Budget 2019: How to strengthen keyman insurance policies
Prasad K S, Vijai Jayaram and Rohit Lal January 29, 2019
Keyman insurance is a great financial recourse for companies when they lose a key functionary. It has many benefits such as reduced taxable income, availability of needed funds and even boosting the morale of the keyman himself. A 'keyman insurance' is essentially a cover that ensures a payout which helps a business recover from the loss of a valuable asset such as its owner, partner, chief executive officer, general manager, or any employee the company considers to be an integral part of its functioning.
Keyman insurance can be defined as an insurance policy where the proposer is a company, the premium is paid by the company, the claim also goes to the company, but the insured is an employee. This employee discharges significant responsibilities, contributes immensely to the company's profits and is therefore crucial to the working of the business. The purpose of keyman insurance is to enable the company to recoup the financial loss from the event of the keyman's untimely death.
Though there are numerous benefits that a keyman insurance policy can provide to a company or the employee, there are certain challenges that we have discussed below.
Double taxation of proceeds under keyman insurance policies
In case of assignment of a keyman insurance policy by a company/business to any person, the surrender value under such policy, including the sum allocated by way of bonus, becomes taxable as 'Profit in lieu of salary' by the virtue of section 17(3)(ii) of the Income-tax Act, 1961 (the Income-tax Act) i.e, at the time of assignment of the keyman policy, the surrender value is taxed as a part of the salary of the employee.
Section 10(10D) of the Income-tax Act provides that any sum received under a life insurance policy, including bonus, is exempt from tax. However, the above provisions, specifically exclude amount received under keyman insurance policy.
If a Keyman insurance policy is assigned to any person before the maturity date, the policy is not treated as a regular life insurance policy and continues to be a keyman insurance policy. Thus, at the time of maturity of the policy, the employee is not able to claim exemption under section 10(10D) of the Income-tax Act for the maturity value. This leads to double taxation to the extent of value that has already been taxed under section 17(3)(ii) of the Income-tax Act, at the time of assignment of the keyman insurance policy.
Difference in definition
Keyman insurance policy has been defined by Insurance Regulatory and Development Authority of India (IRDAI) as an insurance policy taken out by a business, to compensate that business for financial losses that would arise from the death or extended incapacity of an important member of that business.
As per the Income-tax Act, 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.
The definition under the Income-tax Act is vague. A plain reading of the definition as per the Income-tax Act suggests that an insurance policy taken for any employee can be considered a keyman insurance policy. This difference between the definitions of keyman insurance in the Income-tax Act and the Insurance Act has left scope for multiple interpretations.
In the past, this has caused litigation where the tax authorities were of the opinion that the policies were bought in the name of employees who did not qualify as "key person" as per their understanding (i.e. CEO, MD, CFO, etc.). This resulted in disallowance of the policy premium.
Further, lack of clarity about the criteria for qualifying as a keyman insurance policy has also led to litigation. For eg, premium paid in relation to Unit Linked Insurance Plan (ULIP) has not been allowed as tax deductible expenditure, since the tax authorities were of the view that ULIP, not being in the nature of pure term insurance plan, does not qualify as a keyman insurance policy.
(Prasad K.S. is Partner with Deloitte Haskins and Sells LLP; Vijai Jayaram is Director with Deloitte Haskins and Sells LLP; and Rohit Lal is Deputy Manager with Deloitte Haskins & Sells LLP).