Insuring key players
Many small to medium size companies are highly dependent on key
employees who have intricate knowledge of the company and contribute
significantly to the businesses’ success. While these key players
are invaluable assets to a company as a source of competitive
advantage, a company’s reliance on these employees can put the
company in a vulnerable position. For example, in the ill-fated
event of an accident or death, the company not only loses an
employee, it loses the experience, skills, and business
relationships the employee has developed.
In light of this inherent risk, businesses are taking up ‘key
man’ life insurance policies and similar types of policies to ease
the impact on the company in the event of an injury or death of a
key employee. In doing so the insured parties should, however, be
aware of the tax implications of these insurance policies.
Key man policies
As a general rule, the cost of premiums on life insurance is not
deductible. An exception to this is where the insurance policy
proceeds are intended to replace a revenue receipt, which the death
of the employee, for instance, has prevented from arising.
Accordingly, the cost of a policy premium is deductible if the
policy is intended to make up for the loss of business earnings
resulting from the death of a ‘key man’.
For these purposes, the Commissioner considers that the intention
of a policy should be determined having regard to ‘all the
surrounding circumstances’, including the use to which proceeds
from the policy are put. This may be shown by advance declarations
of the taxpayer’s intentions evidenced by minutes of meetings and
book entries.
Proceeds from policy claims are generally not assessable. As
above, they are, however, included in a company’s assessable
income to the extent that they are received on revenue account, for
instance where the purpose of the insurance policy is to replace a
revenue receipt.
Cross insurance policies
In certain situations where there are, for example, two key
employees in a private company, it may be appropriate for the two
employees to take out cross insurance policies in respect of each
other. In these cases, premiums paid are not deductible to the
policy owner to the extent that the proceeds from these policies are
used by the policy owner to acquire the insured’s interest in the
company from the deceased party’s estate. In such cases, as the
policies are intended to provide funds for a potential future
capital outgoing, any proceeds from the cross insurance policies to
the policy owner are tax-free on capital account. Under the CGT
rules, the proceeds paid constitute consideration for the
acquisition of a capital asset being the other employee’s interest
in their estate.
This is an extract of an article that appeared
in Thomson’s InTax (March 2007); Australia’s best
independent monthly tax magazine. It provides concise reports of the
latest tax news, plus the practical implications of tax developments
in an easy-to-read magazine format. To find out more, phone Thomson
Customer Service on 1300 304 197 or click here.
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