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Beauty contest

This week, I will continue my look at the taxation fundamentals of keyperson insurance and the deductibility of premiums. To be deductible, the premium must be paid wholly and exclusively for the purpose of the trade (section 74(1)(a) ICTA 1988).

Within BIM 45525, specific reference is made to BIM 45530 in connection with greater detail on what constitutes a non-trade purpose which would give rise to non-deductibility for a premium. Even if there is some trade purpose but it is not the sole purpose, this amounts to duality of purpose. Duality of purpose results in non-deductibility.

The detail of BIM 45530 is as follows: “Whether the sole purpose condition is met is a question of fact, to be determined by evidence of what the directors of the company concerned, or the proprietors of an unincorporated business, were seeking to achieve by taking out the insurance policy (NB: it is the purpose at the time of taking out the policy that is relevant. It seems that a purpose test is not run at the point each premium is paid. In this respect, the test seems to be rather like that for insurable interest, that is, applied at outset. It is thought that this is a pragmatic approach and relates to the test being run once at the time the asset – the life policy – is brought into existence rather than when each expenditure of premium maintaining the asset – the policy – is paid) and paying the premiums.” General guidance on the “wholly and exclusively” test in section 74(1)(a) ICTA 1988 is at BIM37000 onwards as follows: “Circumstances in which there may be non-trade purposes for taking out a ‘key person’ policy are:

  • where the policy is in respect of directors who are major shareholders but not other employees,

  • if benefits under the policy exceed sick pay arrangements – or other employee benefits – typically offered to employees of equivalent status in similar concerns.

    For example, where the key person is a director whose death would significantly affect the value of shares in the company, one of the purposes for taking out the policy may be a non-trade purpose of protecting the value of the director’s shares and therefore the value of their estate.” (This would then amount to, at best, duality of purpose and thus deny relief. It is important to remember that for deductibility the sole purpose must be a trading one. So, for deduct-ibility it is an “all or nothing” test. Where the life assured has a major shareholding, the value of the shares (assuming they have a reasonable value) could be materially affected by that person’s death so the keyperson insurance policy could be said to have a part capital purpose. Thus. it would seem safe to say that premiums paid under any policy on the life of a shareholding director would not be deductible.

    This was the case with one of the policies in Beauty Consultants v Inspector of Taxes (SPC321/2002) where the special commissioner decided that the premiums on all four of the insurance policies in dispute were not paid wholly and exclusively for the purposes of the company’s trade:

  • The first two policies, which were on the life of each of A and B, the two directors of the company, were taken out a number of years before the company was formed, and related to the directors’ ownership of their private residence – the only connection between the company and these policies was that the bank lending to the company had a second charge on the house. The Special Commissioner denied a deduction of these premiums because the general conditions were not satisfied.

  • The third policy was in the directors’ own names and linked to a first charge on the property from which the business was conducted under which the directors’ preference shares would be repaid on the sale of the business premises. As the excess of the policy moneys over the secured debts would belong to the directors the Special Commissioner could not identify any benefit to the company or its trade in paying the premiums.

  • The fourth policy was taken out by another company of which A and B were the sole shareholders and directors. It was assigned to Beauty Consultants Ltd in circumstances where A and B were about to become directors of the company with arrangements to acquire shares in it. The Special Commissioner decided that this policy had a dual purpose, similar to that in Samuel Dracup & Sons Ltd v Dakin [1957] 37TC377. Although the policy would benefit the trade of the company it would also improve the value of the directors’ shares. (Reaffirmation of the “all or nothing” test).

    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 a general liability under the law to pay compensation, the premiums are allowable as a deduction.

    Finally, for group policies, where there is a non-trade or personal purpose in paying premiums in the case of some members but not others, a reasonable apportion- ment may be made.

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