How some firms use a loophole to save tax with keyman insurance | Mint

How some firms use a loophole to save tax with keyman insurance

There are two types of life insurance policies offered to employees: keyman life insurance and employer-employee (E-E) insurance.
There are two types of life insurance policies offered to employees: keyman life insurance and employer-employee (E-E) insurance.

Summary

  • Unlike typical keyman policies, these come with a savings plan and the maturity benefit is given to employees

NEW DELHI : Employee stock options (Esops), bonuses, and health insurance. These are a few perquisites given by companies to retain top talent. A few employers provide life insurance as well.

Typically, there are two types of life insurance policies offered to employees: keyman life insurance and employer-employee (E-E) insurance. In the first, the life insured is of key managerial persons (KMPs)—the employees whose services are indispensable to run the company, as defined by The Companies Act, 2013. The proposer and the premium payer is the employer, who is eligible for tax exemption on premium payments.

In case of an eventuality, the company gets the death benefit and the proceeds are added to the company’s business income. Insurance regulator Irdai, however, has specified that only pure term plans can be bought under a keyman policy. The benefits can thus be claimed only if an employee dies in harness. The policy lapses if the employee quits the company ahead of the maturity period.

Keyman insurance, but with a twist
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Keyman insurance, but with a twist

E,-E insurance, though, can incorporate a savings life plan—a financial product that combines savings and life insurance into a single package. Employers can buy it for one or multiple employees. The premium is paid by the employer, with the employee as the proposer. The life insured will be that of the employee. The premium payment by the employer will be considered as perquisite in the hands of employees and will be taxable. The maturity benefit, however, is received by the employee and is tax exempt up to the defined limits.

Now, a seemingly new policy construct has made its way to the industry. It is essentially a keyman insurance but with a savings plan that is supposed to benefit employees eventually.

While many insurance companies are currently offering such policies, financial experts are unsure whether this is authorized by Irdai.

An email sent to Irdai did not elicit any response.

In such policies, the employer is the proposer and pays the premiums, while the employee is the life assured. The employer gives an undertaking to assign the policy to the employee after the premium payment term is over. Thereafter, the employee gets the survival/maturity benefit. This amount will be treated as profits in lieu of salary under section 17(3) of the income tax Act. The premium payment by the employer is not considered perquisite in the hands of employees. However, employees only benefit if the companies do not renege on the undertakings given to them. A company will be eligible for the maturity proceeds if the policy is not assigned to the employee.

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“Companies buy it majorly for its top management such as owners or directors. Some have begun to offer it to all their employees including junior and mid-level ones," says Naveen Kumar Midha, executive director– health & benefits, Global Insurance Brokers.

Rushabh Gandhi, deputy CEO, IndiaFirst Life Insurance, says E-E policies are a great tool for attracting and retaining talent.

“There is no perquisite tax for an employee. From an employer’s standpoint, premiums are considered as business expenses and deductible under the income tax Act. In the unfortunate event of the death of the employee, the claim proceeds are tax free," he says, adding “while we offer such policies to various mid-sized companies, this does not tantamount to a sizable portion of our overall premiums."

Benefit for employees

If an employer wants to deploy company profits as bonus or a salary hike to its employees, it will be fully taxable in the latter’s hands. That is where E-E insurance comes in handy. The employer can purchase one of these policies for its employees instead of issuing bonuses. This payment won’t be considered as a perquisite since the employer is the policy proposer.

The employer can assign this policy to the employee after the premium payment term is over. Employees get the survival/maturity benefit which is taxable.

“Even if it is taxable, it is still better than taking a bonus which comes with an upfront tax cut. You would anyway be investing your bonus somewhere. Why lose some of it in taxes? E-E solutions allow you to invest the full amount in a savings life plan," says Sajja Praveen Chowdary, head, business, corporate insurance vertical of Policybazaar.com, an online insurance distributor platform.

For instance, your employer wants to pay you 10 lakh per annum over and above your salary. If you are in the 30% income tax slab rate, taking the extra amount as a bonus or salary will reduce this amount to 7 lakh. You can make use of the entire 10 lakh if your employer can purchase a savings life plan on your behalf with an undertaking that it will assign it to you after the premium payment term is over.

However, this will mean that you will have to stick to the company for a longer term. In case employees quit before the policy is assigned to them, the surrender/maturity benefit will come to the employer and get added to its business income.

How employers stand to gain

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Be it the insurance premium, bonus or salary hike, for employers, all such transactions fall under business expenses. Companies can claim tax exemption against these under section 37(1) of income tax act. For employers , the policies are a tax-efficient way to deploy company profits.

More importantly, it offers the companies a chance to log perpetual tax benefits.

Industry insiders say some companies use it to defer corporate tax for perpetuity as there is no upper limit under section 37(1). In fact, they can buy a single premium payment policy in which they are the proposer and life assured is of a KMP. This amount claimed under section 37(1) substantially reduces the taxable profit.

It is likely that some such companies may never assign the policy to the employee. After the policy matures, the proceeds is received by the company and is considered business income. The company is liable to pay tax on the same. However, if it again buys one or multiple employer-employee insurance solutions with this amount, the firm can again claim it as business expenses.

It is open to interpretation if this practice falls under tax planning or tax avoidance, say experts.

“Insurance should not be treated only as tax-saving instruments. The regulator and the government may not appreciate it given they have already started taxing the maturity benefit in high-premium traditional and unit-linked policies," says Yogesh Agarwal, founder & CEO, Onsurity, an employee benefits company that works with small and medium enterprises and startups.

The E-E solution is largely sold as a tax solution to small businesses. But, it can be designed as a social security benefit for all employees. “It can get a good offtake if they link such policies to the employee’s compensation package. The employees can receive their due periodic/lump-sum income after the payout period starts, provided they stay with the company till then," says Midha of Globe Insurance Brokers, a composite insurance broker.

“It can be designed as defined contribution plans to minimise an employer’s long-term financial obligations while still enhancing employee engagement. Under this construct, the employer and employee can jointly fund the plan, much akin to how it works in a provident fund," he adds.

Employers can consider buying such a policy in a group construct also.

“If the employer takes the group insurance policy, neither premium nor maturity benefit shall be taxable in the hands of the employees," says Naveen Wadhwa, vice president at Taxmann, a tax consultancy firm.

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