3 Key-man insurance is an insurance taken by a business firm on the life of an employee (key-man) whose services contribute substantially to the success of the business of the firm. The object of key-man insurance is to indemnify business firm from the loss of earnings resulting from the death of a valuable employee. Loss of earnings may occur because immediate replacement of the key-man may not be possible and it may take longer time to train another person to perform his functions. Further, loss may occur if the key-man can be replaced only at considerable cost of training etc. to the business of firm. The amount of key-man insurance can be estimated to be the monetary value of the likely setback to the profits of the concern due to the death of the key-man.Section 37(1) of the Insurance-tax Act,1961 provides that any expenditure laid out or expended wholly and exclusively for the purposes of the business or profession , shall be allowed as a deduction in the computation of income from the business or profession.
4 Premiums paid on insurance policy taken by the employer on the life of his employees or expert advisers against death or injury or liability for compensation in respect of accidents to its employees are allowable as business expense in terms of the said Section 37(1).The Corporation made a reference to the Central Board Of Direct Taxes about key-man insurance. The Board has informed the Corporation that if the concern is able to establish before the Income-tax officer that the premium paid on such insurance is an expenditure laid out wholly and exclusively for the purpose of business, it will be entitled to a deduction under Section 37(1) of Income-tax Act ,1961. They have further mentioned that the employees should not derive any benefit from the insurance. If these conditions are satisfied the amount of premiums paid by the concern will not be treated as perquisite in the hands of the employee. It may be noted that if the premiums in respect of insurance on the life of key-man is allowed as business expenses, the proceeds of the policy in the hands of the concern will be treated as revenue receipt.
5 Please refer to the letter dt. 16-12-63 of L. I Please refer to the letter dt of L.I.C to Secretary,Central Board of Revenue and letter dt of Under Secretary,Central Board of Direct Taxes to L.I.C.Information about key-man & the company is generally called for (please see KEYMAN QUESTIONNAIRE) to determine whether the proposal is a bona fide proposal put forward for the purpose of indemnifying the employer against any loss arising on the death of a key-man ( employee):“Key-man Insurance can be taken by business firms on the life of its employee /s and no benefit of any sort accrue to the concerned employee/s. While the primary object of this insurance is to protect the Company against premature death of a valuable employee, the Company secures also some tax advantages.The object of key-man insurance is to indemnify the company for the loss of earnings resulting from the death of a valuable replacement of any trained person to perform his functions. In addition, loss may be more if the key-man can be replaced only at considerable cost of training.
6 It would not be appropriate to issue a key-man insurance where the profit has been in the decline and turnover of the company is also on decline, unless there are very special circumstances. The Divisional Offices must very carefully consider the need and justification for key-man insurance under such circumstances.( C.O Circular No. 1563/4 dt )“ A key-man Insurance Policy, of the Life Insurance Corporation of India, etc. provides for an insurance policy taken by a business organisation or a professional organisation on the life of an employee, in order to protect the business against the financial loss,which may occur from the employee’s premature death. The key-man is an employee or a director, whose services are perceived to have a significant effect on the profitability of the business. The premium is paid by the employer.”(Circular No.762/4 dt issued by C.B.D.T)
7 MAXIMUM ALLOWABLE SUM ASSURED A) “ Maximum allowable S.A in case of key-man insurance dependsupon nature,size and business of the company. The normal guidelinesfor maximum S.A for a large quoted Public Limited Company are asfollows :Maximum allowable S.A will be lower of the following:i) 5 times average net profit (after making provisions for depreciationand income tax ).ii) Two to three times the gross profit ( Net Profit + Depreciation +Income Tax)”(C.O Circular No. Actl/1683/4 dt )
8 B) “ Maximum Sum Assured for Private Limited Companies or closely held Public Limited Companies ” - NO. OF SHAREHOLDERS =< 10 BUT >= TWO TIMESOR OF AVERAGENO. OF EMPLOYEES =< 10 BUT >= OF 3 YEARSNET PROFITOTHER CASES THREE YEARSTOTAL NETPROFIT.
9 Recently established company where audited Profit & Loss Accounts for the last three years are not available-NO. OF YEARS FOR WHICH MAXI. SUMAUDITED ACCOUNTS ARE ASSUREDAVAILABLE.2 YEARS TIMES AVG. N.P.1 YEAR EQUAL TO N.P.LESS THAN 1 YEAR NIL
10 FAMILY INCLUDES KEY PERSON ,SPOUSE AND MINOR CHILDREN. KMI COVER IS PERMISSIBLE IFA) KEY PERSON SHAREHOLDING =< %ANDB) FAMILY SHAREHOLDING =< %FAMILY INCLUDES KEY PERSON ,SPOUSE AND MINOR CHILDREN.( C.O CIRCULAR REF: ACTL/1729/4 DT )
11 In case of death, the sums paid under the policies would be treated as an income of the business. The insured amount may be paid under the policy either in a lump sum or in the form of an agreed number of fixed or variable annual instalments ,depending upon the nature of the impact of the key-man’s withdrawal on the company’s business.In case the key-man leaves the service, the concern would surrender the assurance and show the surrender value of assurance as income received during the year. In this case the surrender value, being much less than the sum assured, may not fully compensate the business for the loss of the key-man. It would be only a partial reimbursement of the loss.The insurance would be proposed by the company for its own benefit and there is no element of perquisite involved in so far as the employee is concerned.We shall, therefore be glad to have your advice if the position explained above in para 5 in respect of key-man insurance is correct.
12 CENTRAL BOARD OF DIRECT TAXES New Delhi,the 3rd February,1964 F.NO.35/12/64-ITCENTRAL BOARD OF DIRECT TAXESNew Delhi,the 3rd February,1964To,The Life Insurance Corporation Of India,Jeevan Kendra, Jamshedji Tata Road,Mumbai-1Sirs,Subject : Key-man Insurance -Liability to tax
13 I am directed to refer to your letter dated 16th December,1963 on the above subject and to say that if the assessee firm taking out the insurance policy is able to establish before the Income-tax Officer that the premium paid on such insurance is an expenditure laid out wholly and exclusively for the purpose of business , it will be entitled to the deduction under section 37(1) of the Income-tax Act The matter will, however depend upon the facts of each case.2. According to what you have stated, the proposed insurance will be effected only for the benefit of business and there will not be any benefit to the employees. In view of this, the premium paid by the company will not be treated as perquisite in the hands of the employee.SD/-J.RAMA IYER
14 POLICY PREPARATION AND POLICY LOAN The following endorsement will be placed on the policy- bond:“ It is hereby agreed and declared that in the event of the employee life assured leaving employment of the employer the within mentioned policy shall be:(I) Either surrendered to the Corporation for its cash valueOR(II) Assigned absolutely in favour of the employees lifeassured.
15 It is further agreed and declared that the within policy shall not be allowed to be assigned to anyone except the life assured himself absolutely or to the Corporation as a security towards the loan on the within policy.”It may be noted that prior consent from the employer to place the endorsement on the policy has to be obtained for entertaining the proposal and/or issuance of the policy under Key-man Insurance :While issuing the policy, the following points may also be noted:1) The words “Key-man Insurance” should be typed prominently on the face of the policy and copy policy.
16 (2) The name of the Life Assured and the Proposer should appear in the schedule. 3) The words “Nominee under Section 39 of Insurance Act “ appearing in schedule should be deleted.POLICY LOAN: Policy loan is available under Table 112/151 after 1 year from D.O.C provided premium for at least 1/10 of the premium paying term has been paid. Under Table 11,14,47 and 48, loan is available as under Endowment plans.Note: According letter Ref: Actl/JS dt of Executive Director (Actuarial) Central Office to Sr. Divnl. Manager D.O-I, Mumbai, a policy under key-man insurance can be assigned to a bank or a financial institution for the purpose of raising loan.