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Markel Tax

21 Jul 2020

Tax on Business Interruption Claims

There has been considerable comment and speculation in the media during the current Covid-19 crisis as to whether insurance companies will agree to settle claims on policies containing clauses that prima facie include cover for Business Interruption. I will not attempt to cover the merits or otherwise as to whether such policies will or will not pay out for the effect of Covid-19 on business.  Clearly the appropriateness of settling claims for Business Interruption will rest on the wording of policy documents.

There will be some disappointed policy holders who will not receive a pay-out for Business Interruption caused by Covid-19 but conversely there will be others who will receive a settlement from their insurers. That being the case, what is the tax treatment of such insurance pay outs?

The first point to stress is that whether or not a deduction has been claimed in the accounts for the insurance policy premium is not necessarily relevant to the tax treatment of proceeds paid to the insured. The following extract from HMRC’s Business Income Manual 45500 highlights the potential ambiguity as to the tax treatment of insurance premiums and proceeds received from policy claims.

Whether insurance premiums are deductible from trading profits depends on what is insured and whether the insurance has been taken out for the purposes of the trade. In most situations, if the insurance premiums are allowable deductions from trading profits, the receipts from the policy are taxable as trading income. Where no deduction is allowed, often the receipts are not taxable as revenue.

The cost of maintaining an insurance policy in respect of loss or damage to the trade and its assets are generally considered to be incurred wholly and exclusively for the purpose of the business and is deductible as such. Given the HMRC manual contents reproduced above, the default tax position is that any proceeds received under such an insurance policy are taxable, where an allowable deduction would be available for the premium.

Businesses may be currently in correspondence with insurers regarding their claims and will need to consider how such receipts are recognised within the books of the company. Under UK Generally Accepted Accounting Principles (GAAP) the recognition of the insurance receipt may well have to be made in accounts prior to the receipt of the funds where matters remain unresolved. 
The actual tax treatment of the insurance receipt will also depend on whether the receipt is deemed to be revenue or capital in nature and the wording of the policy that gave rise to the insurance pay out.

A typical policy schedule relating to business interruption may well include clauses relating to:

  • The premises

  • Stock held on the premises

  • Assets held at the premises

  • Turnover

Clearly policy terms will vary from provider to provider but a precise trail needs to be followed as the detail of a claim to accurately determine the correct tax treatment. 

Receipts under insurance claims to compensate a trader for a loss of stock or a ‘hole’ in their commercial profits, whether that is due to a loss of sales or the incurring of additional costs, due to the impact of COVID-19, will likely be treated as a trading receipt. This will include any amounts received in excess of the cost to the trader of the stock concerned or the perceived hole in profits.

Sums received under an insurance policy covering damage or loss of a fixed asset used in the business would be deemed to be capital in nature. However, where expenditure is incurred to make good the damage or loss by repairing or replacing the asset and this expenditure is an allowable deduction, a portion of the capital sum received under the insurance policy must be included as a receipt in calculating the taxable profit of the trade up to the amount of the deduction received.

It is important that the terms of any insurance policies are reviewed in detail to determine whether the cost of the policy is an allowable deduction and any receipts are taxable.

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Tagged Tax for entrepreneurs and corporates
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CJRS – HMRC’s Compliance powers confirmed in 2020 Finance Bill