Tax issues relating to assignment of keyman insurance policy to a keyman

(1)

1

Tax issues relating to assignment of keyman insurance policy to a keyman

In brief

The Delhi High Court (HC), while considering a batch of appeals¹ dealt with tax issues arising on assignment of keyman insurance policy to the keyman (director).

It held that an employer can claim deduction for premium paid on such policy even though the same is subsequently assigned to the keyman. As regards the differential amount representing the benefit arising on account of premium paid by the company being higher than the surrender value paid by the employee, the HC

1 In the case of three assesses namely, Escorts Heart Institute & Research Centre Ltd, Rajan Nanda, Naresh Trehan [TS-809-HC-2011 (DEL)]

held that the same could not be taxed as salary. Also, the maturity proceeds of such assigned policy were held to be exempt.

Facts of the case

Escorts Heart Institute & Research Centre Ltd (company), was taking keyman insurance policy for its directors each year. After paying premium on these policies for the first year, the policies were assigned to the directors. At the time of the assignment, the directors paid surrender value of the policy to the company. For the remaining period, the insurance premium was paid by the assignees, i.e., the directors.

Sharing insights

News Alert

9 February, 2012

(2)

PwC News Alert February 2012

2 The Assessing Officer (AO) disallowed the premium paid by the company on the

ground that it is not an expenditure incurred wholly and exclusive for business.

The Commissioner of Income-tax (Appeals) (CIT(A)) held the appeal in favour of the company and the decision of the CIT(A) was upheld by the Tribunal.

As regards the taxability in the hands of the directors, the AO took a view that substantial benefit was derived by the directors by paying only surrender value as against the high premium paid by the company. The AO taxed this differential amount in the hands of the directors. The AO also sought to tax the maturity value received by the directors on these policies.

Appeals were filed before the HC challenging the orders of the Tribunal in the case of the company as well as the directors.

Issues

• Can the company claim deduction for premium paid for keyman policies after adjusting the surrender value?

• Is the differential amount representing the benefit arising on the actual premium paid by the company, being higher than the surrender value paid by the directors to the company, taxable as salary in the hands of the directors?

• Is maturity value received by directors taxable in their hands?

Revenue contentions

Deductibility of insurance premium for the company

• The company had been taking keyman policies year after year and thereafter assigning the same at nominal value. This modus operandi was clearly a colourable device which cannot be part of tax planning.

• The company had no commercial expediency to make such exorbitant payment.

• The object of the keyman insurance policy is to indemnify the company for loss of earning and the company had acted in contravention to the clauses of policy.

• The surrender value is applicable only if the company surrenders the policy to the insurer and it is not relevant when the company passes the benefit to the keyman.

• The Tribunal failed to appreciate the true spirit of the CBDT Circular No. 762² as the purpose was to cover the risk of premature death of the keyman and it could not be applied to the current case.

Taxability in the hands of directors

• The revenue reiterated its arguments on modus operandi and colourable device. The differential amount represents benefit received by the directors and accordingly taxable as perquisites under section 17 of the Income-tax Act, 1961 (the Act).

• The letter from LIC stating that the keyman policy turns into ordinary life insurance policy could not govern the taxability under the Act. The original terms and conditions of the keyman insurance policy cannot change on surrender as the quantum of premium and maturity amount remains unchanged.

2 CBDT Circular No. 762 dated 18 February 1998

(3)

3 Assessee contentions

• Principle of consistency needs to be followed as in the earlier assessment years, the claim of the assessee was not disputed.

• The CBDT Circular No. 762 (above) was binding on the Revenue, as per which deduction is allowed for premium paid on keyman policy.

• Reliance was placed on decision in the case of B.N.Exports³, wherein relying on the CBDT Circular No. 762 (above), premium paid for keyman insurance policy was held to be wholly and exclusively for business.

• Case of colourable device could not be projected as assignment of policy was envisaged in the CBDT Circular No. 763 (above) itself. Also, the ingredients of section 37 of the Act were duly met by the assessee.

• No provisions of the Act were violated by assigning the policies and argument of violation of scheme was never raised before lower authorities.

• The assessee relied on the Tribunal decision wherein it was concluded that only ‘sum received’ under the keyman policy would be treated as profits in lieu of salary. Keyman policy is taxable only when the amount is 'received'.

• Treating maturity value as taxable was untenable, because for the remaining term of policy after assignment, it was an ordinary policy.

• The concept of assignment is embedded in the very scheme of a keyman policy.

Assignment leads to conversion of policy.

3CIT v. B.N. Exports [2010] 323 ITR 178 (Bom.)

• When such course of assignment is legally permissible there was no question of colourable device.

HC Ruling

• The expenditure was liable to be allowed on ‘principles of consistency’.

• The CBDT Circular No. 762 (above) treats such expenses as business expense and the circular is binding on the department. The expenditure was to be seen at the time it was incurred. Merely because the policy was assigned after sometime would not mean that the expenditure incurred in the first instance would lose its character as being ‘business expenditure’. The circular permits assignment of policy.

• The HC also relied on the decision in case of B.N.Exports (above) wherein premium paid for keyman insurance policy was held to be wholly and exclusively for the purpose of business.

• If the transaction is otherwise valid in law and is a part of tax planning, merely because it resulted in reduction of tax, it cannot be ignored raising the issue of its underlying motive. Thus, when such tax planning is permissible by law, the argument of it being colourable device cannot be advanced by the revenue.

• The differential amount representing benefit arising on account of premium paid by the company being higher than surrender value, was not 'profits in lieu of salary' under section 17(3)(ii) of the Act.

(4)

PwC News Alert February 2012

4

• In view of the specific language of section 17(3)(ii) and section 2(24)(ix) of the Act, only the sum received under keyman insurance policy was to be treated as profits in lieu of salary. Similarly, the differential amount could also not be taxed as income from other sources, since a conjoint reading of section 56(2)(iv) and section 2(24)(ix) of the Act implies that the amount under keyman insurance policy has to be actually received.

• The CBDT Circular No. 762 (above) clarifies that only surrender value of the policy can be taxed at the time of assignment or the sum received by the individual at the time of retirement can be taxed. At the time of assignment, surrender value was paid by the directors to the company and therefore nothing can be taxed.

• The maturity amount received by the directors was exempt under section 10(10D) of the Act, as the assignment of a keyman insurance policy to the directors changed the character of the policy to an ordinary life insurance policy. Such assignment or conversion was permissible since LIC had accepted the assignment and there is no prohibition on the same in the Act.

• The HC, while concluding, observed that the transaction of assignment could not have been treated as a case of tax evasion despite the fact that the company and its directors were hugely benefitted and had also reduced their tax liability.

Conclusion

The HC reiterated the law regarding deductibility of premium paid on keyman insurance policy and taxability at the point of assignment. The HC concluded that once the employer assigns the ‘keyman policy’ in favour of the employee, the character of the policy changes from it being a ‘keyman policy’ to an ‘ordinary policy’. This is relevant for employees who can then claim exemption under section 10(10D) of the Act on maturity value of such policy assigned in their favour.

The HC also emphasised that every assessee has a right to plan its affairs in such a manner that it may result in payment of the least possible tax within the framework of law.

(5)

5 For private circulation only

Ahmedabad

President Plaza, 1st Floor Plot No 36 Opp Muktidham Derasar

Thaltej Cross Road, SG Highway Ahmedabad, Gujarat 380054 Phone +91-79 3091 7000

Bangalore

6th Floor, Millenia Tower 'D' 1 & 2, Murphy Road, Ulsoor, Bangalore 560 008 Phone +91-80 4079 7000

Bhubaneswar

IDCOL House, Sardar Patel Bhawan Block III, Ground Floor, Unit 2 Bhubaneswar 751009

Phone +91-674 253 2279 / 2296

Chennai

PwC Center, 2nd Floor 32, Khader Nawaz Khan Road Nungambakkam

Chennai 600 006 Phone +91-44 4228 5000

Hyderabad

#8-2-293/82/A/113A Road no. 36, Jubilee Hills, Hyderabad 500 034, Andhra Pradesh

Phone +91-40 6624 6600

Kolkata

South City Pinnacle, 4th Floor, Plot – XI/1, Block EP, Sector V Salt Lake Electronic Complex Bidhan Nagar

Kolkata 700 091

Phone +91-33 4404 6000 / 44048225

Mumbai

PwC House, Plot No. 18A, Guru Nanak Road - (Station Road), Bandra (West), Mumbai - 400 050 Phone +91-22 6689 1000

Gurgaon

Building No. 10, Tower - C 17th & 18th Floor, DLF Cyber City, Gurgaon Haryana -122002 Phone : +91-124 330 6000

Pune

GF-02, Tower C, Panchshil Tech Park, Don Bosco School Road, Yerwada, Pune - 411 006 Phone +91-20 4100 4444

For more information contact us at, [email protected]

The above information is a summary of recent developments and is not intended to be advice on any particular matter. PricewaterhouseCoopers expressly disclaims liability to any person in respect of anything done in reliance of the contents of these publications. Professional advice should be sought before taking action on any of the information contained in it. Without prior permission of PricewaterhouseCoopers, this Alert may not be quoted in whole or in part or otherwise referred to in any documents

©2012 PricewaterhouseCoopers. All rights reserved. "PwC", a registered trademark, refers to PricewaterhouseCoopers Private Limited (a limited company in India) or, as the context requires, other member firms of PricewaterhouseCoopers International Limited, each of which is a separate and independent legal entity.