MUMBAI, APRIL 23, 2013: THE issues before the Bench are - Whether when assessee, engaged in insurance business, is required to compute income u/s 44, it can still avail exemption u/s 10(34); Whether the assessee has correctly taken the negative reserve at ‘0’ value as AO has no power to modify the amount after actuarial valuation was done, which was the basis for assessment under Rule 2 of 1st Schedule r.w.s.44 of the I.T. and Whether the profit earned on investments is to be taxed as income from other sources and is to be taxed as income transferred to policy holders’ a/c. And the verdict partly favours the assessee.

Facts of the case

A) Assessee claimed dividend from domestic companies to be exempt u/s 10(34) and reduced the same from the income worked out as per Rule 2 of the Schedule-I of Act. AO held that the computation of income in the case of Insurance business was to made as per provisions of section 44 of the Act, which provided that dividend income under the head ‘income from other sources’ could not be taken as separate from profit and gains of insurance business, thus the dividend income which fell under the head income from other sources was not eligible for claiming exemption u/s 10(34). Further normally the premia accepted from policyholders is invested in various- investments including loans, deposits, bonds, shares etc., thus, the income received from it is income from its normal business and to be assessed under the head ‘income from business or profession. The revenue account and actuarial valuation prescribed under the Insurance Act,1938 and IRDA guidelines specifically showed the dividend as an income, that intention of the Legislature was not to exclude the dividend income of a Life Insurance Company from taxation. Thus, held that dividend income was business income and hence taxable.

CIT (A) held that that total income of a company engaged in the business of Insurance was to be calculated as per Rule 5 of the First Schedule. Once the P&L A/c had been prepared as per the Insurance Act and submitted to the Controller of Insurance figure of profit could not he altered. The only adjustments permitted were as per [Clause(a) & Clause(c)] of Rule 5 for computing the total income. There was no provision under Rule 5 to exclude any tax exempt income u/s 10(15) or dividend income u/s 10(34). In absence of any specific provision in Rule 5, AO could not make any changes in profit figure worked out under the Insurance Act. The tax free income falling u/s 10 could not be excluded in view of no express provision for the same in Rule 5 and thus, upheld the order of AO.

Assessee contended that Rule 5 to Schedule I was for General Insurance. However, the assessee was engaged in the business of Life Insurance and rule 2 of Schedule was applicable to the business of the assessee and the assessee was entitled to exemption u/s 10(34).

B) On perusal of the actuarial reports in Form-I, AO found that there was an item called ‘Negative Reserve’. AO observed that the issue in negative reserves to be taken as ‘0’ was specific to situations mentioned in the regulation. Rule 5(ii) mandated that mathematical reserves should be taken without any modification for the purpose of Section 35 of the Insurance Act and provisions of Insurance Act clearly indicated that actuary was not mandated to take negative reserves at ‘0’ in all situations. By taking Negative Reserves at ‘0’ surplus had been made less than the real actuarial valuation and in Income Tax assessments real income of an assessee had to be debited. Ignoring negative reserve was in accordance with IRDA Regulations was also not material.

Assessee’s contention in respect of taking Negative Reserve at ‘0’ was not tenable as the same were not in accordance with the Insurance Act and IRDA Regulations. Accordingly, the Negative Reserve reported by actuary was added back to the income of the assessee as surplus of Actuarial Valuation of Life Insurance business of the assessee-company.

First appellate authority held that under IRDA, Negative Reserves were to be taken under specific situations and not as a general rule. The appellant corporation wanted to take un-due advantage by reducing its taxable surplus by the amount of Negative Reserves. Actuarial had erred in applying Insurance Act correctly and properly in the case under consideration. Negative reserve was to be taken at Zero in specific situations only -under Rule 5(ii) of Schedule IIA, that said mandate was not applicable in all situation as argued by the assessee. Negative reserves already disallowed in earlier years could not be allowed in the AY under consideration. There was no provision for incremental addition/set off of negative reserves under the Insurance Act or IRDA Regulations.

Assessee contended that para 5(iii) of IRDA (Assets, Liabilities and Solvency Margin) Regualtions,2000 mandated that for the purpose of section 13 the Appointed Actuary should set the amount of mathematical reserves to zero in the case of negative reserve. Appointed Actuary had done the same in arriving at the net valuation surplus.

C) Assessee prepared its revenue and profit and loss account in two parts-first part was called technical account or policyholders’ account whereas the second part was called non-technical account or shareholders’ account. In the first part premium, other receipts, expenses etc. relating to insurance policies issued by the assessee were accounted for and in the second part surplus from first account was carried forward. In the non-technical account, apart from the transfer from technical account income from the investments, made out of shareholders’ funds, was also credited. Computation of total income showed the total income only in respect of policyholders’ account (technical account) and no income had been showed in respect of shareholders’ account.
AO held that assessee was the corporation owned by Government of India. The relationship between the Government of India and assessee was that of shareholder and Company. It was a separate legal entity itself. Income of LIC could not be said to be income of Government of India. Any income arising from assessee’s activity belonged to it as a statutory entity and not to the Government of India as such, that income to Government of India would arise-only when the assessee paid dividend to the Government of India. Income of the assessee corporation’s income appearing in shareholder’s account had to be taxed. Item of income in question was not derived from Life Insurance business but fell under the head ‘income from other sources’ and was liable to tax as per normal provisions of the Act. Provisions of section 44 would clearly not be applicable on this income.

The funds of the stakeholder (Govt of India) were also utilized by the LIC for earning dividend income and interest income on that capital contribution for which a separate account had been maintained by LIC. Income on dividend and interest income earned on the amount contributed by the Government of India as capital was taxable under the head Income from other sources, that the AO had already exempted the dividend income earned on the investment of capital contributed by the Government of India, that AO had rightly taxed other income falling under the head Income from other sources which was different from the Insurance business.

Assessee contended that income assessed by the AO belonged to Government of India. Assessee had computed its income as per actuarial report. Out of the share-holders’ account 95 % went to policy holders’ account and balance would to government’s account. AO could not determine surplus for assessing income. Income assessed by AO in the hands of the assessee was directly connected / derived with/ from life insurance business.

After hearing both the parties, the ITAT held that,

A) ++ Rule Nos. 1 to 4 of the schedule are about Life Insurance business, whereas Rule 5 onwards deal with General Insurance Business. Relying upon Rule 5 of the schedule and denying benefit on that basis cannot be endorsed. In view of the decision of ITAT in the case of ICICI Prudential Insurance wherein it was observed that Section 44 of the Income-tax Act read with the rules contained in the First Schedule to the Act lays down an artificial mode of computing the profits and gains of insurance business. For the purpose of income-tax, the figures in the accounts of the assessee drawn up in accordance with the provisions of the First Schedule to the Income-tax Act and satisfying the requirements of the Insurance Act are binding on the Assessing Officer under the Income-tax Act and he has no general power to correct the errors in the accounts of an insurance business and under the entries made. Thus, the assessee is entitled to exemption under section 10 of the Act, the appeal of the assessee is allowed;

B) ++ while making actuarial valuation, requirement of reserve to service insurance policies issued is ascertained. Such reserve (called mathematical reserve or value of liability) is equal to present value of future benefits payable and future expenses to be incurred less present value of future premium receivable. When the present value of future premium is more than the present value of future benefits payable and future expenses to be incurred, this amount becomes negative, known as ‘negative reserve’. It means that the insurance contracts under consideration do not warrant any provision and is, in fact, an asset. As for following IRDA guidelines, insurers may not treat policies as assets and they set any negative reserves to zero.’ A policy which has a negative reserve is in nature of an asset. In the case of ICICI Prudential Insurance Co., the Tribunal held that the mathematical reserve is a part of Actuarial valuation and the surplus as discussed in Form-I under Regualtion 4 takes in to consideration this mathematical reserve also. AO has no power to modify the amount after actuarial valuation was done, which was the basis for assessment under Rule 2 of 1st Schedule r.w.s.44 of the I.T. Act. Thus, this ground of assessee is allowed;

C) ++ the basis for allocation for profit between the share holder and the Government of India is the provisions of section 28 of the LIC Act. Profit was allocated by the assessee on the basis of a particular formula. There is no doubt that income had accrued to the assessee and same was transferred to the share holders’ account. Once income is earned by the assessee and later on it is applied for some specific purpose it cannot be treated as charge on profit. It is application of income. Preparation of books of accounts as per the Insurance account is different from determining the tax liability under income tax. Income transferred to policy holders’ a/c. was not application of income-it was charge on income and therefore AO had rightly excluded it from taxation. Income earned by the assessee corporation on dividend and interest cannot be held to be earned from the insurance business. Income from insurance business is exempt from taxation and not every type of income. Initial capital contribution was made by the Government of India in 1955 for carrying out insurance business, but income earned by the assessee as dividend and interest in the year under consideration cannot be termed as income of the Sovereign. LIC cannot claim that it represents Government of India. Income earned by it for carrying of business of Life Insurance is exempt as per the provisions of section 44 of the Act and not because that income of LIC is income of Government of India.

(See 2013-TIOL-275-ITAT-MUM)