Ola Adeosun, Senior Wealth Planner
In a year where our health has been on the global agenda, we assess one of the ways in which small and medium sized enterprises (SMEs) can insure against business continuity risk, in the event of a key person becoming critically ill or worse.
SMEs often employ certain individuals whose skills and expertise are vital to their long-term success. For a sole trader, it is often the business owner, whereas with larger businesses, it might be a specialist with a unique skillset. Regardless of the business structure, it is essential to be aware of the financial implications that the death or serious illness of a key person would have on the business’ future.
The loss of a key person due to critical illness or death often comes with grave financial implications for SMEs. Key person insurance could represent an effective way for such businesses to mitigate the loss of profit and cash flow difficulties resulting from such a situation.
How does it work?
For a sole trader who is also the key person, the insurance policy would need to be taken on an own-life basis or on the life of another basis if it is to provide insurance cover for an employee.
In England, Wales and Northern Ireland, partnerships are not recognised as a separate legal entity, so the policy will normally need to be taken out by the individual and written under a business trust for the other co-partner/s.
Limited liability partnerships (LLPs) and Scottish partnerships have a separate legal entity and could use the life of another basis, in which case they would need to prove an insurable interest in the life assured. Where the key person is employed by a limited company, the policy is taken out on a life of another basis. In this instance, the policy would be for the benefit of the employer, with the life assured having neither a legal nor a beneficial title.
A sufficient insurable interest in the life of the person being insured needs to be demonstrated.
It is important that the business understands the tax implications of taking out the insurance. The tax treatment of each case will be determined by the facts pattern and the local inspector of taxes, which means accepted practices vary.
Her Majesty’s Revenue and Customs (HMRC) ultimately decides whether to allow the premiums as tax-deductible or not. However, it is imperative that the business obtain an advance indication as to how the premiums will be treated for tax purposes.
Persons with significant interests
Shareholding directors who are key persons can choose one of three routes in regards to how the insurance policy could be set up, each with different outcomes from a tax perspective:
If the use of a key person insurance policy for protecting a business loan would not be appropriate, instead a business loan protection arrangement should be set up. Business loan protection helps the business to pay any outstanding borrowings, in the event the person covered is diagnosed with a critical illness or dies.
How does it work?
The structure of the business will determine the appropriate arrangement for the loan protection:
In regards to the tax treatment of business loan protection, the premiums are generally paid by the business and do not qualify as a deductible business expense.
The pandemic has triggered a greater awareness of the relationship between personal and business health. The shutdown of most of society for months leaving a devastating impact on the prospects of many businesses. Despite the financial hardship, the priority for most businesses looking forward will be keeping their employees and customers safe.
To read the full article, found in this quarter's STEP magazine, please contact firstname.lastname@example.org
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