KEY PERSON COVER
Business Protection Arrangement
This article provides an outline of the taxation issues to be considered when you are considering a business protection arrangement for your business or company. It is based on our understanding of current legislation and Revenue practice.
In all cases we would recommend that business owners obtain professional legal and tax advice to ensure that any arrangement they put in place is appropriate to their personal and corporate circumstances.
1.1 MANAGEMENT EXPERTISE
Management expertise, experience and contacts are often the most important assets of a business.
It is the difference in the quality of management expertise that explains why some businesses
prosper while others fail.
1.2 THE LOSS OF KEY PERSONNEL
Statistics show that over 90% of business failures result from management breakdown. In many
such cases it is likely that failure results from the sudden loss of key personnel.
The sudden death or serious illness of a key person could give rise to a number of immediate
financial pressures for the company:
- the ‘calling in’ of company loans, in particular any to which the ‘key person’ had given a
- a costly interruption in business
- a loss of business contacts
- extra resources may have to be committed to the recruitment and replacement of the key individual.
2.1 KEYPERSON COVER
Keyperson cover is life assurance effected by an employer on the life of a key employee, who may also be a shareholder or director, to protect the company against the financial consequences of that individual’s sudden death or serious illness.
Keyperson cover is designed to protect the value of the company’s human assets in much the same way as fire insurance protects a company’s physical assets.
Keyperson cover can provide an immediate lump sum payment to the company. The company would use these funds in any way it chooses:
- repayment of bank loans, particularly any to which the key individual has given a personal guarantee.
- repayment of any loans the key person may have made to the company.
- recruitment of a successor.
- investment in the business.
2.2 WHO IS A KEYPERSON?
A keyperson is any ‘key’ employee or director on whom the business depends for its continued success, or existence, and on whose death or serious illness the business could suffer a financial loss.
2.3 AMOUNT OF COVER
In determining the appropriate amount of keyperson cover an insurable value must be put on the potential financial loss the company would suffer on the death or serious illness of a key individual.
In assessing the amount of cover two important factors to consider are:
- Loan Repayment, any loans personally guaranteed by a “keyperson” or any loans made by him or her to the company.
- Loss of profits cover. The death or serious illness of a key individual could jeopardise the trading position and profitability of the company.
The cover required is the estimated financial loss that the business would suffer plus the costs of replacing the key individual.
Other than in the case of loan cover, estimating the financial loss can be extremely difficult. The level of cover is normally related to either the person’s salary or to the company’s profitability.
Typical maximum cover levels should not exceed 10 times salary, or if the calculation is in relation to profit then the keypersons percentage contribution to profit to a maximum of twice gross profit or 2.5 times net profit (i.e. profit after expenses but before tax).
The most important point to consider in relation to the taxation of key person contracts is whether the proceeds payable on death or serious illness will be liable to tax.
3.1 PLAN PROCEEDS PAYABLE ON DEATH OR SERIOUS ILLNESS
The purpose of the plan is to protect the company financially in the event of the death or serious illness of a key person, so the company needs to know, if they affect cover of €100,000, will they actually end up with €100,000 or €100,000 less Corporation tax.
The purpose for which the plan is taken out, whether to cover a “Capital” or “Revenue” type loss, is the main consideration in establishing whether or not the proceeds will be taxed.
If the purpose of the plan is to protect a company loan then the proceeds are likely to be treated as a capital receipt for the company and thus not subject to Corporation Tax. The proceeds of a company owned plan, paid out on death or disablement, are exempt from Capital Gains Tax.
So, no tax liability arises for the company.
If the plan is to protect “loss of profit” (if the profits were earned they would be subject to Corporation Tax) or other “revenue items” such as replacement costs then the proceeds are likely to be treated as a “revenue receipt” and subject to Corporation Tax.
Where the cover is required for two different purposes i.e. loan cover and loss of profits cover, we would recommend two separate plans should be taken out.
3.2 TAX DEDUCTION FOR PREMIUMS
Generally speaking keyperson cover premiums are ‘not’ admissible deductions for Corporation Tax purposes. However, the Revenue Commissioners have outlined the circumstances in which such premiums may qualify as admissible deductions:
a) the sole relationship is that of employer and employee,
b) the employee has no substantial proprietary interest in the business,
c) the insurance is intended to meet loss of profit resulting from the loss of the services of the employee as distinct from loss of goodwill or other capital loss, and
d) the plan is a short-term insurance, providing only for a sum to be paid in the event of death.
Therefore, premiums on keyperson cover life assurance plans which do not meet all of the above requirements are not admissible deductions for Corporation Tax purposes.
On this basis, keyperson cover life assurance premiums for plans taken out to repay loans or other outstanding debts are not admissible deductions for Corporation Tax purposes.
|REASON FOR COVER||BENEFITS||PREMIUM|
Loss of Profit /
Tax deductible - if the
4 conditions across are
/ Share Purchase
No – Not
|Not tax deductible|
More details on the Revenue interpretation of conditions (a) to (d) above are set out below.
3.3 BOARD RESOLUTION
We recommend that the company pass a board resolution recording their intention to affect keyperson cover. The resolution should cover the purpose for which the plan is being taken out.
The following is an extract from a circular issued by the Superintending Inspector of Taxes, dated July 1986, with regard to the admissibility of keyman insurance premiums as an allowable deduction for Corporation tax purposes.
“..the term ‘Keyman’ may be applied to a range of policies not all of which may give rise to admissible tax deductions and the allowability or otherwise of premiums paid will be determined by reference to the terms and purposes of the policy, rather than any description which the Insurance Company may give it. In applying the conditions (a), (b), (c), (d) ‘(see Section 3.2)’ the following guidelines are followed:
a: “Employee” is taken as including a Director.
b: A person who directly or indirectly, owns or is able to control more than 15% of the ordinary share capital of a company is regarded as having a substantial proprietary interest in the company.
c: The policy must be for a fixed term with no surrender value and no endowment or other investment content; it must not contain provisions whereby benefits could be paid to any person other than the employer.
d: The insurance must be related to loss of profits only and it will be necessary to satisfy the Inspector of Taxes that the contingency insured against will genuinely have an adverse effect on the employers business.
Premiums on policies taken out to cover loans or other outstanding debts which would become repayable on the death of an employee are not admissible deductions....”