Life Insurance – Current tax issues - Welcome to the Institute of Actuaries of India tax...

August 2009 1 PricewaterhouseCoopers

Life Insurance – Current tax issues

August 28, 2009


Presentation outline

Overview - Indian life insurance

Governing tax provisions

Determination of taxable income

Tax Litigation – issues & its effects

Other tax issues

Reasons for change in tax law

Direct Tax Code


Overview - Indian life insurance


Overview – Indian life insurance sector…

• Indian life insurance sector opened up in year 2000 for private players

• Until opening of sector – Life insurance corporation of India was the only

player

• 26:74 Joint Venture permissible with foreign companies

• Insurance Regulatory & Development Authority (‘IRDA’), regulatory body

constituted under IRDA Act ,1999

� to provide for governing rules & regulations for life insurance companies

• Significant changes brought about/ new regulations introduced under IRDA

Act, 1999

• Following key regulations introduced –

� IRDA (Actuarial Report & Abstract) Regulations, 2000

� IRDA (Assets, Liabilities, Solvency Margin of Insurers) Regulations, 2000

� IRDA (Preparation of Financial Statements and Auditors’ Report of Insurance Companies)

Regulations, 2002


…Overview – Indian life insurance sector

• IRDA (Preparation of Financial Statements and Auditors’ Report of Insurance

Companies) Regulations, 2002

� Under new format, two separate accounts prescribed as compared to one single account under

old format

� Policyholders’ account known as Revenue account (Technical account) and

� Shareholders’ account known as Profit & Loss account (Non-Technical account)

� New format of Valuation Balance Sheet (i.e. Form I) different from old format

� New Form I reflects surplus/ deficit only under policyholders’ account

• No change in tax provisions applicable to life insurance companies since 1976

• Eradi Committee constituted by Government in year 2000 to review tax laws

related to life insurance taxation

� Recommendations of committee never implemented

Tax provisions not kept pace with regulatory changes


Governing tax provisions


Governing tax provisions…

Provisions governing Life insurance business

Section 44

“Notwithstanding anything to the contrary contained in the provisions of this Act relating to the computation of income chargeable under the head “Interest on securities”, “Income from house property”, “Capital gains” or “Income from other sources”, or in section 199

or in sections 28 to 43B, the profits and gains of any business of insurance, including any such business carried on by a mutual insurance company or by a co-operative society,

shall be computed in accordance with the rules contained in the First Schedule”

“The profits and gains of life insurance business shall be taken to be the annual average

of the surplus arrived at by adjusting the surplus or deficit disclosed by the actuarial

valuation made in accordance with the Insurance Act, 1938 (4 of 1938), in respect of the

last inter-valuation period ending before the commencement of the assessment year, so

as to exclude from it any surplus or deficit included therein which was made in any earlier

inter-valuation period.”

Rule 2

Section 115B

Profits & gains from life insurance business subject to tax @ 12.5%*

Profits & gains from other than life insurance business @ 30%*

* Applicable surcharge and education cess will be additionally levied


…Governing tax provisions…

• S. 44 read with First Schedule

� Separate code for taxation

� Basis of taxation different from basis that is generally applicable to other corporate entities

� Provides for taxation of insurance companies & computation of profits thereof

� Overrides other tax provisions relating to business profits/ capital gains/ other income

� Specific provisions dealing with deductions/ disallowances of expenditure applicable to

other corporate entities do not apply

• S. 115B

� Special rate of 12.5% for profit from life insurance business

� Other income - normal tax rate


…Governing tax provisions

• Rule 2 of First Schedule

� Provides for computational methodology of life insurance profits

� Plain reading suggests

o Surplus/ deficit of prior inter-valuation period to be excluded from surplus/ deficit of current inter-

valuation period

o Surplus of current period is excess of Assets over Liabilities

� Specific provisions dealing with deductions/ disallowances of expenditure applicable to

other corporate entities do not apply

• Difficulties in applying Rule 2

� Term ‘annual average’ referred to in Rule 2 redundant since actuarial valuation carried out

on yearly basis by insurance companies

� ‘Actuarial valuation’ not defined in the Income-tax Act

� Only policyholders’ account considered if Form I is adopted as basis for taxation

� Policyholders’ surplus as per Form I is including transfer of funds from shareholders‘

account

Rule 2 – not happily worded and capable of subjective interpretation


Basis of Taxable Profits


Basis of taxable profits…

• Taxable profits from life insurance business to be computed as per S.44 read

with Rule 2 of First Schedule

• Whether taxable profits to be determined based on

� Financial statements or

� Actuarial valuation report i.e. Actuarial Report & Abstract as per IRDA requirements

• Whether Policyholders’ account (‘PHA’) & Shareholders’ account (‘SHA’) forms

part of single life insurance business

• Different approaches present in life insurance industry


…Basis of taxable profits…

Determination of taxable profits - No uniformity in approach

followed

Approaches

Aggregate SegregateForm I

based


…Basis of taxable profits…

• Aggregate Approach (based on financial statements)

� Policyholders account (‘PHA’) & Shareholders’ account (‘SHA’) are considered part of one

single business of life insurance

o Maintenance of two separate accounts is as per IRDA requirements

� Aggregate results of both PHA & SHA (after nullifying effect of transfer between accounts)

represents the profit of company

– Thus, taxable surplus / deficit computed to include impact of both the accounts

• Segregate Approach (based on financial statements)

� PHA & SHA represent two separate businesses

� Profits of each account to be calculated independent of other

� Only PHA represents insurance business and should be taxable @ 12.5%*

� SHA not to be taxed as income from insurance business and should be taxable as Income

from other Business @ 30%** Applicable surcharge and education cess will be additionally levied


…Basis of taxable profits

• Form I based Approach (based on actuarial valuation report & partially on

financial statements)

� PHA & SHA considered part of one single business of life insurance

� Surplus reflected in Form I (part of Actuarial Report & Abstract) considered as policyholders’

surplus

� Profit/loss in SHA aggregated with Form I surplus to arrive at taxable profits

• Results arrived in all 3 approaches further subject to certain tax adjustments

such as

� Exemption for pension income - S.10(23AAB)

� Exemption for dividend income - S. 10(34)

� Disallowance for expenditure pertaining to exempt income - S.14A


Tax Litigation – Issues & Effects


Tax Litigation – Issues...

• Several issues sprung during assessments & pending at various levels because

of -

� no clarity in computation of taxable profits as per Rule 2

� No uniformity in approach adopted by life insurance players

• Profits as per financials - generally rejected

• PHA & SHA considered not to represent single business of life insurance

• Characterisation of taxable profits

� PHA profits - considered as Income from life insurance business, taxable @ 12.5%*

� SHA profits - considered as income from other business/ income from other sources,

taxable @ 30%* (corporate tax rate)

Lack of clarity – No precedents – Issue pending at Tribunal level

* Applicable surcharge and education cess will be additionally levied


...Tax Litigation – Issues

Computation of taxable profits of life insurance company

Policyholders’ account

� Actuarial surplus (reflected in Form I)

considered taxable as PHA profits &

not as per financials

� Transfer of funds from SHA

considered income in PHA

Shareholders’ account

� Profits as per financials considered

taxable as SHA profits

� No deduction allowed for transfer of

Funds to PHA resulting in double

taxation

� Effectively fresh capital introduced by

Shareholders becomes taxable

Other issues

� Incremental Negative Reserves (reflected in Form I)

representing potential income considered taxable

� Set off of brought forward losses not allowed

� Dividend income considered as business income

� Higher disallowance of expenses to earn exempt income


Tax Litigation - Effects

• Traverse views adopted by tax authorities across cities

• Reassessment proceedings likely to be initiated as most years open

• High exposure on account of levy of penalty and interest

• Degradation of financial position in annual accounts

• Results in immediate cash outflows, thereby hampering working capital

• Huge gamut of tax litigation awaiting involving millions of rupees & causing of

financial hardships

Huge gamut of tax litigation awaiting


Other Tax Issues


Other tax issues

• Other relevant tax issues for computing taxable income

� Deductibility of bonus to policyholders

� Applicability of Minimum Alternative Tax

� Exemption for pension [u/s 10(23AAB)]

� Exemption for dividend [u/s 10(34)]

� Tax treatment of set up related expenses

� Disallowance of expenses pertaining to exempt income [u/s 14A]

� Carry forward of losses beyond 8 years


Reasons for Change in tax law


Reasons for change in Rule 2

• Computational provision (Rule 2) capable of different interpretations

• Not kept pace with major regulatory changes brought about by IRDA

� No amendment since 1976

• To provide for uniform methodology for computation of profits from life

insurance business


Direct Tax Code


Direct Tax Code

• Pass thru status accorded to life insurance company

� Will not be required to pay any tax on actuarial surplus in policyholder’s account

• Taxable profits of Insurance business

• Profits determined in Shareholder’s account (+)

• Specified income taxable as ‘Income from business’ but not included in Shareholder’s

account (-)

• Losses in respect of life insurance business, for any FY immediately preceding relevant FY

• Taxable profits to be treated as NIL, if negative

• Tax rate – 25%

• Surcharge and education cess removed

• Carry forward of losses – Permitted perpetually…no restriction on number of

years

• Applicability of MAT to life insurance company

• 2% of gross assets

Life Insurance – Current tax issues - Welcome to the Institute of Actuaries of India tax...

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