[2020] 120 taxmann.

com 335 (Article)

[2020] 120 taxmann.com 335 (Article)

Date of Publishing: October 21, 2020

Taxability for Keyman Insurance Policy

PARTH PANCHAL
CA

Summary of the Article:

The business entities normally take Keyman Insurance Policy on life of key personnel of the
organisation. In case of Keyman Insurance Policy, there are various triggering events, where taxability
is required to be determined. The provisions of the Act are silent regarding taxability at few events.
Further there are also several conflicting judicial pronouncements which are in favour of revenue as
well as assessee. In such a scenario, it becomes necessary to determine taxability of Keyman Insurance
Policy. Read on…..

Content of the Article:

♦ In order to safeguard the entity from any loss that may occur to it in case of death of the key
 personnel, Keyman Insurance Policy are taken by organisation. There are three events where
taxability is required to be determined.
♦ First is deduction of premium paid for the Policy as revenue expense to the business entity.
♦ The policy is usually assigned in the name of insured in subsequent years with or without
consideration. Second is taxability at the time of such assignment of policy.
♦ Third is taxability of the receipts on maturity of the Policy.
(A) Circular No. 768 dt. 18-02-1998

♦ There were certain doubts regarding taxability of Keyman Insurance Policy. The same were
addressed by the Board in para 14.1 to 14.5 of Circular No. 768 dt. 18-02-1998.
♦ Para 14.4 is reproduced herewith -
"14.4 The Act also lays down that the sums received by the said organisation on such policies,
be taxed as business profit; the surrender value of the policy, endorsed in favour of the
employee (keyman), or the sum received by him at the time of retirement be taken as "profits
in lieu of salary" for tax purposes; and in case of other persons having no employer-employee
relationship, the surrender value of the policy or the sum received under the policy be taken as
income from other sources and taxed accordingly. The premium paid on the Keyman Insurance
Policy is allowed as business expenditure."
(B) Deduction of premium paid for Keyman Insurance Policy

♦ There is no express provision for deduction of premium paid for Keyman Insurance Policy.
However as the Policy is taken on life of employee in order to safeguard the entity from any
loss that may occur to it in case of death of the insured, it can be said that the expenditure
incurred by way of premium on such policy is for the purpose of business and profession and
therefore allowable as expenditure u/s 37(1) of the Act. This is also clarified at para 14.5 of
Circular No. 768 dt. 18-02-1998 as discussed above.
Judicial Rulings in favour of assessee
 (a) Pharma Search v. Asstt. CIT [2012] 21 taxmann.com 44/53 SOT 1 (Mum.)
(b) ITO v. Radha Raj Ispat (P.) Ltd. [2011] 15 taxmann.com 291/48 SOT 153 (Delhi) (URO)
(c) CIT v. Harit Exports Ltd. [2014] 49 taxmann.com 200/226 Taxman 260 (Bom.)
Facts: Assessee took keyman insurance policy on last day of relevant financial year. Assessing Officer
finding that insurance policy cover was extended to next financial year, allowed only proportionate
amount of premium claimed by assessee.

Held: Mere fact that insurance policy cover was extended to next financial year did not mean that
premium paid during year under consideration was not an allowable expenditure

Certain issues:

Issue No. 1 : Whether partnership firm can claim deduction of premium paid on Keyman
Insurance Policy of partners or not.

♦ The term 'Keyman' is not defined anywhere in the Act. However 'Keyman Insurance Policy' is
defined at Explanation 1 to section 10(10D) of the Act which is reproduced herewith -
"For the purposes of this clause, "Keyman insurance policy" means a life insurance policy
taken by a person on the life of another person who is or was the employee of the first-
mentioned person or is or was connected in any manner whatsoever with the business
of the first-mentioned person and includes such policy which has been assigned to a person, at
any time during the term of the policy, with or without any consideration"
♦ The partner cannot be said an employee of the partnership firm. However the partner is
directly connected with the business of the firm. Therefore, such policy taken on life of partner
shall be covered within the ambit of Explanation 1 to section 10(10D) and hence considered as
Keyman Insurance Policy.
Judicial Rulings in favour of assessee for Issue No. 1
 (a) Pharma Search's case (supra)
(b) CIT v. Agarwal Enterprise [2015] 55 taxmann.com 54/229 Taxman 525/374 ITR 240 (Bom.)
(c) ITO v. Modi Motors [2009] 27 SOT 476 (Mum.)
(d) CIT v. Gem Art [2012] 22 taxmann.com 243/208 Taxman 47 (Guj.)
(e) CIT v. B. N. Exports [2010] 190 Taxman 325/323 ITR 178
(C) Taxability at the time of assignment of Keyman Insurance Policy in favour of the Insured
(Keyman)

♦ After issuing Keyman Insurance Policy, the entities sometimes assigns the policy in favour of
the Insured (Keyman) at the time of resignation, retirement or otherwise. Whether any
taxability shall trigger or not to the Insured at the time of such assignment is required to be
determined.
♦ There are various judicial rulings that at the time of assignment of policy, surrender value on
date of assignment shall be taxable in the hands of Insured. However there are contrary
judicial rulings in favour of assessee that there shall be no taxability at this event.
Judicial Rulings in favour of assessee

(a) Ravi Poddar v. Asstt. CIT [2017] 80 taxmann.com 192/164 ITD 104 (JP.Trib)

Facts: The partnership firm took Keyman Insurance Policy in name of assessee-partner. Later on the
policy was assigned in favour of partner in FY 2007-08. AO made addition of surrender value as on date
of assignment in hands of assessee-partner in FY 2007-08. The addition was confirmed by CIT(A). Such
policy was surrendered and surrender value was received by assessee-partner in FY 2008-09.

Held: The appellant contended that he has not 'received' any amount during the year under
consideration and in all the relevant sections, the word used is 'received' and not 'accrue or arise'. The
question that arises for consideration is whether the taxable event is the date of assignment which falls
FY 2007-08 or the date when amount was actually received which is in FY 2008-09. In our view, the
pendulum of taxability will start titling from the firm towards the appellant as soon as the
policy has been assigned but the taxability will only be fastened on the appellant when
appellant actually receives the surrender value. The assignment alone cannot be a basis for
bringing to tax the surrender value but the act of assignment along with actual receipt of money would
be correct basis for bringing to tax such amount. So far Circular No. 768 is concerned, it covers
taxability under various possibilities, however in each case, taxable event remains to be actual receipt
of money either at the time of surrender of the policy or at the time of maturity/retirement.

(D) Taxability of receipt on maturity of Keyman Insurance Policy

♦ As per section 2(24)(xi), "income" includes 'any sum received under a Keyman insurance policy
including the sum allocated by way of bonus on such policy.'
♦ Section 10(10D) covers exemption of amount received on maturity of life insurance policy.
Section 10(10D) provides certain exceptions from such exemption. One such exception at
clause (b) of section 10(10D) is ' any sum received under a Keyman insurance policy'.
Therefore, any receipt under Keyman Insurance Policy is fully taxable.
♦ As section 28(vi) of the Act, any sum received under Keyman Insurance Policy shall be taxable
under Business Head. Section 28(vi) is reproduced herewith -
"any sum received under a Keyman insurance policy including the sum allocated by way of
bonus on such policy."
♦ This is also clarified by the Board in para 14.4 of Circular No. 768 dt. 18-02-1998.
♦ Therefore any sum received by entity under Keyman Insurance Policy shall be taxable in the
hands of business entity under Business Head.
Certain issues:

Issue No. 2 : Whether taxability shall arise at the time of maturity only or at the time of
surrender of policy also?

♦ It is nowhere specified that taxability shall arise only on receipt of maturity value. The term
specified is 'any sum received under a Keyman Insurance Policy'. Therefore, any surrender
value received shall also be taxable in hands of recipient.
Issue No. 3 : On maturity of the policy, amount is received by the Insured (Keyman) and not
the entity. What shall be the taxability under this scenario?

♦ As per section 56(2)(iv) of the At covers the taxability of income referred in section 2(24)(xi) of
the Act. The same is also covered in para 14.4 of Circular No. 768 dt. 18-02-1998. Therefore,
any sum received by the Insured on maturity of Keyman Insurance Policy shall be taxable
under head 'Income from other sources' as per 56(2)(iv) of the Act. Extract of section 56(2)(xi)
is reproduced herewith -
"…..income referred to in sub-clause (xi) of clause (24) of section 2, if such income is not
chargeable to income-tax under the head "Profits and gains of business or profession" or under
the head "Salaries"…."
Issue No. 4 : Whether entire amount of receipt shall be taxable or any deduction can be
claimed against such receipt and only net receipts shall be offered for tax.

♦ On receipt of surrender value or maturity value for Keyman Insurance Policy, entire gross
amount shall be taxable in the hands of recipient and no expense can be claimed against such
income.
Judicial Rulings in favour of assessee for Issue No. 4:

(a) Rajan Nanda v. Dy. CIT [2009] 30 SOT 304 (Delhi)

Facts: The entity took Keyman Insurance Policy and after couple of premium payments, the same was
assigned to the assessee. The assessee received maturity amount of Rs. 8.55 crores. As against this
amount, the assessee disclosed a sum of Rs. 1.38 crores. It has been explained that due to loan
obtained by the appellant, after deducting loan as well as interest thereon, the Insurer has paid net
amount which was declared as maturity value instead of the gross amount in the submission made by
the appellant.

Held: Amount of loans and interest thereon as availed by the assessee on Keyman Insurance Policy
assigned to him will not affect maturity value of the policy (including bonus thereon) which the assessee
is entitled to get. Accordingly the action of assessee in offering the net amount received from Insurer
after deduction of loan and interest thereon as availed by the assessee on these policies are not correct.
The entire gross amount of Rs. 8.55 crores shall be considered for determining taxability.

Issue No. 5 : Once the Keyman Insurance Policy is assigned to Keyman (Insured), it becomes
ordinary policy and so whether exemption u/s 10(10D) of the Act can be availed or not.

♦ Prior to 1-04-2014, the definition of Keyman Insurance Policy under Explanation 1 to section
10(10D) was as under:
"For the purposes of this clause, "Keyman insurance policy" means a life insurance policy
taken by a person on the life of another person who is or was the employee of the first-
mentioned person or is or was connected in any manner whatsoever with the business of the
first-mentioned person"
♦ As per plain reading of this Explanation, it may be construed that this definition does not
include such policies do not include those policies which are later assigned to Keyman.
Therefore, once the policy is assigned to Keyman, the policy shall lose its character of Keyman
Insurance Policy and shall be considered as any other ordinary life insurance policy. Therefore,
in such cases, any sum received by the Insured shall be exempt u/s 10(10D) of the Act.

♦ However this loophole came to notice of the Board and amendment was brought w.e.f. 1-04-
2014. As per amendment, following phrase was inserted in Explanation 1 to section 10(10D) of
 the Act:
"and includes such policy which has been assigned to a person, at any time during the term of
the policy, with or without any consideration"
♦ After this amendment, even after assignment of policy in favour of Keyman, the policy
sustained its character as 'Keyman Insurance Policy'. So, any sum received by the Insured
after assignment of such policy shall be taxable.
Judicial Rulings in favour of assessee for Issue No. 5:

(a) CIT v. Rajan Nanda [2012] 18 taxmann.com 98/205 Taxman 138/349 ITR 8 (Delhi) [Discussed
at Ruling No. 6 of part (G)]
(b) Dy. CIT v. Manjit Kumar [2014] 45 taxmann.com 573/65 SOT 117 (Asr-Trib)
(c) Dy. CIT v. Rajan Nanda [2013] 37 taxmann.com 335/60 SOT 49 (Delhi-Trib) (URO)
(d) CIT v. Prashant J. Agarwal [2016] 75 taxmann.com 54/243 Taxman 119 (Bom.)
Held: Amendment in Explanation 1 to section 10(10D) was brought into effect from 1-4-2014;
it would not govern/apply to amounts received prior to assessment year 2014-15 under
Keyman Insurance Policy
(e) Dr. Naresh Trehan v. Dy. CIT [2014] 48 taxmann.com 21 (Delhi-Trib)
Facts: The assessee received Rs. 4.27 crores as maturity amount towards Keyman Insurance Policy
taken by employer-company. (a) Out of total premium of Rs. 3.17 crores, premium of Rs. 1.80 crores
was paid by employer-company and balance premium was paid by assessee. CIT(A) concluded that
maturity proceeds in proportion to premium paid by employer-company shall be taxable to assessee, i.e.
from Rs. 4.27 crores of maturity receipt, Rs. 2.43 crores shall be taxable (4.25 * 1.80/3.17). (b)
According to assessee, such policy once transferred/assigned to him, becomes a normal policy and on
encashment of such policy, the proceeds are exempt from tax.

Held: (a) The computation method of taxable amount adopted by CIT(A) is not appropriate and entire
maturity proceeds are only taxable. (b) If Keyman policy is converted into ordinary policy on the
occasion of assignment of policy'' the same shall be exempt u/s 10(10D).

(E) Judicial Rulings in other certain issues

(a) Dy. CIT v. Noble Enclave & Towers (P.) Ltd. [2012] 18 taxmann.com 288/50 SOT 5 (Kol.)
Held: Since proceeds of Keyman insurance policy are fully taxable under section 28(vi),
expenditure relating to same cannot come within ambit of section 14A.
(b) Pharma Search's case (supra)
Held: Insurance is a periodic contract and just because in subsequent year there are no
profits, the contract cannot be terminated. Therefore, continuing with policy and payment of
premium in loss situation in subsequent years could not be ignored and would be allowed as
business expenditure.
(c) Habibur Raheman F. Ansari v. Dy. CIT [2014] 50 taxmann.com 87 (Mum.)
Held: Brothers took life insurance policy for each other and one of them claimed deduction for
amount of premium in computing income under business head. The assessee's case fails on the
basis of an inability to discharge the onus to exhibit that the impugned expenditure stood
incurred wholly and exclusively for the purposes of his business, which constitutes the primary
condition for deduction under section 37(1). The deduction claimed under section 37(1) was to
be disallowed.

(d) Shri Nidhi Corpn. v. Addl. CIT [2014] 44 taxmann.com 31/151 ITD 470 (Mum.)
Held:
(a) It does not matter at all that where Insurer invests amount of premium collected in
order to determine claim of deduction u/s 37(1).
(b) It does not matter at all that whether assessee receives or not surrender value or
maturity value in order to determine claim of deduction u/s 37(1)
 (e) Rajan Nanda 's case (supra)
The employer took Policy in name of employee. After paying premium for few years, policy was assigned
to assessee for surrender value as on date of assignment. For remaining period of policy, assessee paid
premium and on maturity, maturity value was received. Specific issues and related pronouncements are
as under:

(a) AO took a view that since premiums paid on policy was much more than surrender value
realized by assessee-company, such premium could not be treated as expenditure incurred
wholly and exclusively for the business purpose. It was held that merely because policy was
assigned after sometime would not mean that expenditure incurred in first instance would lose
flavour of it being 'business expenditure'
(b) AO took view that assessee took benefit by paying surrender value as compared to higher
premium paid by company. Therefore, on day of assignment, difference of premium paid by
company and surrender value given to company shall be taxable in hands of assessee head
'Salary' as per section 17 of the Act.
Held: No amount was received by employee on assignment. Section 17(3)(ii) taxes "any sum
received in a Keyman policy insurance". The word "received" assumes significance. The
Legislature in its wisdom thought to tax only that payment, which is received by the employee.

(c) Tribunal rejected claim of assessee that if maturity value becomes taxable, then premiums
paid by assessee after assignment shall be allowed as deduction. It was held that the Tribunal
is correct in rejecting such claim.
(F) Conclusion

♦ Taxability at all the three events for Keyman Insurance Policy can be concluded as under:
♦ Deduction of premium paid for the Policy to the business entity - Allowable as revenue
expenditure u/s 37(1) of the Act
♦ Taxability at the time of such assignment of policy - Not taxable at the time of assignment.
♦ Taxability of the receipts on maturity of the Policy - Gross amount shall be taxable in the
previous year in which surrender value or maturity value is received by business entity or
employee.
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