How to ensure your firm is protected?

In the fifth part of our business protection special, Maria Merricks reveals the tax implications of safe-guarding a business.

Nothing is certain but death and taxes, the old adage goes. For advisers planning to add business protection to their service proposition, this saying is particularly relevant, as they will need to understand the tax implications of helping companies to prepare for the loss of a key player.

However, the perceived complexities of these tax rules are deterring advisers from entering the market, according to Jerry Bayman national corporate sales manager for Bright Grey and Scottish Provident. This is a myth providers are keen to bust.

Within the business protection universe, it is insurance premiums and benefits which are subject to taxation. This applies to the following solutions: key person protection, partnership protection and share protection. However, it is important to note there are certain criteria which will attract tax relief in particular cases.

Key person protection

The taxation principles for key person protection were set out in 1944, by the Chancellor of the Exchequer, Sir John Anderson. At first glance, his long-winded statement is daunting, but its underpinning requirements have since been described as the Anderson rules.

Gerry Warner, protection development manager at Zurich UK Life, insists the concept is simple in his interpretation of the rule. To discover whether key person protection premiums qualify for tax relief, he outlines four questions which require a simple yes or no answer:

• Is the sole relationship that of the employer and employee (in other words, is the plan is for a legitimate business reason)?
• Does the life assured own not more than 5% of the company’s shares?
• Is the insurance intended to meet the loss of profit resulting from the loss of services of the employee?
• Does the term stay within the employee’s period of usefulness (is it not a whole-of-life policy)?

If the answer is ‘yes’ to all four, tax relief is likely to be granted on the premiums, on the basis that it is a legitimate trading expense. If the answer is ‘no’ to any, tax relief will not be granted, on the basis that it is most likely a capital expense.
“If tax relief is granted on premiums, the proceeds will be taxed,” Warner says. “If tax relief is not granted, the proceeds will be paid free of tax.”

One option is to have key person protection applied to just a controlling director. However, Clare Harrop, head of specialist protection at Legal & General, says this may not be beneficial from a tax point of view:

“Because the director will own a majority of the shares, the company’s tax inspector will feel the policy benefits will be largely for the advantage of the life assured. So tax relief is unlikely to be granted on premiums,” she explains.

Partnership and share protection

When it comes to partnership and share protection, the tax implications are different. For example, covering the purchase of a partnership share cannot be for loss of profits, as stated in the Anderson rules, and therefore does not benefit from tax relief on premiums.

Share protection follows a similar theme: as it is covering the shareholder’s investment in the company it is not deemed to be for trading purposes and therefore is not subject to tax relief.

Who pays the premiums is also an important factor to consider, Bayman says. “If the individual pays the premiums, it is treated as personal cover and so there is no tax relief.

If the company pays the premiums, things get slightly more complicated. Here, the premium is assessed as income on the policyholder, and the company will have to pay tax and National Insurance contributions on the premium payable.

Bayman says: “In this situation, the company will be able to claim corporation tax relief on this amount; not because the insurance is an allowable expense, but because it is treated as salary, and salary is tax deductible.”

Meanwhile, where a company takes out a policy on the life of a shareholder there will be no tax charge for the shareholder themselves: this is because it is the company that will receive the benefits. In protecting the capital base as opposed to the trading base, the company will not be granted tax relief on premiums.

Inheritance tax

Inheritance tax is another consideration. It arises in the context of key person ­protection.

Harrop explains that any cash paid to a company from a policy will boost the value of that company’s shares. So, if the key person who dies is also a shareholder, the value of their estate would increase. If the shares pass to someone other than the wife, husband or registered civil partner of the deceased, any business property relief is not fully available and any inheritance tax liability may increase.

In a partner or director share protection plan, the case is different. Here, the policy used to support a cross option agreement is usually written in trust.

“Any benefits from the policy will be payable to the trustees and not to the partner/ shareholder or to his estate. In addition, the policy premiums may fall within one or more of the inheritance tax exemptions. Also in this case, any business property relief on their share would be preserved,” Harrop explains.

All providers agree that it is vital to check with HMRC how it will treat premiums and benefits at the time the cover is taken out.