Key man insurance policy tax
Some businesses take out keyperson insurance policies on the life of an employee (the keyperson) whose services contribute substantially to the success of the business, and whose death or disability will result in a loss for the business. The policy is owned and paid by the business.
Upon the loss of a keyperson, the proceeds may assist the business by enabling the business to survive losses during the adjustment period and/or meet the special expenses of recruiting and training a new employee.
Deductibility of policy premiums paid
Underlying business expenses are potentially deductible by the employing business, and the premiums in respect of insurance intended to meet such expenses should be similarly deductible.
Taxpayers seeking an upfront deduction for keyperson policy plans would have to have opt into the regime. Inaction will mean that the premiums in respect of the policy will remain non-deductible (despite satisfying the other objective requirements). Non-deductible treatment means that the policy will give rise to a tax-free payment of proceeds.
Taxpayers that opt into the regime should have expressed a choice in the policy agreement by adding to the agreement that section 11(w)(ii) is intended to apply to that policy agreement. For policies entered into before 1 March 2012, it should be stated in an addendum to the policy agreement by no later than 31 August 2012 that section 11(w)(ii) applies in respect of premiums payable under that policy.
This choice is to be expressed by making this statement in the policy agreement so that the choice is clearly visible for all parties involved (including SARS). The once off choice cannot be changed once made.
Other than expressly exercising the choice in the policy agreement that section 11(w)(ii) applies to that agreement, the taxpayer must also meet other objective criteria (introduced in the 2010 legislative cycle):
- The business must be insured against the loss of a keyperson by reason of death, disability or severe illness;
- The policy must solely be a risk policy (without any cash or surrender value associated with investment policies); and
- The taxpayer must be the sole owner of the policy.
Proceeds received by the employer (paragraph (m) of the “gross income” definition)
In the case of risk policies, the policy pay-outs are either in the form of a lump sum paid out to the beneficiaries (such as in the case of a death benefit) or in an annuity format (such as in case of income protection policies). In the case of investment policies, the policy proceeds are typically paid out in the form of a lump sum.
As stated previously, an employer can either take out an employer-owned insurance policy that relates to the death, disablement or severe illness of employees for the employer’s benefit or for the benefit of the employees. In the case where the employer intends to benefit, the structure is simple. The employer pays the premiums, and the employer is the beneficiary under the policy entitled to the benefits.
In respect of a proceeds pay out in the case of an employer-owned insurance policy where the policy proceeds are received by the policyholder (the employer), the policyholder will be taxed, subject to a particular exemption.
As per section 10(gH) the exemption relates to keyperson plans where the policyholder did not choose to be eligible for the deduction of the premiums as from 1 March 2012 onwards. Restated for clarification, if the employer policyholder receives the insurance proceeds in respect of an employer-owned insurance risk policy for the benefit of the employer on or after 1 March 2012, the proceeds will be tax-exempt unless the policyholder elected in the policy agreement to be eligible to claim the premiums as deductions.
It should be noted that no exemption is available for the employer in the case of proceeds received by the employer in respect of an employer-owned insurance policy that is intended for the benefit of an employee. The employer will be taxed on the policy proceeds received (as an inclusion of the proceeds in gross income). However, the employer will be eligible for a deduction when paying over the proceeds to an employee (if there is an obligation to do so), leaving the employer in a tax neutral position.
Lindi Penning CA(SA) RA
The information provided herein may not be construed as legal and/or tax advice. Professional advice should be sought with reference to specific background facts before any action is taken based on the information contained herein. We hereby disclaim any responsibility should any person act upon the contents of this publication without due consultation.
PKF South Africa Inc. member of PKF International. PKF South Africa Inc. is a member firm of the PKF International Limited family of legally independent firms and does not accept any responsibility or liability for the actions or inactions of any individual member or correspondent firm or firms.
"PKF" and the PKF logo are registered trademarks used by PKF International and member firms of the PKF International Network. They may not be used by anyone other than a duly licenced member firm of the Network.