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Total Number of Subscribers: 464 |
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Date: 20th August 2008 |
Compiled by Mr. M. Sathya Kumar |
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‘Keyman’ and ‘Tax’ With almost all perquisites now taxable in the hands of
employees, the tax experts are presently finding various ways of tax
planning, especially for high- salary income group of employees. With this
background, a new tool of ‘keyman insurance’ is used with certain
question marks attached to it. In this scenario, it becomes very important to
understand what is ‘keyman insurance’ and its accounting and tax
implications. An effort is made here to look into the said aspect of the
keyman insurance. 1. What is keyman insurance and objects of
the same : 1.1 Keyman insurance is an insurance taken by a
company/firm on the life of an employee/partner (keyman), whose
services contribute substantially to the success of the business of the
company/firm. The object of the keyman insurance is to cover the life of a
keyman for a monetary value so that on death of such keyman, the loss to the
firm is recouped with monetary assistance (insured amount) received from the
insurance company. 1.2 It may be noted that the purchaser of keyman policy
has various options relating to payment of premium i.e., the purchaser can
pay a single premium or can pay premium spread over years of his choice. The
purchaser has also a choice to select how the premium amount is to be
invested by the insurance company. Such choice depends upon the
purchaser’s capacity of risk taking and future needs of funds. On the
choice of the purchaser, the insurance company would invest either in gilt
securities, money market instruments, equity or a mix of these. 1.3 There can be more than one keyman in the company.
Thus, the objects of keyman insurance can be briefly summarised as
below : ·
To protect the company from financial loss due to the death of
keyman, by making funds available to the company in the absence of the
keyman. ·
To make available liquid funds for paying the heirs of a deceased
partner for the credit balance standing to the credit of deceased partner,
plus any further sum payable as per deed of partnership. ·
To fund the cost of replacement of the deceased keyman. ·
The company can create an asset for itself by way of premium
payments and bonuses declared by the insurance company on the policy. ·
In case of need, the company can avail a loan against the policy
from the insurance company. ·
Tax saving, as the premium paid by the company on the keyman’s
policy is allowable as business expenditure. ·
This policy can be used as either an extra superannuation benefit or
an ex gratia payment to the key employee during the service period. 1.4 Thus, the important points to be decided by the
company and the insurance company, before subscribing for keyman
insurance/issue of keyman insurance policy, are as follows : 1.
Identifying keyman/key-men in the organisation/company. 2.
Board resolution for purchasing keyman policy. 3.
Sum to be assured per keyman, based upon company’s turnover,
assets and profitability and also average salary and age of the
keyman. 4.
Overall eligibility amount of keyman insurance of the company, based on the
gross income of the company and liquidity of the company. 5.
Tenure of the policy. 6.
Premium per year. Before I proceed to the accounting and taxation-related
issues relating to keyman insurance, I narrate below the provisions of the
Income-tax Act. 2.
The relevant Sections of the
Income-tax Act and circulars applicable to keyman insurance are
summarised as follows : 3.
Now keeping the above provisions and circular in mind, let us understand various accounting issues and their tax implications. For framing the above tax implications, reliance is
placed upon the above Sections and circulars and upon photocopies
of opinion of eminent chartered accountants and advocates, received by me
from one of the private sector insurance companies. 4.
Now, we may discuss the controversy as
mentioned above. One chartered accountant firm has opined that (as second
view) : "Accordingly,
once the keyman policy is assigned, the employee himself and not the
employer, is the beneficiary under the policy. Once the employer ceases to be
the beneficiary, the very condition critical to the nature of a keyman
insurance policy is not satisfied and the policy should be considered as
having ceased to be a keyman insurance policy." Another firm of
chartered accountant opined that : "It
could lead to double taxation of income from the same source." A prominent
advocate opined that : "Any
sum received by an employee or former employee would be chargeable to tax
under the head ‘salaries’ . . . . . In
the case of other persons who do not have employer-employee
relationship with the organisation, the sum received would be income
chargeable under the head ‘income from other sources’." ". . . . . if
the surrender value is nil, it may be successfully argued that there would be
no income by the employee." Another chartered
accountant opined that, "No
taxable income arises in the hands of the employee who obtains the keyman
insurance policy on assignment without any surrender value being specified by
the insurance company . . . . . . . the
insured pays the balance premium as stipulated by the insurance company, the
character of the policy changes from keyman insurance to ordinary life
insurance. If any sum is received thereafter, then in accordance with S.
10(10D), there is no tax implication at all." On reading of the above opinions, a common factor is to
be noted that in all the opinions, the counsel has tried to conclude that
once the policy is assigned to the keyman, the character of the policy
changes to normal life insurance policy, and thus, the amount received by the
keyman as the beneficiary of the life insurance policy would be exempt
u/s.10(10D) of the Income-tax Act. 4.1 In my opinion, the tax planning thought for the
keyman, as a tax-free ex gratia payment or tax-free amount to be received by
him at the time of maturity of the policy, would be taxable for the following
reasons : (a)
The meaning of ‘Keyman Insurance Policy’ is common for all the
above Sections i.e., as defined in Explanation to S. 10(10D). (b)
Wording in S. 2(24)(xi), S. 10(10D), S. 17(3)(ii), is the
same i.e., any sum received . . on such policy . . under a
Keyman insurance policy. (c)
All the above Sections refer to the taxability of sum received under a keyman
insurance policy i.e., it refers to the sum received and not in whose
hands i.e., to say the sum paid by the insurance company is a
taxable amount, irrespective of its taxability in the hands of employer
or employee. In other words, the sum received under keyman policy is liable
to tax regardless of who receives it. (d)
S. 2(24) defines an ‘income’ which includes a sum received under
a keyman insurance policy. (e)
S. 10 deals with incomes which do not form part of total income and the
clause (10D) relates to the sum received under life insurance policy, except
sum received under a keyman insurance policy. (f)
Both S. 17(3) and S. 2(24)(xi) relate to the taxability of a sum
received under keyman insurance policy, either as salary or as
income from business or profession, while S. 56(2)(iv) relates to its
taxability under income from other sources. 4.2 Now applying the above points in correct chronology, S. 2(24) gives definition of ‘income’ which
includes any sum received under keyman insurance policy. S. 10(10D) defines
the term ‘Keyman Insurance Policy’. The said Section states
that . . . . . under a life insurance
policy . . . . . on such policy other than any sum
received . . . . . under a keyman insurance policy.
Thus, once a keyman insurance policy is purchased by an employer, the said
policy gets the status of ‘keyman insurance policy’ and till the
policy is cancelled/surrendered/matured, it continues its status as a
‘keyman insurance policy’ as defined u/s.10(10D). When a policy
is assigned by employer in favour of the keyman, the insurance company simply
assigns the original policy in favour of the keyman i.e., after such
assignment, instead of employer the keyman becomes the beneficiary, and the
policy continues and remains the same. Thus, on a strict reading of the wording
in S. 10(10D) . . . on such policy the exclusion would
prevail and the amount received on keyman insurance policy, even after
assignment to a keyman, would be taxable in the hands of the recipient. 4.3 The counsels and the insurance company are relying
on the CBDT Circular No. 762 about the taxability in the hands of keyman
after the policy is assigned in his favour and the sum is received by him,
either on maturity or on surrender of such policy. 4.4 The CBDT Circular No. 762 only speaks about the quantum
of amount that will be taxable, as profit in lieu of salary, in the hands of
keyman, who is employee of the person who has purchased the keyman policy,
when (a)
it is endorsed in his favour — the surrender value of the policy at the
time of assignment is taxable. (b)
the sum received by keyman at the time of retirement — the entire sum
received is taxable. Thus, if an employer, during the period of employment,
of a person, selects him as a keyman and buys keyman policy and assigns the
same in favour of the keyman during his employment, only the surrender value
of the said policy will be taxable in the hands of keyman at the time of such
assignment. 4.5 However, the circular is absolutely silent about the
tax impact in the hands of a keyman, when he receives money from insurance
company, either on surrender or on maturity of the policy which was
originally a keyman insurance policy [as defined u/s.10(10D)] and later on
assigned to him. If the circular is silent about this, it seems to be on
account of the fact that the legislative intention is to tax the sum received
from insurance company on any keyman policy. 4.6 This is further supported by the circular, which at
least, has clarified in case of person having no employer-employee
relationship, i.e., the sum received under the policy is taxable under the
head ‘income from other sources’. As the principle of justice
would not make any discrimination between two assessees and there cannot, in
my opinion, be any distinction between a person having no employer-employee
relationship and a person having such relationship. Thus, I conclude that the
sum received under the policy is taxable even in the hands of a person having
an employer-employee relationship. 4.7 By any method or by any accounting treatment, the sum
received under keyman insurance would amount to taxable receipts either in
the hands of the employer or employee, since the words used are ‘on
such policy’. 5. Conclusion : Keyman insurance is a good tool for the liquidity needs
of the company/firm/employer on loss of a keyman or partner, but is not a
device of tax planning for providing tax-free ex gratia payment to keyman or
partner, as it is made out to be. 6. Acknowledgement : I thank Jal Dastur, chartered accountant, for
continuously giving me all the encouragement for writing such articles and
further, in spite of his overburdened professional work, correcting and
giving me valuable suggestions for this article. Source: Mr. Bharat
Talati Chartered Accountant |
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