What is Key Person Protection?
Key Person Protection helps safeguard a business against the financial effects of death, terminal illness, or critical illness* of a key person. The loss of a key person may result in reduced sales, loss of profit/turnover, wasted time, recruitment costs, the disruption of developing plans or increased workloads for remaining staff.
* if critical illness cover is chosen as an additional option.
Who is a Key Person?
A key person is an employee whose continued absence would affect the profits of the business. Someone whose skills, knowledge, experience or leadership are important to its continued financial success. Examples of a key person include, but are not limited to:
- - Sales Director
- - IT specialist
- - Managing Director
- - Head of product development
- - Technicians and R&D personnel
A note about the information
Below summarises taxation issues that apply to our business protection products. In all cases, we have based this information on our understanding of current tax laws and HM Revenue & Customs practice, which is subject to change. We therefore strongly recommend that you and your client seek advice from their company’s inspector of taxes before completion of a policy.
Taxation for Key Person Protection for a company
The company’s local inspector of taxes may allow corporation tax relief on the policy premium, provided that:
- the sole relationship is employer/employee;
- the cover is for loss of profits resulting from loss of service of that employee;
and
- the policy is an annual or short term (less than five years) assurance.
It is thought that the tax inspector might not approve term assurance plans longer than 5 years or whole of life, as the term is likely to be more than 5 years. For life and critical illness cover and critical illness cover, a five year term may be deemed acceptable.
Where corporation tax relief has been given on the premium, the whole policy proceeds will usually be treated as a trading receipt of the company in the year of payment, and will be fully liable to corporation tax.
When choosing to give up corporation tax relief on the premiums it should not be assumed that this will result in tax free policy proceeds. Ask the company’s tax inspector before making any decisions.
Key Person Protection cover should not necessarily be restricted to policies where corporation tax relief on premiums may be available. It could prove wiser to try and ensure that the policy proceeds are received free of tax. In any event, if the sum assured is based on gross profits, the fact that it is taxable will not matter.
Can Key Person Protection be applied to a controlling director?
Yes, but the company’s tax inspector will probably feel that the policy benefits will be largely for the benefit of the life assured (because he or she owns a majority of the shares), and it is unlikely the tax inspector would grant tax relief on premiums.
Are there any inheritance tax issues?
Cash paid to a company from a policy will boost the value of the shares in that company, so if the key person who dies is also a shareholder, the value of his or her estate would be increased. If the shares pass to someone other than the wife, husband or registered civil partner of the person who dies, and business property relief is not fully available, any inheritance tax liability may increase.
Taxation for Partner/Director Share Protection
Inheritance tax
Each protection policy used to support a cross option agreement is usually written in trust for the benefit of the fellow partner(s)/ shareholding director(s). As such, any benefits from the policy will be payable to the trustees and not to the partner/ shareholding director or his estate. In addition, the policy premiums may fall within one or more of the inheritance tax exemptions.
If a partner/ shareholding director dies and the cross option method has been used then any business property relief on their share of the business would be preserved.
Capital Gains Tax
There is no capital gains tax on death but the beneficiaries of the estate may be liable for the increase in value of the share of the business between death and sale, although in practice this would be rare.
However, in the event of the sale of a partner’s or shareholding director’s share due to critical illness, a capital gains tax liability may arise.