Insurance Policies and Tax Implications for Keyman and Non-Keyman Employees under Section 37(1) and Section 10(10D)
Companies often take out Keyman Insurance Policies for key
personnel whose loss could significantly impact the business. These policies
provide financial relief to the company in case of the death, incapacity, or
exit of critical employees. On the other hand, companies may also provide general
life insurance policies for non-keyman employees as part of their compensation
packages or as additional benefits.
The tax implications for both Keyman Insurance Policies and non-keyman
insurance policies differ in terms of deductions for premiums and the taxation
of maturity or death proceeds. This article provides a comprehensive
explanation of these tax provisions under Section 37(1) and Section 10(10D) of
the Income Tax Act, 1961, along with examples to clarify key concepts,
particularly addressing the risk of double taxation.
Section 37(1) of the Income Tax Act, 1961
Summary of Section 37(1)
Section 37(1) allows a general deduction for any expenditure
incurred in the course of running a business or profession, provided the
expense is:
1. Wholly and exclusively for business purposes.
2. Revenue expenditure (not capital expenditure).
3. Not incurred for any illegal purpose or in contravention
of public policy.
4. Not covered under other specific sections (e.g., Section
30-36).
This section is commonly used by businesses to claim
deductions for various operating expenses, including insurance premiums on
policies meant to protect the company.
Reproduction of Section 37(1)
Section 37(1):
“Any expenditure (not being expenditure of the nature described in
sections 30 to 36 and not being in the nature of capital expenditure or
personal expenses of the assessee), laid out or expended wholly and exclusively
for the purposes of the business or profession shall be allowed in computing
the income chargeable under the head ‘Profits and gains of business or
profession’.”
Keyman Insurance Policy and Section 37(1)
A Keyman Insurance Policy is taken by a company to insure
the life of key personnel (such as CEOs, CFOs, or directors) whose loss would
negatively affect the business. The policy ensures that the company is
compensated in the event of the key person’s death, disability, or
incapacitation. Since the policy is meant to protect the company’s business,
the premiums paid are considered business expenses and are deductible under Section
37(1).
Example 1: Keyman
Insurance Premiums
Company A purchases a Keyman Insurance Policy for its CEO with
a sum assured of ₹5 crore. The company pays an annual premium of ₹25 lakh. The
premiums qualify as deductible business expenditure under Section 37(1), which
reduces Company A’s taxable income for that financial year.
Tax Implications on Maturity
or Death Benefit:
– Maturity Proceeds: If the keyman survives the policy term
and the company receives the maturity amount, the entire proceeds are fully
taxable under Section 28 as business income.
– Death Benefit: If the keyman passes away during the policy
term, the death benefit received by the company is also taxable as business
income.
Non-Keyman Insurance Policies for Employees
Many companies provide life insurance policies for non-keyman
employees, either as part of their compensation packages or as a perquisite.
Such policies are not designed to protect the company’s business, but rather to
offer financial security to the employee and their family. This changes the tax
treatment significantly:
1. No Deduction for Premiums: The premiums paid by the
company for a non-keyman employee’s life insurance policy do not qualify as
deductible business expenditure under Section 37(1), as the policy benefits the
employee personally, not the business.
2. Taxation as a Perquisite: The premium amount is treated
as a perquisite under Section 17(2) of the Income Tax Act. The premium is added
to the employee’s salary and taxed accordingly each year.
Example 2: Life
Insurance for Non-Keyman Employee
Company B purchases a life insurance policy for Employee Y
with a sum assured of ₹1 crore. The company pays an annual premium of ₹10 lakh.
Since Employee Y is not a keyman, the premium is treated as a perquisite, and
the ₹10 lakh is added to Employee Y’s salary income each year, resulting in tax
being levied on the amount.
Key Differences from Keyman Insurance:
– The company cannot claim a deduction on the premiums paid
for non-keyman employees under Section 37(1).
– The employee is taxed on the premium amount as a perquisite
each year, which increases their taxable income.
Section 10(10D) of the Income Tax Act, 1961
Section 10(10D) provides a tax exemption for sums received
under life insurance policies, including maturity proceeds or death benefits.
However, the exemption comes with certain conditions:
1. The premium should not exceed 10% of the sum assured for
policies issued after April 1, 2012 (or 20% for policies issued between April
1, 2003, and March 31, 2012).
2. Proceeds from Keyman Insurance Policies are not exempt
and are fully taxable.
3. Death benefits are always exempt, irrespective of premium
limits.
Reproduction of Section 10(10D)
Section 10(10D):
“Any sum received under a life insurance policy, including the sum
allocated by way of bonus on such policy, other than:
(a) any sum received
under a Keyman insurance policy; or
(b) any sum received
under an insurance policy issued on or after the 1st day of April 2003 but on
or before the 31st day of March 2012, in respect of which the premium payable
for any of the years during the term of the policy exceeds twenty per cent of
the actual capital sum assured; or
(c) any sum received
under an insurance policy issued on or after the 1st day of April 2012, in
respect of which the premium payable for any of the years during the term of
the policy exceeds ten per cent of the actual capital sum assured.”
Assignment of Policies and Fair Market Value
(FMV)
When a company assigns a life insurance policy to an
employee, the fair market value (FMV) of the policy at the time of assignment
is typically treated as a perquisite under Section 17(2) and is taxable as part
of the employee’s salary income. This applies to both keyman and non-keyman
insurance policies. However, a key concern arises if the premiums have already
been taxed as perquisites each year—taxing the FMV at the time of assignment
would amount to double taxation.
Avoiding Double Taxation
If the premiums have been taxed each year as part of the
employee’s salary, taxing the FMV at assignment would result in double taxation.
To prevent this, the FMV should be adjusted to account for the premiums that
have already been taxed. In practice:
– The tax authorities generally ensure that double taxation
does not occur. If the premiums have already been taxed, the FMV should not be
taxed again at the time of assignment.
Hypothetical Scenarios and Tax Implications
Scenario 1: Keyman Insurance Policy Matures
Company X has a 10-year Keyman Insurance Policy for its CFO.
In the 8th year, the CFO passes away, and the company receives ₹5 crore as the
death benefit. The proceeds are fully taxable as business income under Section
28 of the Income Tax Act, as the policy is a Keyman Insurance Policy.
Scenario 2: Assignment of a Non-Keyman Policy
in the 9th Year
Company Y assigns a life insurance policy to Employee Z in
the 9th year of a 10-year policy. The fair market value (FMV) of the policy at
assignment is ₹30 lakh, but the company has already included the premiums in
Employee Z’s taxable salary as a perquisite every year.
To avoid double taxation, the FMV of ₹30 lakh is not taxed
at the time of assignment, as Employee Z has already paid tax on the premiums
annually.
Scenario 3: Assignment
of Policy Just Before Maturity
Company Z assigns a life insurance policy to Employee W in
the 9th year of a 10-year policy, and the policy matures in the 10th year. No
further premiums are due after the assignment. Since the premiums were taxed as
perquisites every year, no additional tax is imposed on the FMV. Upon maturity,
the proceeds are tax-exempt under Section 10(10D) if the premiums do not exceed
10% of the sum.
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