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An unsound deduction

Last week&#39s article was on the seemingly stable issue of tax relief on premiums paid by companies under policies on the lives of key people. The rules for deductibility of the premiums and assessability of the policy proceeds are well known and, broadly speaking, provide that premiums will not be deductible unless they are in respect of a policy on the life of an employee with no substantial shareholding in the premium-paying company, the policy is a short-term insurance, the sum assured is reasonable and the policy is effected to meet a revenue not capital purpose.

Little has happened to change this since 1944 so finding that there has been a recent case on the subject seemed too good an opportunity to pass up. The case I started considering last week was that of Beauty Consultants Ltd



Inspector of Taxes which was heard by a Special Commissioner. I set out the facts regarding the three policies effected for different purposes by the company. The three policies were:

•The policy styled QV effected by the holding company (Co 3) on the joint lives of its two shareholders (A and B) on a first-death basis and which was assigned to the taxpayer company (Co 4) when A and B were about to become directors and shareholders in that company.

•The policy styled QZ on the joint lives of A + B (again on a first-death basis) which was owned by A and B jointly and was linked to a charge on The Manor, which had been transferred to Co 4.

•Two Equitable policies on the joint lives of A and B which were effected in connection with the purchase of their home.

First, we will consider the QV policy – the only policy actually effected on a life-of-another basis by a company, albeit the original holding company (Co 3). Premiums had been paid since its formation by the taxpayer company (Co 4).

Lenders had originally insisted that the QV policy was taken out by the holding company (Co 3) because they were lending to companies in the group which did not have any assets. The borrowings were secured on the premises, owned by the directors, and on their home. The QV policy was subsequently assigned to the taxpayer company (Co 4).

In respect of the QV policy, the Special Commissioner decided there was duality of purpose. With Co 4 paying the premiums under the policy, A and B would benefit personally as the payment of the sum assured to Co 4 would increase the value of their ordinary shares and preference shares. In light of the dual purpose, no deduction was permissible.

Now the QZ policy. The company paid the premiums but the policy seems to have remained in the ownership of A and B. It will be recalled that the policy was a joint-lives, first-death policy. On the death of the first to die, the company&#39s debt would be paid off with the proceeds, which would benefit the survivor and the personal representatives of the first to die. They would then stand in the shoes of the bank as a secured creditor. This was of no benefit to the company&#39s trade so no deduction was permissible.

With regard to the Equitable policies, the only connection with the taxpayer company was that, when the loan to the taxpayer company was made, it was secured by a second charge on A and B&#39s home. Premiums paid by the company under their policies would serve no benefit to the company&#39s trade and so would not be deductible.

The question as to whether expenditure is capable of satisfying the wholly and exclusively test in the legislation is one of law. Once this is established, it is a question of fact whether it is incurred wholly and exclusively for the purposes of the trade. There is usually no difficulty in determining whether there was a business motive for incurring a particular item of expenditure, it is more difficult to determine whether there was some other motive.

In this case, we have the issue of a company paying premiums under a life policy on the lives of owners. There were relatively convoluted facts but, as I said earlier, the basic rules in respect of deductibility would seem to have applied, that is, that to be deductible, a premium paid by a company should be in respect of a policy where:

•It is a short-term policy.

•The sum assured under the policy is reasonable.

•The policy is not for a capital purpose.

•The sole relationship between proposer and life assured is employer/employee.

Using those tests (which do not appear to have been referred to in this case), it seems that no deduction should have been allowed as, indeed, it wasn&#39t. Only the QV policy was owned by the taxpayer company. The QZ and Equitable policies appear to have continued in the ownership of the shareholders with (presumably) the taxpayer company paying the premiums. If this were the case, it would seem that it may have been arguable that, in effect, the taxpayer company was meeting a pecuniary liability of A and B to pay the premiums, so that income tax and NIC should be payable. In this case, payments would have been deductible expenses for the company. This issue does not appear to have been considered.

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