Income protection & personal insurance

Conditions

1. Premiums paid by a sole trader or partner to provide life, accident or sickness insurance cover for themselves or a partner are not allowable deductions in computing trading profits, and the benefits paid under such policies are not trading income (BIM45560). HMRC notes that such policies are often known as permanent health insurance policies. BIM45560 adds that the benefits are generally tax-free under section 735 ITTOIA 2005. That exemption has conditions of its own — among them, that no part of any premiums under the policy has been deductible in calculating the income of the insured (section 735(1)(b)) — so check with your insurer or an accountant that your policy meets them.
2. BIM45560's bar is on cover a sole trader or partner takes out for themselves. Cover a business takes out for its employees, or on a key person, is decided under the rules below, and HMRC's key person guidance applies to the proprietors of an unincorporated business as well as to company directors (BIM45530). This page's sole-trader answer is about your own policy.
3. Where a company insures to fund sick pay for its employees or directors (often called group income protection), HMRC's policyholder manual says the employer's treatment of premiums is not dealt with there, and points to BIM45500 for whether a premium is an allowable deduction (IPTM6120). BIM45500's test is that whether insurance premiums are deductible from trading profits depends on what is insured and whether the insurance has been taken out for the purposes of the trade; a company's statutory test is section 54 CTA 2009. Whether your company's premiums meet it is a question for an accountant.
4. For the employee or director covered, the right to receive sick pay under arrangements with an insurance company is not a benefit chargeable on them (EIM21820; section 202(1)(c) ITEPA 2003) — unless it is provided under optional remuneration arrangements, such as salary sacrifice, in which case that exclusion does not apply (section 202(1A) ITEPA 2003; IPTM6120). The sick pay itself is taxable as earnings, whether the insurer pays the employer or pays the employee directly (EIM06410). Where the employee has also contributed to the fund the sick pay comes from, only the part attributable to the employer's contributions is treated as earnings (section 221(4) ITEPA 2003; EIM06410), and amounts funded by salary sacrifice count as employer contributions, not employee contributions (IPTM6120). HMRC's earlier guidance, given on 15 October 2019, said salary sacrificed as part of these arrangements could be taken into account as employee contributions. HMRC now says that guidance was incorrect, but it will not seek to revisit the tax treatment where people relied on it in the cases set out at EIM06474 — among them, it accepts that payments of sick pay relating to salary sacrificed in the period from 15 October 2019 to 31 December 2023 may continue to be taxed in accordance with the previous guidance (EIM06470). If your sick pay relates to salary sacrificed on or after 6 April 2017, ask an accountant whether one of those cases applies to you.
5. Key person insurance is different: an employer takes out a policy in its own favour insuring against loss of profits resulting from the death, critical illness, sickness, accident or injury of an employee, director or other key person. HMRC allows the premiums only if all of its conditions are met (BIM45525). First, the sole purpose of taking out the insurance is the trade purpose of meeting a loss of trading income that may result from loss of the services of the key person, and not a capital loss. Second, a life insurance policy is term insurance, providing cover only against the risk that one or more of the lives insured dies within the term of the policy, with no other benefits — and the term should not extend beyond the period of the employee's usefulness to the company. Premiums on whole life or endowment policies, or critical illness or accident policies with an investment content, are capital expenditure and are not deductible (BIM45525).
6. Where both key person conditions are met, the premiums are deductible and sums received under the policy are income of the employer's trade (BIM45525). Where they are not, as a general rule the premiums cannot be deducted and receipts under the policy are not taxed as trading income — but HMRC says no assurance can be given that any future receipt will be excluded from trading income even though the premiums are not allowable (BIM45525).
7. Whether the sole purpose condition is met is a question of fact, determined by evidence of what the directors of the company, or the proprietors of an unincorporated business, were seeking to achieve (BIM45530). HMRC names two circumstances in which there may be a non-trade purpose: where the policy is in respect of directors who are major shareholders but not other employees, and where benefits under the policy exceed the sick pay arrangements or other employee benefits typically offered to employees of equivalent status in similar concerns. Where a group policy has a non-trade or personal purpose for some members but not others, a reasonable apportionment may be made (BIM45530).
8. Life cover a company funds for an employee or director and writes in trust for their family (often sold as a 'relevant life policy') has conditions of its own that this page does not set out. Ask an accountant before relying on any tax treatment for one.
9. For an employee paying for their own policy, the general rule for employee expenses allows a deduction only for an amount the employee is obliged to incur and pay as holder of the employment, and which is incurred wholly, exclusively and necessarily in the performance of the duties of the employment (section 336 ITEPA 2003). Cover that replaces your own income if you cannot work is not paid in performing your duties, which is why this page answers 'no' for employees. On the other side, HMRC says payments from policies taken out to protect a person from sickness, disability or unemployment will generally be tax free where the premiums were paid out of taxed income (IPTM6110).

Common mistakes

• A sole trader claiming their own income protection premiums as a business expense — HMRC says premiums a sole trader or partner pays for life, accident or sickness cover for themselves are not allowable deductions (BIM45560).
• Assuming that sick pay from a company-funded group income protection policy is tax-free for the employee. It is taxable as earnings (EIM06410), apart from any part attributable to the employee's own contributions to the fund (section 221(4) ITEPA 2003), and apart from the salary-sacrifice cases in which HMRC will not seek to revisit the tax treatment where people relied on its earlier guidance (EIM06474).
• Assuming salary sacrifice leaves group income protection outside the benefits charge. Where the cover is provided under optional remuneration arrangements, the right to sick pay is not an excluded benefit (section 202(1A) ITEPA 2003).
• Confusing key person insurance with personal cover. Key person cover is taken out by the employer in its own favour to meet a loss of trading income from losing the key person's services (BIM45525); cover a sole trader takes out for themselves is not allowable (BIM45560).
• Taking out key person cover on directors who are major shareholders but not on other employees. HMRC names this as a circumstance in which there may be a non-trade purpose (BIM45530), so the sole purpose condition may not be met. That is a different failure from the capital-expenditure rule for policies with an investment content (BIM45525).

What to keep

• For your own income protection policy: the policy documents and premium records, so you can show that no premium was deducted in calculating your income if you rely on the tax-free treatment of benefits.
• For company-funded group income protection: the policy schedule showing the company as policyholder and the premiums paid, and a record of whether any employee contributes, or is covered through salary sacrifice.
• For key person insurance: a record of what the directors or proprietors were seeking to achieve by taking out the policy — HMRC treats whether the sole purpose condition is met as a question of fact, determined by that evidence (BIM45530).

Real-world example

A limited company director pays for a personal income protection policy in his own name, out of his taxed income. Payments he receives under it would generally be tax free where the premiums were paid out of taxed income (IPTM6110), subject to the conditions in section 735 ITTOIA 2005. Separately, the company takes out group income protection for all its staff, including him, with no salary sacrifice. The right to sick pay under that policy is not a taxable benefit for him (EIM21820), but any sick pay he receives under it is taxable as earnings (EIM06410). Whether the company can deduct the group premiums turns on BIM45500's test — what is insured, and whether it was taken out for the purposes of the trade — which the company's accountant checks.

Frequently asked