When advising on business protection policies it is broadly accepted that it is good practice to write to the client’s tax office about their policy. Indeed, many providers even supply suggested wording for advisers to use, including details on setting out the purpose of the policy, whether the client intends to claim tax relief on the premiums, and how they expect any pay out to be treated.
So while there’s no doubt that informing HMRC is sensible, how effective are these letters?
Many of the points raised in the letters go unanswered beyond an acknowledgement of receipt. Many don’t get even that.
The fact remains that, no matter how politely you put it, HMRC is highly unlikely to agree the future tax treatment of an event that may, or may not, happen at some point in the future. Therefore, the tax treatment of the premiums and policy proceeds are unlikely to be guaranteed in advance, especially when the ultimate decision is at the discretion of the tax office.
By not confirming anything, HMRC reserves the right to withhold judgement until it is actually needed.
If the product you sell is advice, it helps if you can be certain that the advice you give is going to work. If a client is paying for a plan designed to ensure the future survival of their business, it’s not unreasonable for them to expect a bit of certainty with the advice they get.
So, in the absence of certainty, how do advisers make sure their carefully-laid plans stand the best chance of meeting expectations?
I’ve seen many instances where the profit and the loan protection elements of a key person plan have been lumped together in one policy. Some advisers argue it saves the cost of extra policy fees, or that it saves on paperwork by submitting one application for each life assured, rather than two or three. However, when it comes to the tax side of things, both elements qualify for different treatment. In these instances, it is little wonder the tax office reserves judgement until the final day of reckoning.
In order to best address the question marks surrounding the tax treatment of premiums and pay outs, it would be wise to make sure that the purpose of the policy is clearly defined. If a business is looking at key person cover, the policy should relate directly to the loss of revenue or profits that would occur if that person was suddenly lost to the business through death or critical illness.
Most businesses have some form of long credit arrangement, either with banks, equipment suppliers, (typically for plant and machinery), and even their own directors. So, if a policy is being taken to cover a capital risk, it should reflect that risk, i.e. the shape of the cover and the term of the policy should reflect the terms of the finance agreement (decreasing term for repayment loans, level for interest-only). This also helps with the financial underwriting.
In some instances, people argue that they’ll re-finance the arrangement, in which case a renewable term facility that reflects the initial loan term might be more suited. This way, cover can be maintained at the point the finance agreement is renewed.
If there is more than one loan arrangement in place, it does no harm to set up separate policies for each of them. Granted, there may be a little extra on the premiums to pay for an extra policy fee, but if this points more clearly to the exact purpose of the policy, it is probably money well spent.
So while an adviser can never guarantee what the tax office may decide in the future, by setting up policies that precisely reflect the risks they are designed to cover, it becomes much easier to argue your case at the time a claim is paid.
Paul McDowell is a business account manager at Zurich
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