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Taxability of 'Keyman Insurance Policy'

SEPTEMBER 11, 2023

By Dr Sanjay Kalra, LLM., Ph.D.(GST Law), Advocate, KPS Legal

"KEYMAN Insurance Policy" is a type of life insurance policy where the proposer as well as the premium payer is the employer, the life to be insured is that of the 'keyman' and the benefit, in case of a claim, goes to the employer. The `keyman' can be any person employed by a company having a special skill set or substantial responsibilities and who contributes significantly to the profits of that organization. A director or a partner can also be a 'keyman' for his company or partnership firm, as the case may be. The sum assured or the maturity amount received by the employer on death of the said 'keyman' or maturity of such policy, is taxable in the hands of the employer. Premium paid by the employer on such Keyman Insurance Policy is eligible for deduction as a business expenses under Section 37(1) of the Income Tax Act, 1961. Loan can also be raised on Keyman Insurance Policy and the interest on such loans is allowed as business expenses of the employer.

2. Taxability of 'Keyman Insurance Policy' : Income Tax for any assessment year is charged at a rate specified for that year in accordance with and subject to the provision of Section 4of the Income Tax Act, 1961 in respect of the total income of the previous year of every person. Section 5 ibid provides that total income of any previous year of a person who is resident of India includes all income which is received or deemed to be received in India in such year; or accrues or arises or is deemed to accrue or arise to him in India during such year; or accrues or arises to him outside India during such year. While deriving at such total income as defined under Section 5 of the Income Tax Act, the incomes specified under Section 10 of the Act shall not be included therein. It means that certain incomes specified under Section 10 ibid are exempted from Income Tax. Keeping in mind this brief background of incomes attracting income tax, let us analyse law provisions regulating the 'Keyman Insurance Policy' for the period before and after the significant Amendment in the Finance Act, 2013.

3. Law position before Amendment 2013 : Before the amendment in the Finance Act, 2013, sub-section 10(d) to Section 10 of the Income Tax, 1961 provided that while computing the total income of a previous year of any person, any sum received under a life insurance policy, including the sum allocated by way of bonus on such policy, other than (b) i.e. any sum received under a 'Keyman Insurance Policy', shall not be included. It means, as per provisions of Sec.10(10D) of the Income Tax Act, 1961, the sum received under 'Keyman Insurance Policy' is not exempted in hands of the employer. However, while deciding the issue of taxability on sums received by the Keyman on maturity of the assigned 'Keyman Insurance Policy' in favour of the assigned (Keyman), Hon'ble Delhi High Court in case of CIT vs Rajan Nanda ITA No. 400/2008 dated 16.12.2011 - 2012-TIOL-321-HC-DEL-IT held that once the employer assigns the 'Keyman Insurance Policy' in favourof the employee, the character of the policy changes from it being a 'Keyman Insurance Policy' to an ordinary 'Life Insurance Policy'. The keymen / employees can claim exemption under Section 10(10D) of the Act on maturity value of such policy assigned in their favour. While dealing with another similar matter pertaining to the period prior to the amendment in Finance Act, 2013, Hon'ble Delhi Bench of Appellant Tribunal in 'Brijesh Kumar Gupta vs DCIT' [(2022) 10ITAT CK 0039] also held that amount received under 'Keyman Insurance Policy' is clearly taxable in Sec.10(10D)(b) of the Income Tax, 1961. However, the premium paid by the Keyman (after assignment) was allowed to be deducted from such amount received under the said policy.

After ruling of the Delhi High Court, the tax authorities observed that the policies taken as 'Keyman Insurance Policy' were being assigned to the Keyman before its maturity. The Keyman pays the remaining premium on the policy and claims the entire sum received under such policy as exempt on the ground that the policy is no longer a 'Keyman Insurance Policy'. The exemption under section 10(10D) was claimed for policies which were originally 'Keyman Insurance Policies' but during the term these were assigned to some other person.

4. Law position after Amendment 2013:

Before Amendment, Company used to assign 'Keyman Insurance Policy' to its keyman who used to get tax exemption on sum received by paying premium for the remaining period after the said assignment, by pleading that after assignment the said 'Keyman Insurance Policy' is no longer a 'Keyman Insurance Policy'. With a view to plug the loophole and check such practices to avoid payment of taxes, as explained above, the provisions of clause (10D) of section 10 of the Income-tax Act, 1961 have been amended to provide that a 'Keyman Insurance Policy' which has been assigned to any person during its term, with or without consideration, shall continue to be treated as a 'Keyman Insurance Policy' and consequently would not be eligible for any exemption under section 10(10D) of the Income-tax Act. Pursuant to the ruling of Hon'ble Delhi Court in case of Ranjan Nanda (supra), the Parliament has amended the provisions of Section 10(10D) of the Income Tax Act, 1961 and inserted Explanation-1 in the Finance Act, 2013, which is effective from 1st April, 2014, as below:

Explanation-1 - For the purpose 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;

Now, in view of the amended provisions of Section 10(10D) the character of 'Keyman Insurance Policy' will not get changed after assigning the policy in favour of Keyman (Employee) and so the sum received by the assignee (keyman) on maturity of 'Keyman Insurance Policy' is taxable under the provisions of Income Tax Act 1961. The CBDT board has also issued a Circular No. 03/2014 dated January 24, 2014 to this effect clarifying that this amendment will effect from 1st April, 2014. ITAT, Indore in case of Bhatia International company held that the sum received under a 'Keyman Insurance Policy' assigned before 1st April, 2014 not taxable.It was held that the amendment in the definition of 'Keyman Insurance Policy' is prospective in nature and the same would not be applicable to the taxpayer since the assignment of 'Keyman Insurance Policy' in favour of keyman was made on October, 2010 and January 2013 which was much before the effect date of amendment i.e. 1st April, 2014.

[The views expressed are strictly personal.]

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