Keyman insurance is a crucial tool for businesses looking to protect themselves against the financial impact of losing a vital employee, such as a top executive, founder, or specialist. It provides a financial safety net if the key individual dies or becomes critically ill, ensuring the business can continue to operate without immediate disruption. While the protective benefits of Keyman insurance are well understood, its tax implications are often overlooked or misunderstood. Whether you’re a small business owner or part of a corporate finance team, understanding how this type of policy is treated under tax laws can help you make informed financial decisions.
What Is Keyman Insurance?
Before diving into tax treatment, it’s important to clarify what Keyman insurance is. It is a life (or sometimes critical illness) insurance policy that a business takes out on a key employee. The business pays the premiums and is also the beneficiary of the policy. If the insured key person passes away or becomes incapacitated, the company receives a payout that can be used for operational continuity, recruiting replacements, paying debts, or reassuring investors and clients.
Tax Treatment of Premiums
In most jurisdictions, the way Keyman insurance premiums are treated for tax purposes depends on the reason the policy was taken out and who receives the benefit. Here’s how it generally works:
- Premiums Are Typically Not Tax-Deductible: If the policy’s purpose is to protect the business’s profits or to cover potential financial losses, the premiums are generally not tax-deductible. Tax authorities view this as a capital expense rather than an operational one.
- When Premiums May Be Deductible: In rare cases, if the policy is strictly for revenue protection and not for capital gains or shareholder benefit, some jurisdictions may allow the deduction. However, this usually requires documentation and clear intent behind the policy.
- Policies for Employee Benefit: If the policy is structured so that the proceeds will go to the employee’s family or estate, the premiums may be considered a benefit-in-kind and taxed accordingly as part of the employee’s remuneration package.
Taxation of Policy Proceeds
When a claim is made and the policy pays out, the taxation of those proceeds also depends on the policy’s purpose and structure:
- Proceeds Typically Not Taxable: If the business is both the policyholder and the beneficiary, the payout is usually not considered taxable income. However, this can vary depending on local tax rules.
- Capital Gain Considerations: If the policy is part of a broader business sale or succession plan, the proceeds may be subject to capital gains tax, especially if they increase the valuation of the business.
- Impact on Shareholders: If shareholders receive the benefit directly or indirectly from the policy payout, this could trigger personal tax liabilities.
Accounting Implications
In accounting terms, Keyman insurance premiums are generally recorded as an expense, but how it is classified (capital or revenue) may depend on the purpose of the policy. On the balance sheet, the surrender value of a whole-life Keyman policy may also be recorded as an asset, especially in cases where the policy accumulates value over time.
Businesses should work closely with their accountants to ensure premiums and proceeds are treated correctly in financial statements and tax filings.
International and UAE Considerations
In the UAE and other tax-friendly jurisdictions, corporate taxes may not apply in the same way as in Western economies. However, with the UAE gradually introducing corporate tax frameworks (such as the 9% corporate tax on business profits starting from June 2023), businesses should be prepared for evolving rules. Currently, Keyman insurance premiums are often treated as a non-deductible business expense, but official guidance may evolve as the tax system matures.
Best Practices
To ensure you’re compliant and maximizing the financial efficiency of Keyman insurance:
- Document the Policy’s Purpose: Keep records showing why the policy was taken out and how it supports business continuity.
- Consult a Tax Advisor: Because tax laws vary by country and change over time, professional advice is essential.
- Separate Personal and Business Benefits: If the policy serves both business and personal interests, clearly distinguish the portions and their tax treatments.
- Review Policies Regularly: As business needs and tax regulations change, it’s wise to reassess your insurance strategies annually.
Final Thoughts
Keyman insurance is a powerful financial tool that protects a business against the loss of a crucial team member. However, its value can be diminished if not properly understood from a tax perspective. By knowing how premiums and payouts are treated, businesses can better plan their finances and ensure compliance with evolving tax laws.Whether you operate in a tax-heavy jurisdiction or a low-tax environment like the UAE, being aware of the tax implications of Keyman insurance can help you use it more strategically and responsibly.