D&O insurance and work liabilities: the exemption

Q: What mistakes come up most often?

Leaving it off the P11D. The cost still has to be reported even though the deduction cancels it. Mixed policies. A package combining management liability with unrelated covers may fail the qualifying contract test unless the liability section is a separate contract. Paying through salary sacrifice or allowances. This loses the National Insurance disregard. Treating fines as covered. Penalties paid for an employee are pay. Missing the six year window for former employees who settle a claim personally. The company's own corporation tax position on premiums is a separate question, covered in whether business insurance premiums are deductible. If HMRC opens a check into your return, tax investigation insurance pays your accountant's fees. Solar Protect cover pays up to £100,000 with no excess; it never pays tax, interest or penalties. Read how our cover works or get a quote.

When an employer pays for insurance that covers an employee or director against liabilities arising from their work, or pays those liabilities and the legal costs directly, the cost is a benefit but section 346 of the Income Tax (Earnings and Pensions) Act 2003 gives a matching deduction, so no tax is due. No National Insurance is due either, though the employer still reports the cost on form P11D. Where the employee pays the liability, the legal costs or the premium personally, the same section lets them deduct it from their earnings.

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What does the exemption actually cover?

Strictly, this is a deduction rather than an exemption. HMRC’s Employment Income Manual at EIM30501 explains that if an employer meets a director’s or employee’s liability arising from legal action, the payment is normally taxable as earnings, and if the employer buys insurance against those liabilities, a benefits code charge arises on the proper proportion of the premium. Section 346 then allows a deduction equal to that charge, so the two cancel out (EIM30505).

Section 346(1) lists what qualifies:

payments in or towards a liability related to the employment
costs and expenses of defending a claim that the employee is subject to such a liability, including the proceedings that follow
since 2017 to 2018, costs of giving evidence about issues related to the employment in proceedings or an investigation, even if nothing is alleged against the employee
since 2017 to 2018, costs connected with proceedings or investigations where the employee’s acts, or other aspects of the employment, are being or are likely to be considered
the part of a premium under a qualifying insurance contract that covers any of the above

Section 346(4) defines proceedings widely: civil, criminal and arbitration proceedings, disciplinary or regulatory proceedings of any kind, and complaint or dispute resolution processes. That brings professional body hearings within the rule, which is useful for employed professionals such as engineers, nurses or accountants.

Is this only for directors?

No. The heading in the manual refers to directors and officers, but the relief applies to any employee. Section 348 defines a qualifying liability as one imposed in respect of acts or omissions in the person’s capacity as holder of the office or employment, or in connection with proceedings arising from such acts (EIM30511). HMRC accepts that a liability is imposed even if it arises from an out of court settlement, provided the claim, if pursued, would on the balance of probabilities have succeeded at least in part. Where an employee is required by the job to act in another capacity, such as a trustee of the employer’s pension scheme, liabilities in that second capacity are treated as arising from the employment.

For the company law limits on what a company may pay for its own directors, see indemnifying directors.

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Which insurance policies qualify?

For the premium part of the relief, the policy must be a qualifying insurance contract under section 349. HMRC summarises the exclusions at EIM30513. A contract does not qualify if it:

covers risks other than the qualifying liabilities and costs
is connected with another contract, other than the contract of employment
gives the policyholder anything significant beyond the cover and the right to renew
gives cover for more than two years, except through renewals
requires the insured to renew

The first exclusion removes mixed policies that cover both qualifying and other liabilities. The connected contract test in section 350 is aimed at value shifting; HMRC confirms at EIM30517 that a group discount on identical policies bought together does not, by itself, disqualify them. Where one policy covers several people or risks, section 346(3) requires a just and reasonable apportionment, but HMRC notes at EIM30519 that in practice nothing is likely to turn on it because the deduction simply cancels the charge. The practical points on buying cover are covered in directors and officers insurance for small companies.

What does the employer have to report and pay?

GOV.UK guidance on employee liabilities and indemnity insurance says the employer must report on form P11D the total cost of the legal or insurance expenses for each employee, and does not have to deduct or pay any tax or National Insurance. The employee then claims the section 346 deduction against the reported amount.

For National Insurance, the National Insurance Manual at NIM05665 explains that regulation 25 and paragraph 10 of Part 10 of Schedule 3 to the Social Security (Contributions) Regulations 2001 disregard from Class 1 any payment covered by section 346. That applies whether the employer meets the liability, arranges the cover, or reimburses premiums the employee has paid. No Class 1A arises because there is no tax charge.

There is an important exception. From 6 April 2016, the National Insurance disregard is not available where the cost is met through a salary sacrifice arrangement, an unapproved scale rate or a round sum allowance (NIM05665). A general allowance described as being for legal or insurance costs is therefore treated as ordinary pay. For P11D mechanics generally, see benefits in kind and P11D.

What if the employee pays personally?

EIM30505 confirms that section 346 gives the same deduction to employees who bear all or part of a qualifying liability themselves, or who pay for or towards their own indemnity insurance. The deduction is only available against earnings of the employment concerned, so it cannot be set against other income.

Typical cases include an employed professional who buys a personal indemnity policy because the employer’s cover does not extend to them, or an employee who funds their own representation at a regulatory hearing. The claim goes on the Self Assessment return if the employee files one; GOV.UK says anyone who completes a return must claim job expenses there. Others can claim directly from HMRC, as explained in claiming employment expenses. Relief is at the employee’s marginal rate and cannot exceed the tax paid in the year.

What is never covered?

Section 346(2) denies a deduction for any liability or cost that it would be unlawful for the employer to insure against. EIM30523 gives fines and penalties, and some costs associated with them, as examples. If an employer pays a fine imposed on an employee personally, the payment is taxable earnings with no section 346 relief.

Section 346(2A), added by the Finance Act 2009, also blocks the deduction for payments made under arrangements whose main purpose, or one of whose main purposes, is avoiding tax (EIM30505).

What happens after the employee leaves?

Claims often arrive years after the work was done. Section 555 gives a former employee a deduction from total income for an uninsured qualifying liability they bear themselves, where it would have been deductible under section 346 had they still been employed and met it from their earnings (EIM30530). The same provisions cancel charges that would otherwise arise where a former employer pays the liability or provides qualifying insurance after the employment has ended.

There is a time limit. Under section 556, the deduction is only available for amounts paid after the employment ends and within six years of the end of the tax year in which it ended (EIM30534). A director who left in 2026 to 2027 could therefore claim for payments made up to 5 April 2033.

How does this work in practice?

Illustration only. A company employs a structural engineer. A client complains to the engineer’s professional body about a design she signed off, and the body opens a disciplinary investigation. The company pays £6,000 of legal fees for her representation, and the bill is addressed to the company.

The £6,000 is reported on her P11D.
She claims a £6,000 deduction under section 346 because the costs relate to a disciplinary process considering her acts in the employment.
Net taxable amount: nil. No Class 1 or Class 1A National Insurance is due.

If the professional body later fined her £2,000 and the company paid it, that £2,000 would be taxable pay with no deduction, because a fine cannot lawfully be insured.

What mistakes come up most often?

Leaving it off the P11D. The cost still has to be reported even though the deduction cancels it.
Mixed policies. A package combining management liability with unrelated covers may fail the qualifying contract test unless the liability section is a separate contract.
Paying through salary sacrifice or allowances. This loses the National Insurance disregard.
Treating fines as covered. Penalties paid for an employee are pay.
Missing the six year window for former employees who settle a claim personally.

The company’s own corporation tax position on premiums is a separate question, covered in whether business insurance premiums are deductible.

If HMRC opens a check into your return, tax investigation insurance pays your accountant’s fees. Solar Protect cover pays up to £100,000 with no excess; it never pays tax, interest or penalties. Read how our cover works or get a quote.

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Sources

Reviewed by Christine Anderson, Broker, Solar Protect. Last reviewed 24 October 2026. Part of Accountapedia, the Solar Protect guide to UK tax and accounting. This page is general information, not personalised advice.