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Business
Taxation of life insurance cos.
This is the second and concluding part of the article on Taxation of life insurance companies. The first part appeared in these columns on September 30.
IT IS but natural to expect that, after the nationalisation of life insurance, no further representations would have been made by the industry regarding taxation. The Life Insurance Corporation, however, felt that the basis of assessment of life insurance should be simplified and made a formal representation in this regard in February 1974. The representation was referred to the Central Board of Direct Taxes (CBDT). One of the important points that emerged in the meeting of the Consultative Committee of the Ministry of Finance, held in December 1974, was that the gross valuation surplus should be the only basis for taxation and the tax should be equal to a specified percentage of the gross surplus. This change came into effect from April 1, 1977.
Sec.115B of the Income-tax Act now states:
(1) Where the total income of an assessee includes any profits and gains from life insurance business, the income-tax payable shall be the aggregate of
(i) The amount of income-tax calculated on the amount of profits and gains of the life insurance business included in the total income, at the rate of twelve and one-half percent, and
(ii) The amount of income-tax with which the assessee would have been chargeable had the total income of the assessee been reduced by the amount of profits and gains of the life insurance business
Thus the LIC thus got the fairest of fair deals. This system of taxation, where the assessee itself is the assessor, is not only unique but also the simplest. There has virtually been no disputes during the last 25 years since its introduction. Due credit has to be given to the revenue authorities for this smooth functioning.
With this change in the method of taxation, two rates of tax have been introduced. A rate of 12.5 per cent on the computed profits and gains of life insurance business. The normal corporate rate on the net income in the shareholders' fund after excluding the profits from life insurance business. With the entry of private sector in life insurance, this dual system of taxation can lead to certain problems. What can be these problems?
(a) In the case of new companies, the valuation surplus will be negative during the first few years. However, since the rate of tax applicable to the profit and gain from life insurance business is different from that applicable to the balance net income in the shareholders' fund, a loss in the former cannot be set off against the net positive income in the latter. This may lead to representations from the new companies.
(b) During the first three or four years after commencement of operations, till sufficient business volumes build up, the policyholders' fund of a company will be in deficit. Not only in deficit, but may also be negative. This, however, is a normal occurrence and not a matter for concern. But, in their anxiety to project a healthy image, new companies generally try to wipe out this deficit by appropriate transfers from the shareholders' to policyholders' fund. "Can these transfers be treated as valid business expenses and allowed to be set off against the investment income in the shareholders' fund?''
However, since it is not stipulated either in the Insurance Act or Regulations, that the deficit in the policyholders' fund has to be made good by transfer from the shareholders' fund, the revenue authorities can and may take a view that such transfers cannot be treated as valid business expenses. Any such decision is certain to result in protracted legal battles. Before the introduction of the "dual system of taxation'' in 1977, such a problem could not have arisen and so no precedents too may be available.
(c) One can at least argue that transfers from shareholders' fund to wipe out the deficit in the policyholders' fund are to be treated as valid business expenses. But when transfers are made not for just neutralising the deficit but for artificially showing a surplus in the policyholders' fund and declare bonus under policies in force, such transfers cannot be claimed as normal business expenses. What will be the view of revenue authorities in such cases. One can only wait and see.
The coming years may therefore witness many disputes regarding assessment of life insurance companies. What will be the response of the revenue authorities to these disputes?
In the last 25 years the Indian insurance industry has been enjoying the advantages of a liberal tax regime. This, together with concessions under Sec. 88 to the premiums paid and the favourable treatment of maturity benefits received under a life insurance policy, can be the envy of insurance companies in other parts of the world. The revenue authorities too are fully aware of these liberal provisions. The disputes that are likely to be raised in the coming years may provide the authorities with just the opportunity to review the entire system. Any such review may invariably lead to the adoption of the British model. If this happens, the Exchequer will be a handsome gainer and all life insurance companies, without exception, will be the losers.
R. Ramakrishnan
(Actuary)
(Actuary)
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