ITAT, MUMBAI BENCHES `B’
Only employer and employee relationship is not envisaged to allow the premium paid on Keyman Insurance Policy as business expenditure and there can exist other types of relationship; consequently, Keyman Insurance Premium paid by the firm on the life of its partners is allowable as business expenditure.
ITO v Modi Motors - ITA No. 6900/Mum/2006 , December 12, 2008
6.15 As noted earlier, there was a judicial opinion that on distribution or division or allotment of assets to partners by the firm on dissolution or otherwise there resulted no gain exigible to tax, however, by incorporating Section 45(3) and 45(4), the legislature has declared its intention in clear terms that partners and the firm are two independent entities not only for the purposes of assessment but also for the purpose of determining the charge of income tax on the transactions entered into between them. Similarly, from A.Y. 1993-94 partnership firms have been given a corporal personality in a limited sense by making necessary amendments in the provisions of Sections 10(2A), 28(V), 40(b) and relevant procedural sections which also conclusively prove that partnership firm as such is independent from its partners as far as provisions of Income Tax Act, 1961 are concerned. In this regard, we consider it to reproduce the relevant portions of Circular No. 636 dated 31st August, 1992 as reported in 1981 St. 1 wherein the CBDT explained the new procedure of taxation of firm’s income:
“Taxation of firm’s income,- 48. Before the changes made by the Finance Act, the system of levy of tax on firms involved double taxation. The firm as such was taxed in respect of its total income at rates varying from 5% to 18% (the maximum rate being applicable at Rs. 1 lakh and above). After deducting the tax payable by the firm, the balance of income was distributed amongst the partners and they were again taxed at the appropriate rates. Further, the tax liability of a firm and its partners depended upon the question whether the firm was granted registration under the Income Tax Act or not. In case of a registered firm, the firm paid tax on its total income according to the rates prescribed in the schedule for
registered firms. An unregistered firm was taxed at the rates applicable to individuals, with the share income included in the hands of the partners for rate purposes only. There has been a consistent demand for removal of the double taxation. A new scheme of assessment of firms has been introduced from assessment year 1993-94. The scheme is modeled after the scheme introduced by the Direct Tax Laws (Amendment) Act, 19Q7, with suitable modifications to take care of the difficulties pointed out in the context of the 1987 scheme. The3 scheme contained in Direct Tax Laws (Amendment) Act, 1987 sought to tax firms at the maximum marginal rate after allowing interest and remuneration to partners. Further there was a rigorous definition of “whole time working partners” to whom alone remuneration was payable. The deduction for remuneration and interest allowable to partners and allowing remuneration to any partner or partners at the discretion of the firm, have been suitably restructured.
48.1 a firm will now onwards be taxed as a separate entity (section 184 and 185). There will be no distinction between registered and unregistered firms, and clauses 39 and 48 of section 2 containing the definition of “registered firm” and unregistered firm” have been omitted. After allowing remuneration and interest to the partners, the balance income of the firms will be subject to maximum marginal rate of tax of income tax, which will be 40% of assessment year 1993-94. The surcharge on income tax will be at the rate of 12%, of the total tax, if the income tax exceeds Rs. 1,00,000/-. The earlier distinction between rates of income fax for professional and non-professional firms has been removed. Partners are not liable to tax in respect of the share of income from the firm. However, remuneration and interest allowed to partners will be charged to income tax in their respective hands. The only distinction between
professional and non-professional firms will be in respect of slabs for allowing deduction to firms in respect of remuneration.
48.2 The share of the partner in the income of the firm will not be included in computing his total income. [Section 19(2A)J. However, interest, salary, bonus, commission or any other remuneration allowed by the firm to a partner will be liable to be taxed as business income in the partners hand. [Section 2(24) (ve) and section 28 (v)]. An explanation has been added to the newly inserted clause (2A) of section 10 to make it clear that the remuneration or interest which is disallowed in the hand of the firm will not suffer taxation in the hands of the partner. In case any remuneration paid to a partner is disallowed in the hands of the firm or the amount is varied in subsequent proceedings, the partner’s assessment can be rectified. [Section 155(1 A).].
48.3 The gross total income of the firm is to be determined in the normal way under different heads as in the case of any taxable entity. The gross total income so computed is reduced by salary, bonus, commission, or any remuneration payable or paid to a partner. [Section 40(b)]. Remuneration due to or received by a partner is not to be assessee as income under the head ” salanes” [Explanation 2 to section 15]. Any salary, interest, bonus, commission or remuneration to income tax under the head “Profit and gains of business or profession”,
6.16. Thus, specific Sections mentioned hereinabove r.w. the impugned circular go to show that a firm is to be taxed as separate entity and as per para 48.3 the gross total income of the firm is to be determined in the normal way under different heads as in the case of any taxable entity, hence, any expenditure which has been incurred by firm for the purposes of it’s business is to be allowed as a deduction in computing the total income of the firm subject to any specific limitation/prohibit ion provided for the allowance of such expenditure.
6.17. Thus, having regard to judicial opinion as elaborated hereinabove and also the legislative changes in the Act, in our opinion, a partnership firm is a separate entity than that of its partners under the Income Tax Act and if there exist any specific provision in the Income Tax Law modifying the partnership law then, such specific provision shall be applied and if the tax law is silent on a specific issue, then a reference will have to be made to the provisions of partnership law for the adjudication of the same.
6.18. Having held so, now we are required to look into the other issue whether the premium paid by a firm on Keyman Insurance Pojicy on the life of it’s partner(s) is allowable or not, particularly in the back ground that the A.O. is of the view that Keyman Insurance Policy premium is allowable in case of an assessee, being an employer only. In this regard, we find that the amount received on maturity or surrender of Keyman Insurance Policy is taxable under the head income from salary u/s 17(3)(ii), or income from profit and gains of business or profession u/s 28Cj(vii) or income from other sources u/s 56(2)(iv), hence, if the legislature would have intended that such premium was allowable as deduction only in cases were employer and employee relationship existed then, the amount received on maturity/surrender would have been made taxable only under the head income from salary. Further, in this regard, the wordings of explanation to Section 10(10D) are also relevant wherein it has been mentioned that Keyman Insurance policy a life insurance taken by the person on the life of another person who is or was the employee of a first mentioned person or is or was connected in any manner whatsoever with the business of the first mentioned person, hence, the legislature has also envisaged various kinds of relationship which may exist between the person paying the premium and the person on who’s life such Keyman Insurance Policy is taken. The CBDT vide its Circular No. 762 dated 18.2.98 as reported in 230 ITR St. 12 explained the provisions of Section 10(10D) as under:
“Taxation of a sum received under the keyman insurance policy.- 14.1 A Keyman Insurance Policy of the life Insurance corporation of India, etc. provides for an insurance policy taken by a business organization or a professional organization 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 “Keyman11 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.
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 the Income Tax exempts certain income from tax. The Act amends clause (10D) of Section 10 to exclude any sum received under a Keyman insurance Policy including the sum allocated by way of bonus on such policy for this purpose.
14.4 The Act also lavs down that the sums received by the said organization on such policies, be taxed as business profits; the surrender value of the policy , endorsed in favour of the employee (Keyman), 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, the surrender value of the policy or the sum received under the policy be taken as income from other sources and taxed accordingly. The premium paid on the Keyman Insurance Policy is allowed as business expenditure.
14.5 The amendments take effect from the 1st day of October, 1996.”
From the perusal of para 14.4, it is abundantly clear that only employer and employee relationship is not envisaged to allow the premium paid on Keyman Insurance Policy as business expenditure and there can exist other types relationship. It is also pertinent to note the term “person” or “persons” have been used in the explanation to Section 10(10D) which may refer to natural person or artificial i.e. legal persons or entities treated as having legal entity under the provisions of Income Tax Act, 1961 and in thjs view of the matter, we hold that A.O.’s interpretation of “first mentioned person” as mentioned in Section 10(10D) of the Act is not correct.
6.19. One other important fact which needs specific mention that the assessee firm is comprising of four partners, however, it has taken Keyman Insurance Policy only in respect of two working partners, hence, even though the partnership firm may be a compendium of partners, but, in the present case it is so, of four partners and not of two partners, hence, the fact of Keyman insurance Policy, being taken on the life of two working partners only, further justifies the claim of the assessee.
6.20. Thus, in the facts and circumstances of the case and in view of above discussion, we hold that Keyman Insurance Premium paid by the firm is allowable as business expenditure. Accordingly, we confirm the findings of the Id. CIT(A) on this issue. Thus, this ground of the Revenue is dismissed.