Quora Answer: Is Keyman Insurance Tax Deductible?

The following is my answer to a Quora question: “Is keyman insurance tax deductible?” 

In Singapore, there are some considerations to be addressed before it can be.  The premiums incurred on a keyman insurance policy is deductible, but only if all the following conditions are met.  Firstly, the purpose of the policy is to insure the business against loss of profits arising from the death or disability of the keyman.  Secondly, the capital sum insured is directly related to the extent of the annual profits directly attributable to the services of the keyman.  This means that the payout is tied to the impact of the keyman’s verifiable contribution on revenue.  Thirdly, the insurance policy remains the property of the business, and there be no assignment of the benefits under the policy to the insured or his family.  Should the business intent to pay out to the family of the keyman or the keyman, it must be a distinct transaction from the insurance payout itself, and cannot be through some form of assignment of proceeds.  Aside from all this, the insurance policy does not provide for a cash surrender or investment value.  This precludes whole life and investment-linked plans.  It has to be a term policy.  Also, the loss of the keyman should not affect the entire profit making structure of the business. 

Singapore’s Income Tax Act 1947, Section 14, allows deduction for expenses that are wholly and exclusively incurred in the production of income only.  Section 15, of the same act, further provides, among other things, that capital expenditure is not deductible.  Generally, businesses can claim deductions on premiums incurred on any insurance policy where an employee or a nominee of the employee is the beneficiary of the policy.  This is considered a provision of employment benefits, which constitutes part of staff costs.  Conversely, if the beneficiary of the policy is the business itself, premiums incurred are not deductible because the expense is not incurred in the production of income, but to acquire a capital asset, which in this case, is the insurance policy. 

There is an exception to the principle stated above, though.  Premiums incurred on a keyman insurance policy is deductible for income tax purposes although the beneficiary of the policy is the business if the purpose of the policy is to insure the business against loss of profits arising from the death or disability of a keyman.  The principle is that the keyman has the prime responsibility for the profitability of the business.  Hence, premiums paid, in providing protection against loss of profits from the death or disability of the keyman are wholly and exclusively incurred in producing the income of the business or trade. 

Also, the capital sum insured is directly related to the extent of the annual profits directly attributable to the services of the keyman.  For this to be accepted by IRAS, the responsibilities of the keyman in the operations of the business must be prime, shared, or contributory.  Generally, sum assured is limited by the amount of profits directly attributable to the keyman in his capacity of having the prime responsibility for the profitability of the business.  In cases where the capital sum assured exceeds the annual profits of the business, the premiums will not be deductible as they are considered as not wholly and exclusively incurred in the production of income.  This makes sense since it precludes using excessive coverage as a means to reduce tax exposure. 

The insurance policy remains the property of the business, and there must not be an assignment of the benefits under the policy to the insured or his family.  The tax deductions on premiums may be denied if benefits of the policy accrues to the keyman in his personal capacity.  This is because the premiums paid are not wholly and exclusively incurred in the production of income.  Examples that would preclude this would be in a case where the business is a proprietorship.  Sole proprietorships and partnerships are not distinct legal entities.  The assets and liabilities of the business are the assets and liabilities of the proprietor, and that applies to any insurance policy.  Another example would be in the case where the business is a distinct legal entity by the substantially owned by the keyman or his family, which constitutes an unacceptable conflict of interest from a tax perspective.  On the latter case, however, it is possible to appeal to IRAS and have it accepted.  Whether the benefits of the insurance policy has accrued to the keyman in a personal capacity is determined based on the facts of each case. 

As mentioned above, the insurance policy must not provide a cash surrender or investment value.  Any policy providing a cash surrender value or an investment value, the premiums would not be considered as incurred wholly and exclusively to protect against the loss of profits.  This is because the investment payout under the policy, whether a withdrawal of proceeds, or a coupon of any sort, will be made to the business even if there is no claim on the policy.  Therefore, the premiums of such policies do not qualify for tax deduction.  In addition to whole life, and investment-linked plans, this also includes endowment plans, retirement policies and group personal insurance. 

Deduction of premiums on keyman policies do not apply to any case where the loss of the keyman affects the entire profit-making structure of the business, to the extent that the business can no longer carry on as a going concern.  This is because in such a scenario, premiums are clearly in respect of the capital structure of the business, not just for the loss of profits.  An example of this would be a case where a sole-proprietor is denied tax deductions if the keyman insurance is taken up on his own life.  The sole-proprietorship business is not a distinct legal entity, and the death or disability of the key man will affect the entire profit making structure of the business.  However, it is possible to secure tax deductions if the keyman insurance is taken up on an employee provided that all other conditions are met. 

In the event of a payout of any such policy where the premiums are tax deductible, that payout constitutes a trading receipt and is taxable.