BIM45525 - Specific deductions: insurance: employees and other key persons

An employer may take out in his own favour a policy insuring against loss of profits resulting from the death, critical illness, sickness, accident or injury of an employee, director or other ‘key person’. The premiums on such a policy will be allowable if all the following conditions are met:

• 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. Guidance on possible non-trade purposes is at BIM45530.
• 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.

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, see Earl Howe v CIR [1919] 7TC289, page 300.

Key person 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. The premiums on such policies are not regarded as ’incidental' to obtaining the finance within the meaning of ICTA88/S77 (6), so are not deductible. ’Incidental costs' are defined in ICTA88/S77(6) as ’fees, commissions, advertising, printing and other incidental matters'. 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.

Further guidance on ICTA88/S77 is at BIM45800.

Guidance on allowable expenses under the loan relationships legislation for companies is at CTM53530 to CTM53540.

Guidance on the calculation of gains on company policies held as security for commercial mortgages is in the Insurance Policy Taxation Manual.

Key person insurance receipts - where premiums allowable

As a general rule, where both conditions outlined above are satisfied, the premiums will be deductible, and sums received under such a policy will be income of the employer's trade ( CIR v Williams' Executor [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 above conditions:

• 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).

General guidance on insurance receipts is at BIM40750 onwards.

Insurance against paying compensation to employees

Where an employer takes out a policy to provide against an obligation to pay compensation on the death etc of employees, or where the employer insures against general liability under the law to pay compensation, the premiums are allowable as a deduction.

Benefits paid direct to employee

As regards sickness and life insurance policies in the names of or on behalf of employees, see the guidance on pension schemes at BIM46000 onwards.