ARE MY PERSONAL INSURANCE PREMIUMS TAX-DEDUCTIBLE?

Jun 26, 2014

It’s a good question.  Here’s the expert opinion of John Brown, LL.B, Dip Fin Pl:

Purpose 
Business insurance can be arranged so that business loans can be reduced or repaid not only on the death, or total disablement of the business owner, but also on the owner experiencing a critical illness or trauma, like a heart attack, stroke, cancer etc.

Often business loans are personally guaranteed by the business owner or owners and secured against personal assets including the business owners’ homes. Business insurance can ensure that such loans can be reduced or repaid on the death or disablement of that business owner. This can facilitate the release of personal guarantees and protect personal assets for the disabled business owner or the deceased’s family at what could be a very vulnerable time.

Taxation 
 There is some uncertainty whether premiums on term insurance, the purpose of which is to repay business loans, would be tax deductible. This uncertainty is due to the Inland Revenue Department stating its interpretation of this area of tax law in a Tax Information Bulletin and subsequently in an Exposure Draft – For Comment and Discussion Only, floating the possibility of a retreat from the earlier, stated position.

In Tax Information Bulletin, February 1995 pp19-20 the Revenue Department advised that, “business mortgage repayment insurance” premiums were tax deductible (under what is now section DB 5 of the Income Tax Act 2004*) and that the claim proceeds were tax free provided that they were not in the nature of loss of profits. The Bulletin also noted that the insurance did not need to be a requirement of the borrowings. 

Subsequent to this Tax InformationBulletin, the Revenue Department in 1997 published two papers, Exposure Draft – For Comment and Discussion Only, IS 9701 and PU 9702. These Exposure Drafts referred to court decisions in Australia and Canada. From these decisions the Drafts concluded that where the insurance policy provides additional valuable benefits independent of the loan such as continuing life insurance, annual bonuses, a surrender value or other valuable benefits there should be no deduction for the premium. The Exposure Drafts also concluded that as whole of life and term insurance policies do not relate solely to the loan, premiums paid for these policies should not be deductible, (under what is now section DB 5). 

While it is clear from the court decisions quoted in the Exposure Drafts that there would not be a deduction for whole of life or endowment type insurance, the court decisions quoted do not necessarily support the view, that there should be no deduction for term insurance. In addition there were Canadian tax cases where a deduction for term insurance premiums was allowed but these were not mentioned in the Exposure Drafts. To date the uncertainty created by the Revenue Department has not been finally resolved.

Is it possible to claim a deduction for a premium on term insurance (which does not provide other ‘valuable benefits’), under another section of the Income Tax Act 2004? A possible alternative to section DB 5 may be to claim the premium under section DA (1)(1)(b)(i) which covers general deductions and “expenditure…incurred…in the course of carrying on a business”.  Formerly, under the Income Tax Act 1994, section BD 2 required the expenditure to be “necessarily incurred”. While this is not explicitly stated in the Income Tax Act 2004, it is probably still inferred. Such a requirement could be more clearly established where the lender required the loan to be covered by insurance.   

Because of the uncertainty and the different ways in which a possible deduction could be approached, each taxpayer should therefore seek professional advice about the tax treatment of premiums on life insurance which has been effected in connection with the borrowing of money used in a business.”  

* Under section DJ 11 of the Income Tax Act 1994, a taxpayer was allowed a deduction in respect of expenditure incurred, “in the borrowing of money employed by the taxpayer as capital in the derivation of gross income”. In the rewrite of the Income Tax Act 2004 the expression ‘a taxpayer’ is replaced with the expression ‘a person’. Section 29 of the Interpretation Act 1999 defines ‘person’ to include: ‘a body corporate’ and ‘an unincorporated body’. Under section OB of the Income Tax Act 2004 a company is defined to mean a body corporate. 

CREDITS

Article provided courtesy of Solutions; written by John Brown, LL.B, Dip Fin Pl.
John Brown provides consultancy advice in the areas of trusts, asset planning and business insurance. He has over 28 years experience in these fields and works in an advisory capacity with financial advisers, solicitors and accountants. He is a frequent speaker at seminars for financial planning groups and insurance brokers. He is also a consultant editor to CCH (NZ) the tax and commercial law publishers. John is the author of New Zealand Trusts and Asset Planning Guide and New Zealand Master Trusts Guide

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