Taxation of Keyman Insurance Policy or Employer Employee Policy

Taxation of Keyman Insurance Policy or Employer Employee Policy

Keyman Insurance policy is often considered as a tax planning tool. Under this policy, the premium of the policy is paid by the employer to secure its business as well as the life of the employee. On completion of the policy tenure, maturity proceed is received by the employer. An option to assign the policy at any time during the tenure of the policy is there with the employer. It can be considered as a powerful tool for promoting & retaining the most important assets of the businesses i.e., Human Resources.
Keyman Insurance Policy Vs. Employer Employee Insurance Policy
Keyman insurance policy is a policy taken for a person who has substantial responsibilities or key position in the company whereas employer employee policy is the policy is taken on the life of any employee which may not be Keyman in the organization. The tax implications remains the same, be it a Keyman insurance policy or an employer employee policy.

Benefit of Keyman Policy or Employer Employee Policy:

1. The policy acts as a morale booster & encouragement for employee and do help in their retention. Untimely exit of the employee do create a vaccume of trained personnel in the organization. Employee can be rewarded by assigning the policy after some pre-decided time frame. This insurance policy acts as an encouragement for the employee to continue with his employer.
2. In case of death of the key person, Insurance proceeds can serve as a cushion against the outstanding loan liabilities of the company. It helps business to recover from the loss the persons who run it.
3. Disruption of lines of business credit due to the death of the Keyman can seriously affect the business. It acts as a strong safeguard against business risk of unfortunate death of the key person or important employee of the businesses.
4. The premium paid will be treated as business expenses and will be eligible for deduction.

Tax Treatment:

Under the Income Tax Act-1961, any insurance policy taken by the employer on the life of the employee is reckoned as “Keyman Insurance Policy”. Resultantly, the tax treatment would be same whether it is an employer employee policy or a Keyman insurance policy. Earlier, companies used to buy the Keyman insurance to claim deduction u/s 37 and later-on used to assign it to the Keyman during the tenure of the policy at its surrender value which was meager as compared to the premiums paid or expected maturity proceeds. It was used purely a tax planning tool as the amount received at the time of maturity was exempt u/s 10(10D). However, the provision has witnessed a sea change now. The present tax position is summarized as under:

In the hands of the Employer:

1. Employer who pays the premiums is eligible for deduction like any other expenses as the same is paid wholly and exclusively for the purpose of the business.
2. At the time of maturity or otherwise, amount received by the employer would be taxable as income. It will not be eligible for exemption u/s 10(10D) as it is specifically excluded from exemption. It may be noted that 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.

Taxation in the hands of the Employee:

1. The premium paid by the company is not taken as a perquisite in the hands of the employee u/s 17(2) of the Income Tax as the policy is for the benefit of the company and not the employee.
2. Employee is also not eligible for deduction u/s 80C towards the premium paid by the employer in the year of such payment.
3. If at any time during the continuation of the policy, it is assigned in favor of employee, the amount will be taxable in the hands of the employee. It will be taxable as “Profit in lieu of salary” u/s 17(3)(ii) of the Income Tax Act – 1961. Tax implication would be there even if no amount is received during such assignment. When the maturity proceeds is subsequently received by the employee, it will again be taxable in the hands of the employee as it is specifically excluded by exemption provision contained in section 10(10D). There were some confusions earlier regarding its taxability after assignment in favor of employee. It was believed that Keyman insurance policy seized to be a Keyman insurance policy after its assignment by the employer in favour of employee & as a result it automatically gets converted in to a regular life insurance policy. So, it was considered to be tax exempt u/s 10(10D). The issue is now resolved & it has been made clear that the Keyman insurance policy will remain a Keyman insurance policy even if it is assigned in favour of employee and so it will not be eligible for exemption.
4. In case the policy is assigned to an employee, employee can nominate his dependents in the policy. Consequently, in case of demise of the Keyman/insured during the policy term, the death benefits would go to these dependents. However, even these death benefits would not be tax-free under section 10 (10D).

Why one should buy Keyman Insurance Policies:

Despite the above taxing provision, Keyman insurance policy would be advisable for the reasons that,

1. Employer can claim deduction u/s 37(1) thereby resulting in its deferment of the tax liability till its maturity.
2. It can help in retaining the human resources till its assignments in favour of its employee.

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