2. KEY-MAN INSURANCE TO PARTNERSHIP FIRM

3. “ Key-man insurance to partnership firm was not being allowed because the partnership business is owned by different partners only. Active partners are the source of profits to the firm. In the absence of such partners, there will be significant loss to the firm. Therefore, it is decided to allow key-man insurance on the lives of active partner provided the following requirements are complied with- a) The average turn over of the firm for preceding 3 years must be more than 3 crores. For this purpose the last 3 year’s audited copies of balance sheet and Profit & Loss Accounts are to be submitted.

4. B) Since the firm cannot give certified copy of Board resolution, supplementary partnership deed furnishing the name of the key-man and the person authorised to complete the insurance proposals should also be submitted. C) Maximum S.A will be limited to share capital of the key-man plus proportionate amount of goodwill as being done in case of partnership insurance. Total goodwill of the firm will be total of last 3 years net profits.” -(C.O Circular Ref: Actl/1729/4 dt.24-7-2000)

5. Total capital of partnership firm Rs. 100 lac Name of the Key-man partner Mr. X Key-man Mr.X’s share capital Rs. 35 lac (35%) Last 3 year’s NET PROFIT Rs. 50 lac (Goodwill) Maximum S.A allowable to Share capital + proportionate. Key-man amount of goodwilI = Rs.35 lacs + (35% of goodwill) = Rs. 35 lac + Rs. 17. 50 lac = Rs.52.50 lac EXAMPLE

6. TAXATION ASPECTS C.B.D.T Circular No. 762,date of issue 18-2-1998 “ Introduction : The Finance (NO.2) Act,1996,as passed by the Parliament, received the assent of the President on the 28th day of September,1996 & has been enacted as Act No.33 of 1996. This circular explains the substance of the provisions of the Act relating to direct taxes.... Taxation of a sum received under the Key-man Insurance Policy- 14.1 A key-man Insurance Policy,of the L.IC 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 ‘keyman’ is an employee or a director,whose services are preceived to have a significant effect on the profitability of the business.

7. 14.2 There were some doubts on the taxability of the income including bonus,etc. from such policy and also regarding the treatment of the premium paid- whether it should be allowed as a capital expenditure or as a revenue expenditure. The Act,therefore, lays down the tax treatment of the KEYMAN INSURANCE POLICY. 14.3 Clause (10D) of section 10 of Income-tax Act,exempts certain income from tax. The Act,amends clause (10D) of section 10 to exclude any sum received under a Key-man Insurance Policy including the sum allocated by way of bonus on such policy for this purpose. 14.4 The Act also lays down that the sums received by the said organisation on such policies,be taxed as business profit, the surrender value of the policy,endorsed in favour of the employee (key-man),or the sum received by him at the time of retirement be taken as ‘profits in lieu of salary’ for tax purposes,and in case of other persons having no employer-employee relationship-

8. 14.4 The surrender value of policy or the sum received under the policy be taken as income from other sources and taxed accordingly.The premium paid on the Key-man Insurance Policy is allowed as business expenditure. 14.5 The amendments take effect from the 1st day of October 1996” ---------------------------------------------------------------------------------- SUMMARY I) Premium paid under Key-man Insurance Policy is treated as expenditure under section 37(1) of I.T Act. II) In case of assignment of policy in favour of the life assured, surrender value available under the policy on the date of assignment,will be treated as ‘profits in lieu of salary’,however if there is no employer-employee relationship between the employer and the assignee at the time of assignment of the policy,the surrender value will be treated as ‘income from other sources’.

9. III) After assignment,the policy will be covered under section 10(10)(d). IV) Any amount (including death claim) received under the policy by the employer will be taxable under section 28(vi) as profits and gains from business or profession. V) The company can show interest payment on policy loan as expenditure in its books of accounts.

10. RELEVANT SECTIONS FROM INCOME-TAX ACT 1961 SECTION 2: IN THIS ACT UNLESS THE CONTEXT OTHERWISE REQUIRES ( 24 ) “INCOME” INCLUDES ( xi) ANY SUM RECEIVED UNDER A KEY-MAN INSURANCE POLICY INCLUDING THE SUM ALLOCATED BY WAY OF BONUS ON SUCH POLICY. EXPLANATION- FOR THE PURPOSES OF THIS CLAUSE,THE EXPRESSION “KEY-MAN INSURANCE POLICY” THE MEANING ASSIGNED TO IT IN THE EXPLANATION TO (10D) OF SECTION 10.

11. INCOME NOT INCLUDED IN TOTAL INCOME SECTION 10 : In computing the total income of a previous year of any person, any income falling within any of the following clauses will not be included- - 10(d). Any sum received under a life insurance policy,including the sum allocated by way of bonus on such policy other than any sum received under sub-section (3) of section 80DDA or under a key-man insurance policy. EXPLANATION:For the purpose of this clause,Key-man insurance policy means a life insurance policy taken by a person on the life of another person who is or was the employee of the first mentioned person or is or was connected in any manner whatsoever with the business of the first mentioned person.

12. SECTION 17(3) : (ii) “Profits” in lieu of salary includes- …… or any sum received under a KEYMAN INSURANCE POLICY including the sum allocated by way bonus on such policy.

13. Section 28 :Profits and gains of business or profession, The following income shall be chargeable to income-tax under the head “Profits and gains of business or profession” - - (vi) Any sum under a key-man insurance policy including the sum by way of bonus on such policy. Explanation: For the purposes of this clause,the “Key- man insurance Policy” shall have the meaning assigned to it in clause (10D) of section 10.

14. INCOME FROM OTHER SOURCES SECTION 56: i ) Income of every kind which is not to be excluded from the total income under this Act shall be chargeable to income-tax under the head “Income from other sources”,if it is not chargeable to income-tax under any of the heads specified in section 14,items A to E. ii) In particular and without prejudice to the generality of the provisions of sub-section (1),the following incomes,shall be chargeable to income- tax under the head “Income from other sources ” namely:

15. Section 56:(2) iv) Income referred to in sub-clause (xi) of clause (24) of section 2, if such income is not chargeable to income- tax under the head “Profit and gains of business profession” under the head “SALARIES”

16. GENERAL: SECTION 37- Any expenditure (not being expenditure of the nature described in sections 30 to 36 and not being in the nature of capital expenditure or personal expenses of the assessee), laid our or expended wholly and exclusively for the purpose of the business or profession shall be allowed in computing the income chargeable under the head “Profits and gains of business or profession.” EXPLANATION : For the removal of doubts, it is hereby declared that an expenditure incurred by an assessee for any purpose which is an offence or which is prohibited by law shall not be deemed to have been incurred for the purpose of business or profession and no deduction or allowance shall be made in respect of such expenditure.

17. OTHER IMPORTANT POINTS I) Transfer of Key-man Insurance Policy :- In case the key-man leaves and joins another employer, the KEYMAN policy taken by the ex-employer can be assigned to the new employer subject to agreement between the two and also subject to fulfillment of financial underwriting requirements by the new employer. II) “It is now decided to extend the maximum age at entry upto 65 years and maximum maturity age upto 75 years for proposals under Key-man Insurance under Jeevan Shree Plan. However, this will be allowed where satisfactory documentary evidence of retirement age of the Key-man is submitted alongwith the proposal and age at maturity is not beyond the retirement age.”

18. OTHER IMPORTANT POINTS II) The premium quotations in the above cases may be obtained from the Acturial Departments Of Zonal Offices. -C.O Circular Ref: Actl/1638/4 DT.9-3-98 III) “ All the mandatory medical requirements and financial requirements should be obtained as if it is an individual insurance on the life of Key-man taking into account the present practice.. Under no circumstances should a Key-man proposal be decided at Branch level even when the sum proposed is within Branch limit.”- -C.O Circular Ref. Actl/153/4 DT.2-9-95 It is always desirable “ that the policy ” must mature not later than the date of retirement of the Key-man. - C.O Circular Ref: 1035/4 DT. 5-2-74

19. OTHER IMPORTANT POINTS “A certified true copy of the Board Resolution passed in the meeting of Board Of Directors stating therein the name of the Key-man, the quantum of insurance,plan and term and the name of the authorised person signing the proposal form and allied papers” must be obtained before we register the proposal. -C.O Circular Ref: Actl/1563/4 DT.2-9-95. IV) “KMI proposals can also be considered under Table 47 ( Endowment without profit plan) with minimum sum assured of Rs. 5.00 lakhs. No supplementary benefits such ass Double Accident Benefit and extended permanent disability Benefit are to be allowed while considering Table 47 under KMI. All other terms and conditions for the KMI remain unaltered.” -C.O Circular Ref: Actl/1754/4 DT.17-7-2001.

20. OTHER IMPORTANT POINTS v) Key-man Insurance is not allowed to proprietory firms. vi) In case the firm has obtained sizable amount of loan from a reputed financial institutions like IDBI,ICICI etc., Key-man Insurance on the life of directors can be considered on that basis also.

21. The Various Requirements For key-man Insurance Proposal I) Copy of Memorandum & Article of Association II) Copies of Audited Balance Sheets and Profit & Loss A/Cs for preceding 3 yrs.

22. I B) Plan / Term ( Tables 14,48 and 151 as well as all without profit plans are allowed; policy should mature on or before the date of retirement of key-man. ) C) Name & Signature of the person who is authorised to complete proposal papers. D) The use of seal of the Company. III) Certified true copy of Board Resolution passed in the meeting of Board of Directors containing following information-

23. The Various Requirements For key-man Insurance Proposal IV)Key-man Questionnaire is to be completed in the prescribed format and the same is signed by the authorised person under the seal of the company V) Copies of I.T Returns of the company for preceding 3 years. VI)Consent for the endorsement to be placed on policy. Henceforth revised Key-man Questionnaire annexed will be used (Annexure ‘A’).

24. Qn 1):Can there be more than one Key-man in a company ? Ans :There can be a number of KM’s in a company depending upon their marketing /technical knowledge, experience etc. in the context of their contribution to the success of the company. KEYMAN INSURANCE MADE EASY

25. Q 2):Who is the proposer under KMI ? Ans :The business firm or the professional organisation is the proposer. Q 3) : What is the maximum Insurance cover allowed under KMI ? Ans : There is no limit as such. It all depends on the company’s turnover, assets,profile and basically profitability during the last 3 financial years. The maximum keyman insurance to the company on the lives of its keyman will be limited to maximum S.A. available as per the criteria of its profits in the past 3 years, as discussed earlier. KEYMAN INSURANCE MADE EASY

26. Qn 4): Is there any restrictive clause put on the policy document ? Ans : The policy is issued with special endorsement as under. “It is hereby agreed & declared that in the event of the employee Life Assured leaving the employment of the Employer the within mentioned policy shall be either surrendered to the Corporation for- KEYMAN INSURANCE MADE EASY

27. Ans : cash value,or assigned absolutely in favour of the employee life assured. It is further agreed and declared that the within policy shall not be allowed to be assigned to any one except the Life Assured himself absolutely or to the Corporation as a security towards the loan on the within policy”. KEYMAN INSURANCE MADE EASY

28. Qn 5) : Is any approval required from IT authorities or Company Law Board ? Ans : NO. Qn 6) : If Key-man Insurance is assigned before retirement in favour of key- man,what will be the tax implications ? Ans : The surrender value available as on the date of assignment will be treated as perquisite in the hands of employee. KEYMAN INSURANCE MADE EASY

29. Qn 7) : Can the Company raise loan under Key-man Insurance Policy ? Ans : Yes, the Company can take Policy loan. Qn 8) : Can the KMI policy be transferred to another Company Keyman ? Ans : Yes, the policy can be transferred to the new employer of the Keyman on mutually agreed terms between the ex-employer and the new employer in- KEYMAN INSURANCE MADE EASY

30. Ans- in which case the new employer starts paying the premium. This transfer, however,will be subject to new employer fulfilling our financial underwriting requirements. KEYMAN INSURANCE MADE EASY

31. POTENTIAL AREAS

32. (i) Private Limited Companies subject to proper share holding pattern. (ii) Large Partnership Firms. (iii) Public Limited Companies. There is a huge potential in this segment because hardly any KMI policy is sold in this segment. This may be owing to lack of availability of database of companies.

33. Since “without profit” policies are allowed for KMI, KMI can be sold for- (i) Protection for profits in case of death of KEYMAN / KEYMEN. (ii) Retention of KEYMAN / KEYMEN for longer period by way of offering (by the company) to the concerned KEYMAN that if he stays with the company for longer than usual period, the policy can be assigned to him. Term as well as premium paying term will have to be selected accordingly.

34. If the age of the KEYMAN is 40 years and usual period of retention in the company is 7 years, a policy of TREM 20 years and premium paying term of 10 years can be chosen, so that the KEYMAN has incentive for staying with the company for 10 years (instead of usual 7 years period ), as after 10 years, the policy will be free from liability of premium payment on assignment of the policy to KEYMAN. FOR EXAMPLE

35. Partnership Insurance

36. “ A partnership is a business jointly owned by several parties, but which is not itself a corporate entity. The partnership is generally run in a fairly personal way by the partners. This can create problems if one partner dies as his widow may not wish to take upon his role in the business or may withdraw his stake in the business. On the other hand, the co-partner may not have sufficient funds to buy out the widow’s share. This may result in selling her share to an outsider. The value of the share might have grown many fold after the partnership came into existence. The remaining partners may not like to have outside interference and instead of selling share to outsider, the remaining partners would like to buy out the share of the deceased’s widow.

37. On these principles, we allow partnership insurance on the lives of partners and as far as possible all the partners must be covered under Partnership Insurance. For considering partnership insurance, following requirements are to be obtained- I) Proposal Form in F.No. 340 II) Copy of Deed of Partnership duly attested by the partner authorised to sign insurance proposal. III) Copies of Audited Balance Sheet and Profit and Loss Account for the last 3 years

38. IV) Copies of ITRs of the firm for preceding 3 years duly attested by the authorised partner. V) The copy of audited Balance Sheet containing schedule of partners’ capital accounts. VI) Letter of Authority in favour of a partner signing the proposal.

39. S.A under Partnership Insurance : Normally S.A is allowed equivalent to share capital of partners at the year end of last financial year. However goodwill comes for addition to this level of S.A. depending upon the size, nature and age of business, relationship between profits and capital. Such addition may be lower of two times.” C.O Circular Ref:Actl/1683/4 DT.7.7.1999 (Please refer to “KEY-MAN INSURANCE TO PARTNERSHIP FIRMS” for example.)

40. Tax Implications

41. As per sec. 37 (1) of the I.T. Act, 1961, any expenditure laid out or expeded wholly and exclusively and necessarily for the purpose of the business or profession, the same is permissible as expenses and could be claimed as a deduction from the income of the partnership firm. It is thus felt that the premiums paid on insurance against loss of profits due to withdrawal of capital on the death of a partner should be allowed as a business expenses, in the assessment of the partnership firm. In such situations when insurance premiums are allowed as expense, the proceeds of the policy’s claim amount will be treated as income of the firm. However, proposer firm should consult their tax advisers.

42. The issue regarding deductibility of premia paid by a firm of Chartered Accountants in respect of life insurance policies taken by it on the lives of its partners, under Section 37 (1) of Income- Tax Act, 1961, came up for consideration before the Bombay Bench ‘B’ of the Income-Tax Appellate Tribunal. The judgement of the Bench in ITA No. 1747 (Del) / 1981 was delivered on 23-09-1983 in favour of the assessee firm. On behalf, of the assessee firm arguments were advanced by the learned counsel Sri N.A.Palkhivala.

43. On an appraisal of the entire material on record and after consideration of the rival submissions, the Tribunal came to the conclusion that the Commissioner of Income Tax (Appeals) was right in allowing the expenditure under Section 37 (1). The Tribunal felt that the expenditure in question enabled the firm to conduct and carry on its profession more efficiently and more profitably. As the firm and its partners are separate and distinct entities for the purpose of Income-tax Act, the expenditure in question could not be treated as an expenditure of personal nature of the partners.

44. The Tribunal agreed with the contention advanced on behalf of the firm that the expenditure did not result in any advantage in the capital field and that it was not covered by the scope of Section 40 (b). The fact that the amount on account of premium was paid by the assessee firm to the Life Insurance Corporation and not to the partners was also stressed by the Tribunal. In this view of the matter the Tribunal came to the conclusion that the expenditure in question was incurred by the assessee firm in the interests of and for the promotion of the profession and was, therefore, allowable.