Introduction
Wondering what will happen to your flourishing business when the ?keyman? being either you or your director or sales person or any other person who contributes significantly to your business is no longer there?
Certain employees with specialised skills, foresight and business acumen bring greater revenues, profits, and brand-value to the organisation. Therefore, the sudden exit of these key individuals (for whatever reasons) can have a manifold negative impact on the organisation. Simply put, ?keyman insurance? is a corporate-owned life insurance cover on key person/persons in a firm such as directors, key sales people, key project managers or any person holding substantial responsibility and contributing significantly to profits of that organisation.
Cover for the top
- Keyman insurance is a corporate owned life insurance cover on key person/persons ? directors, key sales people, key project managers or any person holding substantial responsibility and contributing significantly to profits of that organisation
- The Income Tax Act defines a keyman insurance as a life insurance policy taken by a person on the life of a present/former employee or on the life of any other person who is connected in any manner with the business of such person
Who could be the Keyman
Generally a keyman could be a CEO, CIO, Chairman, MD, Directors or a key management person. But as there are several such one-man run companies across the world and there it?s vital for companies to cover the single most important employee to hedge against any financial loss due to death of this keyman.
What could be the cover
The maximum sum assured under keyman insurance for a corporate is based on the company average net profit/average gross profit. A multiple of the individual?s remuneration is also considered.
This is how keyman insurance works
A company purchases a life insurance policy on a certain employee holding key responsibilities, pays the premiums and is the beneficiary of the policy. If that person unexpectedly dies, the company receives the insurance payoff. A keyman insurance policy helps the company survive the blow of losing people who make business happen.
The Income Tax Act specifically defines a keyman insurance policy as a life insurance policy taken by any person on the life of a present/former employee or on the life of any other person who is connected in any manner with the business of such person.
Tax in the hands of the employer
The Central Board of Direct Taxes (CBDT) clarifies that the premium paid by a company on taking keyman insurance policy is a deductible business expenditure for the company.
Further, the term income as defined under the Act specifically includes within its ambit ?any sum received under a keyman insurance policy including any sum allocated as bonus.? The amount received by the company paying the keyman insurance premium on claim or maturity of policy, including the sum allocated by way of bonus on such policy, is taxable in the hands of such company as business profits. The amount received on account of a keyman insurance policy is not exempt under Section 10(10D) of the Act which exempts from tax any sum received under a life insurance policy other than, among other things, a keyman insurance policy.
Tax in the hands of the employee
The company also has the option to assign/endorse the insurance policy in favour of the key employee (keyman) who has been insured under the keyman insurance policy. If such an assignment happens when the keyman is an employee of the company or at the time of retirement, the surrender value of the policy at the time of assignment is taxable in the hands of the keyman as ?profits in lieu of salary? and taxable at the applicable tax rate. The maximum marginal rate of tax in the hands of individuals is 33.99%.
Where no employer-employee relationship exists at the time of assignment, such surrender value or any other payment is taxable as ?income from other sources? in the hands of the keyman. The tax incidence is the same as above.
The CBDT circular, which provides guidelines in respect of taxability of amount received under Keyman insurance policy, does not however provide any guidance on the tax implications in the hands of the keyman when he finally receives money from the company.
Income is taxable in the hands of the keyman at the time of assignment of the policy in his favour by the company. It is a strong case that once the policy is assigned to the keyman, it loses the character of the keyman insurance policy and any amount ultimately received by such individual on maturity of such policies should not be taxable in his hands and should be exempt under Section 10(10D) of the Act.
Example: Company A decides to take a keyman insurance policy on the life of Able, a key sales person aged 30, with the maturity value of Rs 10,00,000. The company pays the premium for 30 years and assigns the policy to Mr Able at the time of his retirement when he is 60 and the surrender value of the policy is Rs 6,00,000. In this case, Rs 6,00,000 shall be taxable in the hands of Mr Able at the time of assignment as ?profits in lieu of salary? and if Mr Able continues the policy, the maturity value of Rs 10,00,000 received at the time of his death shall be exempt under Section 10 (10D). Although keyman insurance does not provide for indemnification of actual loss incurred on loss of a keyman as it only provides benefits as per the plan of insurance selected, it is still a good tool for liquidity.
Benefits of Keyman Insurance
The Central Board of Direct Taxes (CBDT) clarifies that the premium paid by a company on taking keyman insurance policy is a deductible business expenditure for the company.
- Total deduction of premia U/S 37{1}.
- Stop premia payment after 11yrs and assignment after 15yrs leaves a small total cash value.
- On assignment total cash value is taxed.
- After assignment the death benefit becomes tax free U/S 10{10} D.
- No premias to be paid after assignment as the policy is paid by the bonus.