Keyperson cover for companies

To recap, cover on the life of a non-shareholding or shareholding employee would normally be set up on a life of another basis with the company effecting the policy on the life of the employee. Where the cover needs to be established on the life of a shareholding director, there are two ways of achieving this: 

• on a life of another basis with the company effecting the policy on the life of the shareholding director (“the corporate route”); or 

• on the so-called “personal route” whereby the shareholding director effects a policy on his own life subject to a business trust for the benefit of his co-shareholders for the time being in the company. The idea is that if a claim is made and money is paid to the surviving shareholders they can use it to make a loan to the company to cover the business need. 

 

This month we will compare the two routes from the standpoint of: 

1. General considerations
2. Comparative costs
3. Taxation of the policy proceeds
4. Trust taxation

 

1. General considerations 

The corporate route 

• Corporate ownership of a policy taken out to provide keyperson cover is the natural choice. The policy is held directly by the company, which gives certainty, with funds paid to the company which the company can use to meet any business loss. If there are excess funds over and above the company’s needs then these can be distributed as a dividend to the surviving shareholders.  This would have income tax implications. 

• The corporate route is the least complicated route. The company merely effects a policy on a life of another basis and no trust is involved – see later.  

• The corporate route is normally the cheaper – see the comparison table in 2 below. 

• Where the lives assured are major shareholders (generally taken to mean 5% or more), which is likely to be the case, premiums will normally not be deductible for the company but from this it usually follows that the policy proceeds will not be subject to corporation tax as a trade receipt (but needs to be confirmed by HMRC). 

The personal route 

• The policy will be owned outside of the company. The proceeds will be paid to the shareholders as beneficiaries under the trust. If the company is then in need of funds (which would have been the purpose of the policy) the surviving shareholders could help to meet this need by making business loans to the company. There is therefore no certainty that the proceeds would be available to the company.  

• The personal route is more complicated because it involves trusts and there would need to be an understanding that if policy proceeds are paid out they will be lent to the company by the surviving shareholders if that is what is required. 

• Because under a typical “business trust” the beneficiaries are restricted to the shareholders taking part in the arrangement (i.e. each taking out a policy under a business trust for the other shareholders), this route will generally not be suitable unless all the shareholders participate. For example, it will not be suitable if only one of the shareholders is a keyperson and no share purchase arrangement using business trusts is being put in place at the same time. 

• If the company doesn’t need the funds (because business income doesn’t suffer through the loss of the shareholding director) then the surviving shareholding directors can keep the funds with no tax implications. 

• Premiums will not be tax relievable and the policy proceeds will be paid free of income tax (inheritance tax is dealt with in 4. below).

 

2. Comparative costs

In choosing the corporate or personal route for owning the policy in respect of keyperson cover, an important factor will often be the costs involved. If the company will be meeting the cost of the premiums it is undoubtedly cheaper to adopt the corporate route as demonstrated in the following table.

The table compares the position of a company paying a premium of £6,000 into a “corporate route” policy with a company providing a higher/additional rate taxpaying director with sufficient additional salary to pay the £6,000 premium under a “personal route” policy and meet the additional income tax and National Insurance contributions on that salary increase so the director is in the same net income position.  The figures are for tax year 2019/20 and assume that the company pays corporation tax at the rate of 19%, the director pays the 2% NIC surcharge and the company pays NICs at 13.8%. 

 

	“Corporate route” policy	“Personal route” policy
		40% taxpayer	45% taxpayer
	£	£	£
Pre-tax profits	100,000	100,000	100,000
Salary*	-	(10,345)	(11,320)
Employer’s NIC **	-	(1,428)	(1,562)
	___________	____________	____________
Taxable	100,000	88,227	87,118
Corporation tax @ 19%	19,000	(16,763)	(16,552)
	___________	__________	__________
Net	81,000	71,464	70,566
Premium	6,000	-	-
	___________	__________	__________
Company’s net profits after payment of the premium:	75,000	71,464	70,566

The “corporate route” is cheaper.  In the case of a 40% taxpayer the net annual saving is £3,536 and in the case of a 45% taxpayer £4,434.

 

*          The salary level that has to be paid to leave £6000 [net of income tax at 40% /45% and employee’s NICs (2%)] in the director’s hands. 

**        The Employment Allowance is assumed to already be used or unavailable.

 

3. Taxation of the policy proceeds

The position as regards the taxation of the policy is as follows:   

The personal route  

Adopting the personal route, the chargeable event provisions will apply which could result in an income tax charge on the shareholding director or trustees as appropriate.  

If the policy is a qualifying policy the chargeable event legislation should not apply to a payment on death. Even if the policy is non-qualifying then on death giving rise to the payment of benefits the measure of the gain is, broadly speaking, the surrender value of the policy immediately before death less the premiums paid.  This will invariably be nil and so any chargeable event gain is therefore likely to be nil or negligible. 

The corporate route 

For company-owned life assurance policies taken out now, the chargeable event legislation does not apply. Instead, any life assurance policy that is capable of acquiring a surrender value will be taxed under the loan relationship rules. 

However, there is no charge to tax on any mortality or morbidity profit. It is only any investment gains that can be subject to corporation tax under the loan relationship rules. 

As keyperson policies will generally be term assurance policies (with no surrender value) the loan relationship rules will not apply. A company-owned whole of life or endowment policy that might acquire a surrender value would be subject to tax under the loan relationship rules, but only on any investment gain (not on the sum assured payable). So the likelihood of an actual charge to corporation tax under the loan relationship rules is small. 

 

4. Trust taxation

The personal route 

Most trusts created after 21 March 2006 will be subject to the relevant property (discretionary trust) regime for IHT purposes. 

However, as mentioned previously, keyperson cover would generally be provided under a business trust where share purchase arrangements between shareholders are also put in place. The cover for each shareholder would be the amount required for share purchase plus the amount of keyperson cover. If the arrangement is a truly commercial arrangement, ie. each shareholder pays a premium which reflects the cost of the benefits they could receive, then the premiums should not rank as gifts for IHT purposes. In addition, the shareholder could be a potential beneficiary under the trust without infringing the gift with reservation of benefit provisions. 

In theory the income tax pre-owned assets tax (POAT) rules could apply but this is only perceived to be a risk if the sum assured is paid and kept within the trust for a reasonable period of time. 

Despite there being no gifts involved, IHT charges could also arise on 10-year anniversaries and when property leaves the trust. For example, this might happen where the life assured (the shareholder) is terminally ill at the 10-year anniversary because the policy may then have a significant value. Also, if the life assured dies shortly before a 10-year anniversary then the trustees may still be holding significant amounts of cash in the trust at the anniversary. 

The corporate route 

No trust is involved. 

 

In the next article we will review keyperson cover for partnerships and LLPs.