Annette Rothwell looks at the tax implications of group income protection scheme membership for the ...
Annette Rothwell looks at the tax implications of group income protection scheme membership for the employee and employer
In today's economic and social climate it is no controversy to state that income protection has become an increasingly attractive feature of a would-be employee's employment package. The taxation issues surrounding payment for and payments made under insurance policies are, however, less well-known and merit some attention.
Funding sick pay costs
Some employers take out group policies to fully or partly fund the cost of paying sick pay to their employees - insuring themselves against the cost of sick pay provision. Employees may choose to contribute to their employer's scheme, or may take out individual policies themselves.
In relation to an individual policy, benefits are paid to the employee. Are they taxable?
Periodic payments made under a policy are taxable if the sums received are income in nature and have the potential to be paid for a period of more than one year. The payments are then considered to be annual payments. As an example, a policyholder is in hospital for six months. If the policy restricts benefits to a maximum period of less than one year, the sums received are not taxable. However, if there is no such restriction, the sums received are taxable, unless the payment qualifies for the relief outlined below.
Tax holiday
Prior to 6 April 1996, annual payments received under such insurance policies were taxable. However, the Inland Revenue would allow, subject to various conditions, a 'tax holiday' and would raise no assessment unless the benefit had continued for at least 12 months immediately preceding the start of the year of assessment.
The situation has now been revised and the present position is that these annual payments are exempt from tax, providing certain conditions are met. For example, the insurance must be against a 'qualifying risk'. This is defined as a risk that the insured will be affected by the onset or deterioration of a condition resulting from illness, infirmity, or disability, or the risk of unemployment.
The terms of the policy must be self-contained, that is, after taking into account all persons insured, the policy must not provide benefits other than those relating to the qualifying risk. Neither is the exemption available if the premiums are allowable in calculating the insured's income for tax purposes or are deductible from the insured's taxable income.
In relation to the employer's group policy, benefits received are paid to the employer, and are considered to be income of the employer's trade. The sum received under the policy is then used to fund the employee's sick pay and is taxed as income in the employee's hands. The taxation treatment of lump sums received in commutation of future payments under the policy remains unclear, although there is some suggestion that such a sum would be tax-free.
Employee contribution
When the employee contributes to the employer's group scheme, a proportion of the sums paid will be exempt
from tax in the employee's hands because they have contributed to the premiums.
As far as the premiums paid by the employer for the group policy are concerned, these will be deductible when working out the employer's trading profits if the 'sole purpose' for taking out the insurance is the trade purpose. It may be difficult to meet the sole purpose test, for example, where the policy covers directors who are major shareholders, but not other employees, or where the benefits under the policy exceed sick pay arrangements or other employee benefits typically offered to arm's length employees of equivalent status in similar concerns.
Where there is doubt about whether the premiums for a particular type of policy are deductible in computing trading profits, guidance may be sought from the Inland Revenue's business profits division (Schedule D).
Currently, employers pay National Insurance contributions on benefits in kind, such as cars and car fuel. They do not pay contributions on benefits in kind such as income protection premiums paid on behalf of their employees. From April 2000, employer's contributions will be extended to include all benefits in kind which are taxed. This will include all such premiums although, in practice, premiums will rarely be paid on behalf of employees.
However, employer's Class 1 contributions are deductible from trading income and the NIC rate for employers is to be reduced from 12.2% to 11.7% from April 2001. Also, income protection, as defined in Schedule 1 of the Insurance Companies Act 1982, is not a taxable insurance contract for insurance premium tax purposes.
Annette Rothwell is a solicitor in the tax department of solicitors Browne Jacobson
