Income protection & personal insurance

Conditions

• A personal income protection policy taken out by a sole trader to replace their own earnings if they cannot work is not an allowable business expense. The premium protects the individual's personal income stream, not the trading receipts of the business — it fails the wholly-and-exclusively test (BIM37000) and is therefore disallowable. The corollary is that because the premium is not deducted, any benefit received from the policy is tax-free in the hands of the recipient.
• Company-funded group income protection (GIP) — where the company takes out a policy that pays a salary-replacement benefit to an employee or director who cannot work due to illness or injury — is an allowable corporation tax deduction for the company. The premium is a cost of employing staff, paid wholly for trade purposes. Under s202(1)(c) ITEPA 2003, the right to receive sick pay under an insurance arrangement is not a benefit in kind chargeable on the employee when the policy is taken out (EIM21820). However, the actual benefit payments received by the employee when they claim are taxable as employment income (EIM06410, s62 ITEPA 2003), because the company has funded the premium with pre-tax money.
• A relevant life policy is a different product: a single-life, term life assurance policy written in trust for the benefit of the employee's family or dependants, funded by the company. The company's premium is an allowable corporation tax deduction. No benefit in kind arises for the employee or director covered. On death within the policy term, the proceeds are paid from the trust and are generally free of income tax. Relevant life policies have specific qualifying conditions — the policy must be individual (not a group policy), must be term assurance only (no whole-of-life or investment element), and must not be used to fund buy-sell agreements between shareholders.
• Key-person (keyman) insurance is a third distinct product: the company insures against the financial loss from the death, critical illness, or prolonged incapacity of a key employee or director. HMRC's Business Income Manual (BIM45525) sets out two conditions that must both be satisfied for the premium to be allowable as a trading deduction. First, the sole purpose of the policy must be to meet a loss of trading income — not a capital loss, and not a shareholder-protection benefit. Second, where the cover is life insurance, it must be term assurance only, with no investment content or surrender value. Where both conditions are met, the premium is allowable and any policy proceeds are brought into account as taxable trading income. Where the conditions are not met — for example where a policy also serves a shareholder-protection purpose (BIM45530) or contains an investment element — the premium is treated as capital expenditure and is not immediately deductible.
• A sole trader who employs others and funds group income protection for those employees may deduct the cost as a staff expense (not personal insurance — it is an employment cost). The disallowability applies to the sole trader's own personal income protection policy, which protects their own earnings rather than the business.

Common mistakes

• A sole trader claiming a personal income protection premium as a business expense — the premium is disallowable because it protects personal rather than trading income.
• Assuming that because a company can deduct GIP premiums, the benefit payments are also tax-free for the employee — they are not. Benefits are taxable employment income because the employer funded the premium with pre-tax money.
• Confusing a relevant life policy with key-person (keyman) insurance — they serve different purposes and carry different tax treatments. A relevant life policy pays death benefits to the employee's family via a trust; keyman insurance compensates the business for trading losses from losing the key person.
• A company taking out key-person insurance that also serves a shareholder-protection purpose — this dual purpose means the premium may not satisfy the sole-purpose test (BIM45525 and BIM45530) and the premium could be treated as capital expenditure rather than an allowable trading deduction.

What to keep

• For company-funded income protection: policy schedule showing the company as the policyholder and the premium paid.
• For a relevant life policy: evidence that the policy is written in trust and meets the qualifying conditions.
• For key-person insurance: a contemporaneous record of the business purpose for which the policy was taken out, demonstrating that the sole aim was to protect against a trading income loss.

Real-world example

A limited company director considers his options. A personal income protection policy in his own name would not be deductible, but the benefit would be tax-free if paid. Instead, the company funds a relevant life policy written in trust for his family — the company's premium of £1,400 per year is an allowable corporation tax deduction, no benefit in kind arises, and the death benefit from the trust is free of income tax. Separately, the company takes out group income protection covering all employees: the premium is corporation tax deductible, and any salary-replacement payments made under the policy to employees who claim are taxable employment income for those employees.

Frequently asked

Related allowances