With almost all perquisites now taxable in the hands of employees, the tax experts are presently finding various ways of tax planning, especially for high- salary income group of employees. With this background, a new tool of ‘keyman insurance’ is used with certain question marks attached to it. In this scenario, it becomes very important to understand what is ‘keyman insurance’ and its accounting and tax implications. An effort is made here to look into the said aspect of the keyman insurance.

1. What is keyman insurance and objects of the same :

1.1 Keyman insurance is an insurance taken by a company/firm on the life of an employee/ partner (keyman), whose services contribute substantially to the success of the business of the company/firm. The object of the keyman insurance is to cover the life of a keyman for a monetary value so that on death of such keyman, the loss to the firm is recouped with monetary assistance (insured amount) received from the insurance company.

1.2 It may be noted that the purchaser of keyman policy has various options relating to payment of premium i.e., the purchaser can pay a single premium or can pay premium spread over years of his choice. The purchaser has also a choice to select how the premium amount is to be invested by the insurance company. Such choice depends upon the purchaser’s capacity of risk taking and future needs of funds. On the choice of the purchaser, the insurance company would invest either in gilt securities, money market instruments, equity or a mix of these.

1.3 There can be more than one keyman in the company. Thus, the objects of keyman insurance can be briefly summarised as below :

1.4 Thus, the important points to be decided by the company and the insurance company, before subscribing for keyman insurance/issue of keyman insurance policy, are as follows :

1. Identifying keyman/key-men in the organisation/company.
2. Board resolution for purchasing keyman policy.
3. Sum to be assured per keyman, based upon company’s turnover, assets and profitability and also average salary and age of the keyman.
4. Overall eligibility amount of keyman insurance of the company, based on the gross income of the company and liquidity of the company.
5. Tenure of the policy.
6. Premium per year.
Before I proceed to the accounting and taxation-related issues relating to keyman insurance, I narrate below the provisions of the Income-tax Act.

2. The relevant Sections of the Income-tax Act and circulars applicable to keyman insurance are summarised as follows :

3. Now keeping the above provisions and circular in mind, let us understand various accounting issues and their tax implications.
For framing the above tax implications, reliance is placed upon the above Sections and circulars and upon photocopies of opinion of eminent chartered accountants and advocates, received by me from one of the private sector insurance companies.

4. Now, we may discuss the controversy as mentioned above.
One chartered accountant firm has opined that (as second view) :
"Accordingly, once the keyman policy is assigned, the employee himself and not the employer, is the beneficiary under the policy. Once the employer ceases to be the beneficiary, the very condition critical to the nature of a keyman insurance policy is not satisfied and the policy should be considered as having ceased to be a keyman insurance policy."
Another firm of chartered accountant opined that :
"It could lead to double taxation of income from the same source."
A prominent advocate opined that :
"Any sum received by an employee or former employee would be chargeable to tax under the head ‘salaries’ . . . . . In the case of other persons who do not have employer-employee relationship with the organisation, the sum received would be income chargeable under the head ‘income from other sources’."
". . . . . if the surrender value is nil, it may be successfully argued that there would be no income by the employee."
Another chartered accountant opined that,
"No taxable income arises in the hands of the employee who obtains the keyman insurance policy on assignment without any surrender value being specified by the insurance company . . . . . . . the insured pays the balance premium as stipulated by the insurance company, the character of the policy changes from keyman insurance to ordinary life insurance. If any sum is received thereafter, then in accordance with S. 10(10D), there is no tax implication at all."
On reading of the above opinions, a common factor is to be noted that in all the opinions, the counsel has tried to conclude that once the policy is assigned to the keyman, the character of the policy changes to normal life insurance policy, and thus, the amount received by the keyman as the beneficiary of the life insurance policy would be exempt u/s.10(10D) of the Income-tax Act.

4.1 In my opinion, the tax planning thought for the keyman, as a tax-free ex gratia payment or tax-free amount to be received by him at the time of maturity of the policy, would be taxable for the following reasons :
(a) The meaning of ‘Keyman Insurance Policy’ is common for all the above Sections i.e., as defined in Explanation to S. 10(10D).
(b) Wording in S. 2(24)(xi), S. 10(10D), S. 17(3)(ii), is the same i.e., any sum received . . on such policy . . under a Keyman insurance policy.
(c) All the above Sections refer to the taxability of sum received under a keyman insurance policy i.e., it refers to the sum received and not in whose hands i.e., to say the sum paid by the insurance company is a taxable amount, irrespective of its taxability in the hands of employer or employee. In other words, the sum received under keyman policy is liable to tax regardless of who receives it.
(d) S. 2(24) defines an ‘income’ which includes a sum received under a keyman insurance policy.
(e) S. 10 deals with incomes which do not form part of total income and the clause (10D) relates to the sum received under life insurance policy, except sum received under a keyman insurance policy.
(f) Both S. 17(3) and S. 2(24)(xi) relate to the taxability of a sum received under keyman insurance policy, either as salary or as income from business or profession, while S. 56(2)(iv) relates to its taxability under income from other sources.

4.2 Now applying the above points in correct chronology,
S. 2(24) gives definition of ‘income’ which includes any sum received under keyman insurance policy. S. 10(10D) defines the term ‘Keyman Insurance Policy’. The said Section states that . . . . . under a life insurance policy . . . . . on such policy other than any sum received . . . . . under a keyman insurance policy. Thus, once a keyman insurance policy is purchased by an employer, the said policy gets the status of ‘keyman insurance policy’ and till the policy is cancelled/surrendered/matured, it continues its status as a ‘keyman insurance policy’ as defined u/s.10(10D). When a policy is assigned by employer in favour of the keyman, the insurance company simply assigns the original policy in favour of the keyman i.e., after such assignment, instead of employer the keyman becomes the beneficiary, and the policy continues and remains the same. Thus, on a strict reading of the wording in S. 10(10D) . . . on such policy the exclusion would prevail and the amount received on keyman insurance policy, even after assignment to a keyman, would be taxable in the hands of the recipient.

4.3 The counsels and the insurance company are relying on the CBDT Circular No. 762 about the taxability in the hands of keyman after the policy is assigned in his favour and the sum is received by him, either on maturity or on surrender of such policy.

4.4 The CBDT Circular No. 762 only speaks about the quantum of amount that will be taxable, as profit in lieu of salary, in the hands of keyman, who is employee of the person who has purchased the keyman policy, when
(a) it is endorsed in his favour — the surrender value of the policy at the time of assignment is taxable.
(b) the sum received by keyman at the time of retirement — the entire sum received is taxable.
Thus, if an employer, during the period of employment, of a person, selects him as a keyman and buys keyman policy and assigns the same in favour of the keyman during his employment, only the surrender value of the said policy will be taxable in the hands of keyman at the time of such assignment.
4.5 However, the circular is absolutely silent about the tax impact in the hands of a keyman, when he receives money from insurance company, either on surrender or on maturity of the policy which was originally a keyman insurance policy [as defined u/s.10(10D)] and later on assigned to him. If the circular is silent about this, it seems to be on account of the fact that the legislative intention is to tax the sum received from insurance company on any keyman policy.

4.6 This is further supported by the circular, which at least, has clarified in case of person having no employer-employee relationship, i.e., the sum received under the policy is taxable under the head ‘income from other sources’. As the principle of justice would not make any discrimination between two assessees and there cannot, in my opinion, be any distinction between a person having no employer-employee relationship and a person having such relationship. Thus, I conclude that the sum received under the policy is taxable even in the hands of a person having an employer-employee relationship.

4.7 By any method or by any accounting treatment, the sum received under keyman insurance would amount to taxable receipts either in the hands of the employer or employee, since the words used are ‘on such policy’.

5. Conclusion :
Keyman insurance is a good tool for the liquidity needs of the company/firm/employer on loss of a keyman or partner, but is not a device of tax planning for providing tax-free ex gratia payment to keyman or partner, as it is made out to be.