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Replies to Queries -- 1 - Post retirement insurance

11 April 2001
Issue: 3802 / Categories:

The accepted view is that the cost of a run-off professional indemnity policy brings no tax relief. I disagree and propose to challenge it myself. I retire soon from practice as a chartered accountant and have purchased cover for six years after retirement.

The accepted view is that the cost of a run-off professional indemnity policy brings no tax relief. I disagree and propose to challenge it myself. I retire soon from practice as a chartered accountant and have purchased cover for six years after retirement. My grounds for charging the £5,000 cost against profits are first that there has been an assumption on the part of clients that insurance is not only in place whilst I am around but after that, and thus each year's fees to my clients included a cost for run-off time; second, a condition of instructions on some major matters in the last few years – all documented – has been that I take out run-off insurance. I am a sole practitioner: clients instructing partnerships expect the continuing partners to insure in future.

The problem has not been thought through and the profession has given up on it too easily. Am I right?

(Query T15,784) – Sole Practitioner.

 

Although 'Sole Practitioner' raises this issue as an individual who is self employed, all professionals including those in employment should be aware that there is a real commercial risk of claims arising after they have retired. I think that 'Sole Practitioner' is being unreasonably pessimistic about the tax treatment, and I shall support that contention in the following paragraphs. Even if tax relief was denied, the commercial reality is that all professionals should obtain run-off indemnity insurance to cover the period of their retirement. I do not think that six years' cover after retirement is adequate and I should recommend that the policy can only give peace of mind if it covers the remainder of the individual's life. The period of limitation only starts to run from the time when the error is discovered.

In arriving at the amount of profits for tax purposes, a deduction for expenditure wholly and exclusively laid out for trading purposes is deductible unless the deduction is specifically prohibited. An expense falls to be taken into account on the date it is incurred, irrespective of when it is discharged. Generally, where in an accounting period a trader becomes obliged to make a payment in respect of his trading activity related to a future accounting period, he may properly deduct the present value of the future payment in arriving at the trading profit of the present accounting period. This principle has often been challenged by the Inland Revenue, but the recent judicial success in Herbert Smith's case and then the Jenners case proves that attitudes have changed (see [1999] STC 173 and [1998] SpC 166).

Leaving aside provision for future liabilities, the 'matching' principle requires expenses to be matched with the profit generated, and dealt with in the profit and loss account of the period to which they relate. Section 60, Taxes Act 1988 demands that tax is charged on the full amounts of the profits. The commercial risk of a professional indemnity insurance claim arises at the time the work is done and it is entirely proper that if any individual decides to insure against the risk of a claim being imposed on him personally, the expense should be allowed. It is well established that commuting an annually recurrent payment into a single payment does not change the nature of the payment. In the case of professional indemnity insurance, it is a revenue payment each year and it would remain allowable as a revenue payment if a lump sum were incurred in the final year.

In Issue 39 of the Tax Bulletin published in February 1999, the Revenue confirmed this principle after the enactment of section 42, Finance Act 1998 which requires accounts to reflect a true and fair view by writing:

'The question of whether expenditure is capital or revenue for tax purposes is one of tax law. It follows that expenditure, which is revenue for tax purposes, does not, and cannot, lose that character whether or not it is charged wholly in one year's accounts, or spread over the accounts of more than one year. In other words expenditure does not become capital expenditure by being "capitalised"; "capitalised" revenue expenditure is still revenue. Equally, capital expenditure does not become revenue expenditure when, say, depreciation is charged to the profit and loss account.'

I am confident that a deduction can be obtained for continuing professional indemnity insurance cover after retirement. The Revenue published its view in Tax Bulletin, Issue 19, October 1995 at page 256:

'Professional indemnity insurance premiums for work undertaken in the course of business will now, in principle, almost always be allowable. If incurred while the business is continuing, they will be allowed as a deduction in computing profits within the ordinary rules of Cases I and II of Schedule D. If paid after the business has ceased, they will be within the terms of the new relief, subject to the seven-year rule. We would not seek to disallow such an insurance premium paid while the business continues on the grounds that the cover extends to claims lodged after it has ceased.'

'Sole Practitioner' is right to be prudent. The good news is that he is wrong. His fears about obtaining a tax deduction for obtaining professional indemnity insurance coverage during the period of his retirement are unfounded. He will get the deduction. But what about the problem of an employee who retires? Few realise that employees can be held personally liable if the advice given is found to be wrong.

In a landmark test case, Merrett v Babb, the Court of Appeal has ruled that following the insolvency of his former employer, Mr Babb found himself personally liable for a mortgage valuation that he had carried out over seven years earlier. The Court of Appeal emphasised that prudent employees - whether professional, or otherwise - would wish to ensure that their employers' insurance covered them personally and that such employees may need to take steps to obtain personal insurance if that cover did not continue after their employment ended.

The Tax Bulletin published in October 1995 confirms that tax relief may be available to employees and former employees. Section 201AA, Taxes Act 1988 provides tax relief for employees for payments they make to secure indemnity insurance against liability claims arising from their job, or to meet uninsured work-related liabilities. The legislation also cancels out any tax charge on an employee where the employer or someone else pays for the insurance or meets the liability. The relief extends to payments made by or for ex-employees, for periods of up to six years after the year in which the employment ceases. – Prudence.

 

I am not sure where the 'accepted view' complained of comes from. I have used my computerised search facilities to look for it, and the only trace I have found is the now defunct Revenue Interpretation 25. This was replaced by RI 130 when section 109A, Taxes Act 1988 was inserted by Finance Act 1995 to allow certain post cessation expenses, including professional indemnity insurance premiums. The current interpretation includes the following encouraging paragraph:

'… [The Revenue] would not seek to disallow such an insurance premium paid while the business continues on the grounds that the cover extends to claims lodged after it has ceased.'

This appears to remove the only other possible problem – that the Revenue might seek to use the accruals basis to defer relief for the premium until the years to which the cover relates, i.e. spreading the relief over the run-off period. In fact, post cessation expenses are relieved on a 'paid' basis under section 109A, so this would in any case be inappropriate; and the accruals basis, properly applied, would match the premium to the work which necessitated it rather than to the period of cover (i.e. would include it as an expense no later than the final period of business).

I think that 'Sole Practitioner' is preparing to tilt at a windmill that has long ago disappeared. – Gardener.

 

Issue: 3802 / Categories:
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