New tax rules to govern key person insurance policies from 2011

Companies that have in place long-term insurance cover to protect their profit margins against the loss of key employees and directors due to death, illness or disability should seek urgent tax advice to ensure they comply with the 2010 Taxation Laws Amendment Act, which was gazetted last week.

The Act, which comes into effect on 1 January next year, gives effect to the 2010 Budget tax proposals.

Peter Stephan, senior policy adviser at the Association for Savings and Investment South Africa (ASISA), says the Amendment Act introduces radical changes to Section 11(w) of the Income Tax Act, which regulates the tax deductibility of premiums on employer owned policies.

He explains that many employers use key person insurance to legitimately protect the business against loss of profits should a key employee or director die, become disabled or suffer from ill health. Long-term insurance plans have also been used to provide employees with deferred compensation, with the policy proceeds intended for the key employee being taxed at a lower tax rate.

“While existing anti-avoidance laws have largely stopped practices whereby long-term insurance plans are used to provide deferred compensation at a tax mismatch, some remain. Often these anti-avoidance restrictions also undermined legitimate commercial practices such as the use of long-term insurance as collateral for debts owed,” says Stephan.

According to Stephan the new Taxation Laws Amendment Act completely revises the requirements for deductible key person insurance schemes and removes the barriers to legitimate commercial practices.

“The legislation will have a big impact on deferred compensation schemes as they will no longer be tax deductible for the employer after 1 January next year unless the employee is taxed on the premiums. Also affected are group life and disability schemes that fall outside the approved retirement fund environment and therefore receive different tax treatment.”

“It is therefore important that employers making use of long-term key person policies seek professional advice to ensure they have made the necessary adaptations come January 1,” advises Stephan.

He says there are some parts of the new law that are not completely clear. “ASISA is currently engaging with National Treasury and the South African Revenue Service to get clarity on these.”