Without wanting to use one the biggest clichés of the decade, businesses today really do face challenging circumstances. We read about this everywhere. Company owners are working harder than ever to make healthy profits and secure new contracts. To achieve this, the majority of smaller businesses and owner managed companies rely on a core team of people and, if one of those individual is fatally injured or falls ill for an extended period, this can have disastrous consequences for revenues. To counter the financial implications of this happening, many purchase ‘keyman’ insurance policies for protection.Whilst this is a common strategy to adopt and perfectly sensible, it does not come without issues. In particular, it is always essential to consider the potential tax implications of keyman insurance and have the policy wording reviewed for any tax charges that may be payable in the event of a claim. In our experience working with clients who have taken out this type of protection, many have taken out policies believing that any payments were outside the scope of tax and unfortunately this was proven to be incorrect.
Get policies reviewed to understand tax implications.
The following case study highlights how one firm of solicitors inadvertently took out key man insurance and were at risk of receiving significantly less than they were expecting.
The firm, a partnership, took out a keyman insurance policy to ensure that if any one of the partners should become critically ill or were to die, the partnership would receive a lump sum payment. The aim of the payment was to provide the business with funds to recruit and remunerate a new partner and ensure that the future of the business was secured.
Each of the three partners was insured for an amount of £5m and monthly premiums were paid for by the business; tax relief was claimed for the cost of the premiums. Although this is a common scenario, it results in a potential tax liability because should the insurance policy eventually pay out, HMRC would seek to tax the £5m as income because tax relief has been claimed for the cost of the premiums.
In this instance, as the firm is a partnership, the rate of tax payable on any income received on the policy would be at the highest rate of income tax (currently 45%). We pointed out that the net effect would therefore be receipt of an amount of about half of what was expected (and presumably what was required) leaving the business to fund the shortfall. We were able to advise the firm on how to avoid this problem and ensure that in the event of a claim the full amount of funds required was received.
Our advice to clients is that this can be a complex area and if you are considering purchasing keyman insurance, it is well worth seeking advice from both an IFA and tax advisor on the tax implications, to make sure that tax reliefs are available but not at the cost of reduced income for the business. In certain circumstances it may be possible to avoid paying additional tax on any income from a premium, depending on the type of policy utilised and the way it is being financed.
To find out more about this issue, contact Anne Eager by emailing ae@rjp.co.uk.