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Tax-efficient keyperson cover

Tax efficiency is possibly one of the most frequently used phrases in the industry and one that regularly forms the cornerstone of recommendations presented to our customers.

In the same way, reference is often made in corporate protection planning to the “tax efficiency” of particular recommendations being made.

A major sector of the corporate protection market is keyperson cover and it is here that we regularly comment about taxation. Most of the comment is made in the context of the eligibility or otherwise of premiums for corporation tax relief as a business expense. Consideration should also be given to the tax treatment of any claim benefits that may arise in the future from a keyperson policy.

While the guidelines were laid out as long ago as 1944, it is still important to refer to individual local tax inspectors for the position relating to a specific business (draft letters are available from providers for this purpose).

It is not possible to assume that electing to give up corporation tax relief on the premiums would result in tax-free policy proceeds. Therefore it could be worthwhile considering an alternative basis to lump-sum benefits.

Recommending that your clients have benefits payable in instalments rather than as a lump sum could enable them to significantly reduce the burden of corporation tax payable by the company in the event of a claim. Let us look at a sample case focusing particularly on taxation of claim benefits:

In 1999 a shipping agency on the advice of their adviser arranged a five-year keyperson policy for £750,000 on the life of their sales and marketing director.

Her overseas connections, industry knowledge and sales ability meant she was very much a key contributor to the company&#39s bottom line. Sadly in November 2001 she died after suffering a stroke.

Under example (A) below the sum assured is assumed to be payable as a lump sum while in example (B) it is assumed that the claim is payable in three equal annual instalments.

As a result of the death of such a key contributor to the business it is likely that the trading profits of the company could suffer significantly in at least the following two years. Assuming therefore that these fall to nil, the tax payable on year two and three instalments would be £50,000 in each year.

The extra amount of corporation tax as a result of the keyperson lump sum payment is £237,500 i.e. £287,500 minus £50,000. On the other hand the extra amount of tax attributable to the instalment method is £175,000 (i.e.£225,000 minus £50,000).

In this example having the benefits payable in instalments can result in a corporation tax saving of £62,500 (that is, £237,500 minus £175,000).

Advising corporate clients to elect at the outset to have benefits payable by instalments can produce a very tax-efficient position at time of claim. This can prove invaluable to a business when other pressures will be coming to bear.

In the example tax assumptions are based on current legislation, which may change in the future.

Example A

Assume that profits subject to corporation tax in the financial year April 1 2001 to March 31 2002 are £250,000 with the keyperson sum assured of £750,000 being payable as a lump sum. The corporation tax payable is as follows:

Tax calculation excluding keyperson benefits:

First £250,000 @20 per cent = £50,000

Tax calculation including keyperson benefit of £750,000

First £300,000 @ 20 per cent = £60,000

Balance of £700,000 @ 32.5 per cent = £227,500

Total payable on £1m (£250,000 + £750,000) = £287,500

Example B

Assume that profits for financial year April 1, 2001 to March 31, 2002 are £250,000 but rather than a lump sum of £750,000 the company has arranged for the keyperson sum assured to be paid in three equal annual instalments of £ 250,000.

Tax calculation excluding keyperson benefits:

First £250,000 @20 per cent = £50,000

Tax calculation including first keyperson instalment of £250,000

First £300,000 @ 20 per cent = £60,000

Balance of £200,000 @ 32.5 per cent = £65,000

Total payable on £500,000 (£ 250,000 + £250,000) = £125,000

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