Can key person insurance premiums be paid from business funds or do they require personal payment?

Key person insurance premiums are paid from business funds, because the business is the policy owner, beneficiary, and the party with the insurable interest. The key person being insured does not pay the premium personally. Deductibility depends on whether the cover is for revenue or capital purpose under ATO TR 2009/2.

This is one of the structural features that distinguishes key person cover from personal cover. With personal Life, TPD, or IP cover, the individual pays the premium from after-tax income. With key person cover, the business pays the premium from operating cash flow.

How the premium flow works

1. The business signs the application as Policy Owner.
2. The business nominates the key person as Life Insured.
3. The business provides bank-account details for direct debit, BPAY, or credit card payment.
4. Premium is paid monthly, quarterly, or annually from the business account.
5. On claim, the proceeds are paid to the business as policy owner.

The key person does not pay the premium, does not own the policy, and does not personally receive the proceeds on claim (with one exception, noted below).

Why this matters for tax

The ATO TR 2009/2 framework treats the premium payment as a business expense:

• Revenue-purpose Key Person cover (proceeds intended to replace lost business revenue): premiums are deductible under ITAA 1997 s8-1 as a business expense; lump-sum or instalment proceeds are assessable income to the business at the corporate or partner tax rate.
• Capital-purpose Key Person cover (proceeds intended to fund recruitment, capital expenditure, or shareholder buyout): premiums are NOT deductible; proceeds are typically CGT-exempt under ITAA 1997 s118-37(1)(a) where the business is the original beneficial owner.

The PDS itself does not address tax treatment. For example, TAL Accelerated Protection PDS (12 December 2024) notes: "Tax may apply if the policy or insurance is taken out for business purposes and you should seek professional taxation advice. The complexity of taxation laws...". All panel insurers carry similar disclaimers.

No Fringe Benefits Tax for business-purpose cover

Where the business pays the premium and the business is the beneficiary, no Fringe Benefits Tax (FBT) applies because the cover serves the business, not the employee personally. This is consistent across all panel insurers.

FBT becomes relevant only in scenarios where the business pays a premium and the employee or their family receives the benefit:

• Salary-packaged Life cover: business pays premium on a policy owned by the employee, with the employee's family as beneficiary. FBT applies under the Fringe Benefits Tax Assessment Act 1986 (FBTAA). Premium is NOT deductible to the business.
• Company-paid director's Life cover where the director's family is the beneficiary: also FBT-assessable, also non-deductible.
• Company-paid Key Person cover where the company is the beneficiary: NOT FBT-assessable, tax treatment per TR 2009/2.

How to evidence purpose at the time of application

The ATO can re-characterise the tax treatment of premiums and proceeds based on actual use. To support the intended treatment, document the purpose at the time of application:

• Accountant's letter confirming whether the cover is for revenue purpose, capital purpose, or split (with the dollar allocation).
• Application form annotation of purpose.
• Internal business resolution (board minute, partnership resolution, or trustee resolution) authorising the cover and stating the purpose.
• Separate bank accounts for revenue-purpose vs capital-purpose proceeds receipt.

This documentation protects the tax treatment if the ATO reviews the position later.

Mixed-purpose policies

Where a single policy has both revenue and capital components (for example, $1 million Life cover with $400,000 documented as revenue-purpose and $600,000 documented as capital-purpose), the premium can be apportioned between the two purposes. The ATO accepts this approach, but the apportionment must be:

• Reasonable.
• Documented at the time of application.
• Maintained consistently across years.

Maintaining separate policies for each purpose is administratively simpler and reduces ATO challenge risk. The premium economics are usually similar.

What if the business cannot afford the premium?

Where business cash flow is constrained, options include:

• Stepped premium structure: lower initial premium that rises with age. Better short-term cash flow but more expensive over the long term.
• Level premium structure: higher initial premium that stays flat. Better long-term economics but heavier initial cash flow.
• Lower sum insured: reducing the cover amount to manageable levels.
• Shorter benefit period (for Business Expense Cover or IP-style cover): 6 or 9 months instead of 12 months.
• Higher waiting period (for Business Expense Cover or IP-style cover): 60 or 90 days instead of 30 days.

All panel insurers offer stepped and level premium options. The PDS section for each cover type sets out the available options and the differences.

What if the key person leaves?

Where the key person leaves the business voluntarily or through termination, the business has options including cancellation of cover, reassignment to a new key person (subject to new underwriting), or transfer of policy ownership to the departing individual personally. Some transfers attract stamp duty under state-based duties acts. Discuss the specific scenario with a licensed adviser and your accountant.

This is general advice only.