Public Ruling No: 2/2003 - “Key-Man” Insurance

Generally, a premium paid on an insurance, which is intended wholly and exclusively to recover moneys that would replace a loss of profits on the happening of the event insured against, would be allowable as a deduction against the gross income of a business.

Death, critical illness, sickness, accident or injury of an employee or a director may result in a loss of business income for the employer or company. Insurance may be taken on the life of an employee or a director who is a “key” person to cover the risk of loss of business income. This type of insurance is known as “key-man” or “key-person” insurance.

The right to the insurance proceeds of a “key-man” insurance must remain with the employer or company and the proceeds must not be payable to the “key-person” or his family.

Deductibility of Premium Expense

The premium on the policy is allowable if the insurance has no element of investment and the insurance is taken on the life of a “key-person” whose absence would result in a reduction in the profits of the employer or the company.

Policies that have no element of investment are term life and accident policies. These policies expire at the end of the insured period and there is no return on the premium paid if the insured person lives or is not injured. The premium payable on a term life policy or an accident policy of a “key-man” insurance is allowable as a deduction against gross income from a business.

A whole life policy and an endowment policy have elements of investment and are therefore regarded as capital assets of a company. Both policies have cash values that can be redeemed after being in force for several years. For an endowment policy there is a lump sum payable upon maturity of the policy. The premium payable on a whole life or an endowment policy is not allowable in arriving at the adjusted income from a business of a company.

Example 1 

A company purchased a “key-man” endowment policy on the life of the managing director with the company as the beneficiary. The annual premium payable is RM 20,000 and the sum assured is RM 500,000. Under the direction of the managing director, the company’s profits have increased 20% each year for the last five years. 

Although the company is the beneficiary of the insurance policy and the managing director is a “key-person” in the company, the annual premium payable is not allowable as the company has acquired an asset. On maturity of the policy, the company will receive RM 500,000 plus bonuses declared by the insurance company.

Taxability of Insurance Proceeds

The proceeds receivable on a term life policy or an accident policy is taxable on the employer or the company as the sum is receivable in respect of an insurance premium that has been allowed previously. On the other hand, the proceeds receivable in connection with a whole life or an endowment policy is not taxable as the insurance premium has not been allowed.

Example 2 

A company acquired a “key-man” term life policy on the life of the managing director with an annual premium payable of RM 30,000. It also acquired a “key-man” whole life policy on the life of the sales manager with an annual premium payable of RM 20,000. The premium of RM 30,000 had been allowed and the premium of RM 20,000 had been disallowed in the tax computation. Both the managing director and the sales manager were killed in an accident and the company received cash payments of RM 2,000,000 and RM 500,000 in respect of the term life and whole life policies.

The sum of RM 2,000,000 received by the company is taxable on the company as it is received in respect of a policy where the premium had been allowed previously while the sum of RM 500,000 will not be taxable as the premium had not been allowed previously.

In the case of a controlled company, premium paid for a “key-man” insurance policy on the life of a director or an employee who owns shares in the company is not an allowable deduction as there are other motives for the purchase of the insurance policy. Other than providing a cover for the risk of loss of business income, it is also for the advantage of the director or employee in their capacity as shareholders of the company. Similarly, premium paid on “key-man” insurance policy on the life of a partner or sole-proprietor is not allowable.

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Edited by: 浪子

Source: http://lampiran2.hasil.gov.my/pdf/pdfam/PR2_2003.pdf