Evaluation of options Overseas Investments

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Life Insurance Current tax issues August 28,
2009
PwC
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Presentation outline
Overview - Indian life insurance
Governing Tax provisions
Determination of Taxable income
Tax Litigation Issues its effects
Other Tax issues
Direct Tax Code
Concluding remarks
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Overview - Indian life insurance
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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
• 2674 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

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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 not implemented

Tax provisions not kept pace with regulatory
changes
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Governing tax provisions
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Governing tax provisions
Section 44
Provisions governing Life insurance business
Rule 2
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
Section 115B
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.
Profits gains from life insurance business
subject to tax _at_ 12.5 Profits gains from
other than life insurance business _at_ 30
Applicable surcharge and education cess will be
additionally levied
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Governing tax provisions

• Rule 2 of First Schedule
• Provides for computational methodology of life
  insurance profits
• Plain reading suggests
• Surplus/ deficit of prior inter-valuation period
  to be excluded from surplus/ deficit of current
  inter-valuation period
• 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
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Basis of Taxable Profits
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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 Shareholders
  account forms part of single life insurance
  business
• Different approaches followed by life insurance
  industry (see next slide)

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Basis of taxable profits
Determination of taxable profits - No uniformity
in approach followed
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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
• 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 _at_ 12.5
• SHA not to be taxed as income from insurance
  business and should be taxable as Income from
  other Business _at_ 30

Applicable surcharge and education cess will be
additionally levied
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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

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Tax Litigation Issues Effects
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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 _at_ 12.5
• SHA profits - considered as income from other
  business/ income from other sources, taxable _at_
  30 (corporate tax rate)

Lack of clarity No precedents Issue pending
with Appellate Authorities
Applicable surcharge and education cess will be
additionally levied
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Other Tax Issues
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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
• Set-off and carry forward of losses
• Capital Gains taxation u/s 10(38)

Rule 2 Need for change
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Direct Tax Code
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Direct Tax Code

• No specific section taxing Life insurance
  company?????
• Definition of life insurer - An insurer who is
  wholly engaged in the business of providing
  assurance on the life of human beings
• Eighth Schedule of DTC deals with mechanism of
  taxation (relevant text reproduced)
• The profits of the business of life insurance
  shall be the profit determined in the
  Shareholders Account (Non-Technical Account) in
  accordance with the Insurance Act, 1938.
• Introduction of IFRS w.e.f 1-4-2011???
• No specific exemption for Policyholders account
• Insurance company defined as pass-thru Only for
  DDT purposes
• Does not clarify taxability of other income
• No specific provision stating that no deduction
  should be allowed for funds transferred from
  Shareholders account to Policyholders account

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Direct Tax Code

• Treatment of losses Contradicting and confusing
  provisions
• Provisions equivalent to section 115B absent
  Income subject to tax at normal rate of 25
• Applicability of MAT _at_2 of gross assets
• No specific provision or observation stating that
  MAT will not be applicable to insurance company
  
• If applicable, would it apply to assets in
  Policyholders account?
• Taxation of policy proceeds, subject to following
  
• the premium payable for any of the years during
  the term of the policy does not exceed five per
  cent of the actual capital sum assured and
• the sum is received only upon completion of the
  original period of contract of the insurance or
  upon the death of the insured

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Concluding Remarks
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Concluding Remarks
Under Direct Tax Code
Under Income-tax Act
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