Sharing insights. News Alert 9 February, Tax issues relating to assignment of keyman insurance policy to a keyman. In brief.

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1 Sharing insights News Alert 9 February, 2012 Tax issues relating to assignment of keyman insurance policy to a keyman In brief The Delhi High Court (HC), while considering a batch of appeals 1 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. 1

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 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 as the purpose was to cover the risk of premature death of the keyman and it could not be applied to the current case. 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. 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. 2 CBDT Circular No. 762 dated 18 February

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

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. 4

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