14 March 1989. The tax treatment of policies within the new rules will depend on the accounting treatment.

In effect, the Loan Relationship Rules deal with the tax treatment of interest bearing assets held by companies. The important thing to note is that the tax treatment arising from the Loan Relationship Rules should follow the accounting treatment adopted by the company, provided that the accounting treatment follows "generally accepted accounting practice".

Accounting implications for tax under the loan relationship rules

Current Assets.

If the life assurance policy with a redemption value or capital redemption bond is being held as a quasi bank account then it should be shown on the company's balance sheet as a Current Asset. The effect of this is that the asset should be held at current cost or fair value. This means that any change in the value of the asset will be reflected in the company's profit and loss account. Consequently, tax deferral will not be possible.

Fixed Asset Investments.

If the life assurance policy with a redemption value or capital redemption bond is being held as a long term investment for the company then it should be held on the company's balance sheet as a Fixed Asset as an Investment. In these circumstances the company might be able to choose between showing the asset at either historic cost or current cost. If a current cost basis is adopted then the position described in the previous paragraph applies. Alternatively, if an historic cost (i.e. purchase price) basis is chosen then tax deferral might still be possible. A company using the FRSSE (Financial Reporting Standard for Smaller Entities) accounting standard as a basis of reporting, will be using the "historic cost" basis and thus there will be no requirement to account for changes in the value of the asset on a year by year basis.

Existing policies with investment content

The CTA09 part 6 chapter 11 provisions apply to companies that have already invested into a life assurance bond. In these circumstances the company will be deemed to have fully assigned the bond on the day before the accounting period beginning on or after 1 April 2008 and reacquired it on the following day so bringing the policy into the Loan Relationship Rules.

If this assignment, which is made by reference to the carrying value of the bond at that time as recognised for accounting purposes, creates a gain there is no immediate liability to corporation tax. This gain is brought into charge as a non-trade credit when the bond is surrendered in whole or in part (in the latter case the gain brought into account is a calculated fraction of the gain at commencement). Where there is a loss, there are currently no provisions to provide relief.

Losses on policies with investment content in the future

If, following the bond being taxed under the Loan Relationship Rules, the value of the bond falls in a particular accounting period, there are no restrictions in obtaining a tax deduction for such a loss under the Loan Relationship Rules. Any losses on the bond can be offset against trading income, interest income, capital gains and other taxable income in the tax year in question. Furthermore, any excess losses can be carried forward for relief against non-trade income in other subsequent tax years.

Rules applying pre the loan relationship rules

Formerly life policies held by companies may have come within Sch 9 FA 1989. There was a potential charge under Schedule 9 on gains on policies effected after 13 March 1989. The gain in this case would be the excess of the surrender value immediately before death over the total premiums paid.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.