Introduction

A Keyman Insurance Policy is a life insurance policy taken by a business to cover the life of an employee who is crucial to its operations. This can include directors, executives, or other key personnel whose untimely demise or incapacitation would significantly impact the business. While the policy provides financial security to the business, it also raises questions about the taxability of premiums paid and proceeds received under the policy.

In this blog, we will explore the provisions under the Income Tax Act, 1961, and understand the tax treatment of Keyman Insurance Policy premiums and proceeds.

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What is a Keyman Insurance Policy?

A Keyman Insurance Policy is purchased by an employer (the proposer) to insure the life of a key employee (the life assured). The employer is both the policyholder and the beneficiary of the policy.

Purpose:

1. To safeguard the business against financial loss due to the death or incapacitation of a key person.
2. To use the proceeds for business continuity, recruitment, or compensating losses.

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Tax Treatment of Keyman Insurance Premiums

1. Deductibility of Premiums Paid

Under Section 37(1), the premiums paid for a Keyman Insurance Policy are treated as a business expense and are deductible from taxable income, provided:

• The policy is solely for business purposes.
• The insured individual is a key person.

Example:
A company pays ₹5,00,000 as the annual premium for a Keyman Insurance Policy. This amount is deductible as a business expense under Section 37(1).

2. Non-Deductibility in Certain Cases

If the policy is not solely for business purposes (e.g., for personal benefit), the premiums are not deductible.

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Tax Treatment of Keyman Insurance Policy Proceeds

1. Proceeds Taxable as Business Income

As per Section 28(vi), any amount received under a Keyman Insurance Policy, whether on maturity, surrender, or the demise of the insured, is taxable as business income.

Example:
A business receives ₹50,00,000 on the maturity of a Keyman Insurance Policy. This amount is taxable under “Profits and Gains of Business or Profession.”

2. Exemption for Converted Policies

If a Keyman Insurance Policy is subsequently assigned to the insured key person, it is treated as a normal life insurance policy. Proceeds received under such converted policies may qualify for exemption under Section 10(10D), subject to conditions.

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Conditions for Tax Exemption Under Section 10(10D)

To qualify for tax exemption:

1. The policy must not fall under the category of a Keyman Insurance Policy at the time of receipt.
2. The premium must not exceed 10% of the sum assured (for policies issued after April 1, 2012).
3. The policy proceeds must be received by the insured or their nominee, not the employer.

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Practical Scenarios of Tax Treatment

Scenario 1: Death of a Key Person

• Details: A company receives ₹1 crore on the death of its CEO under a Keyman Insurance Policy.
• Tax Treatment: The entire ₹1 crore is taxable as business income.

Scenario 2: Policy Maturity

• Details: The policy matures, and the company receives ₹50,00,000.
• Tax Treatment: The entire ₹50,00,000 is taxable as business income.

Scenario 3: Policy Assignment

• Details: The policy is assigned to the key employee, and they receive ₹20,00,000 on maturity.
• Tax Treatment: The proceeds may be exempt under Section 10(10D), provided the conditions are met.

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Benefits of Keyman Insurance Policies

1. Risk Management:
   • Provides financial stability to the business in case of loss of a key individual.
2. Tax Deductibility:
   • Premiums paid are deductible as business expenses, reducing taxable income.
3. Continuity Planning:
   • Helps cover recruitment costs or losses due to disruptions in business operations.
4. Attraction and Retention of Talent:
   • Demonstrates the business’s commitment to its key employees.

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FAQs

1. Are Keyman Insurance Policy proceeds always taxable?
Yes, proceeds from a Keyman Insurance Policy are taxable as business income under Section 28(vi). However, if the policy is assigned to the insured and later matures, the proceeds may qualify for exemption under Section 10(10D).

2. Can premiums paid for Keyman Insurance be deducted as a business expense?
Yes, premiums paid for a Keyman Insurance Policy are deductible under Section 37(1) if the policy serves business purposes.

3. What happens if the policy is assigned to the insured employee?
Once the policy is assigned, it is no longer treated as a Keyman Insurance Policy. Proceeds received after assignment may qualify for tax exemption under Section 10(10D).

4. Can a business claim tax benefits if the Keyman Insurance Policy is for personal benefit?
No, if the policy is for personal benefit or not linked to business purposes, the premiums are not deductible.

5. Are proceeds from a Keyman Insurance Policy subject to GST?
No, the proceeds from a Keyman Insurance Policy are not subject to GST but are taxable under income tax as business income.

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Conclusion

Keyman Insurance Policies are a strategic tool for businesses to mitigate financial risks associated with losing key personnel. While the premiums paid for such policies are deductible as business expenses, the proceeds are taxable as business income under the Income Tax Act. Proper understanding of these provisions helps businesses plan their finances and optimize tax benefits effectively.

Additional Resources

Learn more about Tax Provisions on the official Income Tax India website.

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