Whether the Keyman Insurance Proceed can be offered to taxation under the head “Capital Gain” – CA Naresh Jakhotia

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Whether the Keyman Insurance Proceed can be offered to taxation under the head “Capital Gain” – CA Naresh Jakhotia

If at any time during the continuation of the Keyman Insurance policy, it is assigned in favor of employee, the amount will be taxable in the hands of the employee even if no amount is received during such assignment. It will be taxable as “Profit in lieu of salary” u/s 17(3)(ii) of the Income Tax Act – 1961. All the more important, when the maturity proceeds is received by the Keyman, it will again be taxable in the hands of the employee as it is specifically excluded by exemption provision contained in section 10(10D). 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.

There were some confusion 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 with due amendment in section 10(10D). 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 u/s 10(10D).

An important question now emerges is, whether it will not result in double taxation of some part of the maturity proceeds being already taxed at the time of assignment of the policy by the employer in favour of employee u/s 17(3)(iii). Some professionals are of the view that taxing it again at the time the proceeds of maturity of Keyman insurance policy in the hands of employee wherein some part is already taxed is like double taxation.

Let us see the basic provision in detail.

Definition of “Income” as given in Section 2(24)(xi) has included the amount received from Keyman including the sum allocated by way of bonus as “Income”.

Clause (xi) to section 2(240 reads as under:
(xi ) Any amount received from Keyman including the sum allocated by way of bonus on such policy.
Explanation: For the purpose of this clause, the expression “Keyman Insurance Policy” shall have the meaning assigned to it in clause (10D) of section 10

Now, a question arises as to the head under which the proceeds of Keyman Insurance Policies will be taxable?  It must be noted that when the definition of income u/s 2(24) was amended by the Finance (No. 2) Act -1996, there were two more amendment were done.

  1. One was done in section 28 wherein a clause (vi) was added so as to tax the income under the head of Income from Business & Profession. Clause (vi) to section 28 reads as under:
    (vi)  Any amount received from Keyman including the sum allocated by way of bonus on such policy.
    Explanation: For the purpose of this clause, the expression “Keyman Insurance Policy” shall have the meaning assigned to it in clause (10D) of section 10
  2. Second amendment in section 56 wherein a clause (iv) was added so as to tax the income under the head of Income from other source. Clause (iv) to section 56 reads as under:
    (vi)  Income referred to in sub clause (xi) of section 2 if such income is not chargeable to income tax under the head “Profits and gains of business or profession” or under the head “Salaries”

It must be noted that if the Keyman insurance policy is not assigned in favour of employee then the maturity proceeds will be received by the employer only and this will be taxable u/s 28 under the head “Income from Business and profession”. In short, there is a specific provision for its taxation under the head “Income from Business and profession” and so its taxability under the head “Income from Capital Gain” is not possible at all.

However, if the Keyman insurance policy is assigned in favour of employee then the maturity proceeds will be received by the employee only. At the time of assignment, income received is taxable as “salary” pursuant to section 17(3) which treats the surrender value of the policy as “Profit in lieu of salary”. However, the amount received at the time of maturity is not taxable as salary as the definition of salary is not expanded so as to include the amount as “salary”. However, section 56 is amended so as to include such amount as Income from other source. It means that there is a specific provision which provides that the income received by employee will be taxable as “Income from Other source”. Since specific charging provision is there, it cannot be treated as “Capital Gain” Income.

An important question now arises, whether in case of employee, does it not amount to double taxation. Once u/s 17(3) and secondly u/s 56 at the time of receipt of maturity proceeds.

In my view, “No”.

The amount which is already taxed u/s 17(3) can be claimed as deduction u/s 57 when the maturity proceeds is offered for taxation u/s 56 by the employee.

Section 57(iii) provides for deduction of all expenditure (not being in the nature of capital expenditure) laid out or expended wholly and exclusively for the purpose of making or earning such income.

In short,

  1. Amount cannot be taxed as Capital gain income whether it is received by the employer or employee.
  2. If received by employer, entire amount will be taxable as business income.
  3. If received by employee, only amount over and above income offered for taxation u/s 17 will be subject to tax u/s 56 as income from other source.

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