Keyman Insurance Policy

 

 

 

Introduction

1. A keyman insurance policy, as defined in Explanationto section 10(10D) 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 whatever with the business of the first mentioned person.

The above definition implies the following ingredients of a keyman insurance policy:

(i) It is a life insurance policy.

(ii) It is a policy taken by one person on the life of another person.

(iii) The relationship between such persons should either be that of an employer - employee or any other business relationship.

For example, Mr. A is the chief operating officer of XYZ Ltd. (the company). XYZ Ltd. is heavily dependent upon Mr. A for its business operations and, thus, Mr. A is ‘a key person’ or a ‘keyman’ of the company Sudden death of Mr. A will seriously affect the business operations of the company. To insure against such losses, the company may take out an insurance policy on the life of Mr. A. Such a policy is known as ‘Keyman Insurance Policy.’

Tax Treatment

2. Tax treatment of keyman insurance policy can be classified as follows :

I. In the hands of the person taking the policy : The premium paid by the person taking the keyman insurance policy (hereinafter referred to as the first mentioned person) is an allowable expenditure in his hands under section 37(1) of the Income-tax Act. Section 37(1) reads as below :

“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.’”

The premium for keyman insurance policy is a revenue expenditure laid out or expended wholly and exclusively for the purpose of the business or profession of the assessee and, hence, is squarely covered by the above provision. Even in case of a firm, premium paid for a keyman insurance policy taken on the life of a partner, is an allowable expenditure under section 37(1). This has been judicially upheld by the Mumbai Tribunal ‘B’ Bench in the case of ITO v. Modi Motors[2009] 27 SOT 476.

As far as the maturity proceeds are concerned, generally any amount received, under a life insurance policy, including the sum allocated by way of bonus on such policy, is excluded from the total income of the recipient under clause (10D) of section 10 of the Act. However, the Finance (No. 2) Act, 1996, has amended section 10(10D) so as to exclude receipts under keyman insurance policy from the ambit of exemption. Simultaneously, sub-clause (xi) has been inserted in clause (24) of section 2 so as to include the sum received under keyman insurance policy in the definition of ‘income’. Further, clause (vi) has also been inserted in section 28 by the above Finance Act.

The net effect of the above amendments is that if the policy matures in the hands of the first mentioned person, then the maturity proceeds are taxable as business income in his hands.

II. In the hands of keyman : The premium paid by the first mentioned person is not taken as a perquisite under section 17(2) in the hands of the keyman. This is because; keyman policy is for the benefit of the first mentioned person and not the keyman. Since no personal advantage or benefit is derived by the keyman, it cannot be termed as a perquisite in his hands.

III. Maturity proceeds in the hands of keyman : Ordinarily, a keyman insurance policy can mature only in the hands of the first-mentioned person. However, the first mentioned person may assign the policy in favour of the keyman or his family members.

Section 17(3) has been similarly amended by the Finance (No. 2) Act, 1996 so as to include any sum received under a ‘Keyman Insurance policy’ within the ambit of ‘profits in lieu of salary’. A similar amendment has been made in section 56(2). A reasonable interpretation of the above two amendments in section 17(3) and section 56(2) implies that if the first mentioned person assigns the policy in favour of the keyman or any of his family members, then the surrender value will be taxable in the hands of the keyman under section 17(3) or in the hands of the family members under section 56(2).

Needless to say that after assignment, the policy will loose the character of a ‘Keyman insurance policy’and, hence, the ultimate maturity in such a case will be covered by section 10(10D).

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