Many small businesses take out keyman insurance policies designed to
pay out on the death or incapacity of a key member of the team, such as
a lead director. The premiums paid for such insurance policies are only
tax deductible as a business expense if all of the following conditions
apply:

• the purpose of taking out the policy is to cover the drop in profits that would result from the loss of the key person;
• the policy only applies for the time that the employee is useful to the company; and
• the policy has no investment element such as a surrender value.

If the purpose of the policy is to pay off a business mortgage or
loan, like an endowment policy, then that would be a capital related
purpose, and the premiums would not be tax deductible. Endowment
policies also tend to have an investment element.

Generally where the premiums paid for a keyman policy have been
correctly deducted as a business expense, if that policy pays out the
proceeds are treated as part of the trading income of the business. The
converse also generally applies that if the premiums paid were not tax
deductible, the receipts from that policy are not treated as trading
income of the business.

Unfortunately there is no law that lays down this clear principle,
and there have been several cases that have been decided either way.
Even where the premiums have not been deducted from profits, the Taxman
may argue that the payout of the policy allows the business to
continue, and the proceeds should be taxed as business profits.

Whether there is tax on the payout may affect the amount you need to
be insured for, so please contact us if you need advice on whether the
receipt of any payout would be taxable.