How Some Firms Exploit a Loophole to Save Taxes with Keyman Insurance
Understanding the Types of Life Insurance Policies Offered to Employees
In the world of employment benefits, companies often provide various perks to retain top talent. Alongside employee stock options (Esops), bonuses, and health insurance, some employers also offer life insurance. Two common types of life insurance policies provided to employees are keyman life insurance and employer-employee (E-E) insurance.
The Distinction Between Keyman Life Insurance and E-E Insurance
Keyman life insurance focuses on insuring key managerial persons (KMPs) within a company. These individuals are crucial to the functioning of the organization, as defined by The Companies Act, 2013. The employer acts as the proposer and premium payer for this policy, making them eligible for tax exemption on the premium payments.
In the event of the insured employee’s death, the company receives the death benefit. This sum is then added to the company’s business income. However, it’s important to note that the Insurance Regulatory and Development Authority of India (IRDAI) specifies that only pure term plans can be purchased under a keyman policy. Consequently, the benefits can only be claimed if the employee dies while still serving the company. If the employee decides to leave the company before the maturity period, the policy lapses.
The Tax-Saving Loophole Exploited by Some Firms
Some firms take advantage of a loophole to save on taxes through keyman insurance. By structuring the policy as a pure term plan for their key employees, these companies ensure eligibility for tax exemptions on the premium payments made. This serves as a means to not only safeguard the company in case of an untimely demise but also to optimize tax planning strategies.
The Importance of Insurance Regulation
The existence of guidelines issued by the IRDAI is crucial in ensuring the transparency and fairness of insurance practices. By setting clear rules regarding the types of plans and the circumstances in which benefits can be claimed, the regulator protects the rights of policyholders and prevents misuse of insurance policies.
companies provide keyman life insurance to secure the services of indispensable employees and protect their interests in case of unfortunate events. However, it is important to adhere to the regulations set forth by the IRDAI to maintain the integrity of insurance practices. By doing so, both employers and employees can benefit from a system that provides financial security while also optimizing tax planning strategies.
Integrating Savings and Life Insurance: An Innovative Approach
Within the realm of employee benefits, one option that employers can consider is E-E insurance, which offers a unique combination of savings and life insurance within a single comprehensive package. This financial product can be purchased for one or multiple employees, with the employer taking on the role of the premium payer, and the employee serving as the proposer. In this arrangement, the life insured is that of the employee, ensuring their financial security.
Understanding the Tax Implications
It’s important to note that while the premium payments made by the employer are considered as a perquisite in the hands of employees and are subject to taxation, the maturity benefits received by the employee are tax exempt, as per the defined limits. This distinguishing feature adds value to the overall benefits package, as it provides employees with a potential avenue for long-term financial growth.
A New Policy Construct: Keyman Insurance with a Savings Plan
In recent times, a new policy framework has emerged in the insurance industry, combining elements of keyman insurance with a savings plan designed to benefit employees in the long run. Many insurance companies currently offer this innovative type of policy, which raises questions about its authorization by the Insurance Regulatory and Development Authority of India (IRDAI).
Clarifying the Employer-Employee Dynamics
Under this type of policy, the employer assumes the role of the proposer and assumes responsibility for paying the premiums, while the employee becomes the life assured. Additionally, the employer provides an undertaking to assign the policy to the employee once the premium payment term concludes. At that point, the employee becomes eligible to receive the survival/maturity benefit. It’s worth noting that this benefit is treated as profits in lieu of salary under section 17(3) of the Income Tax Act.
Balancing Employee Benefits and Company Obligations
The premium payments made by the employer are not considered a perquisite in the hands of employees. However, it is crucial for employees to remember that they can only fully enjoy the benefits if their respective companies uphold their commitments. If a company reneges on the undertakings given to its employees, the employee’s eligibility to receive the maturity proceeds could be compromised.
Seeking Regulatory Clarity
To ensure transparency and adherence to industry guidelines, it is essential to seek clarification from the IRDAI regarding the authorization and regulatory framework surrounding these policies. Requests for clarification can be submitted via email to the IRDAI, but it’s important to note that responses may not always be prompt or guaranteed.
Taking advantage of E-E insurance with a savings life plan offers employers an innovative means of enhancing employee benefits. By delivering a unique combination of savings and life insurance, these policies provide employees with long-term financial security. However, it is important for both employers and employees to remain informed about the regulatory aspects and commitments associated with these policies to ensure a mutually beneficial arrangement. Seeking clarity from the IRDAI can help address any uncertainties and provide guidance for optimal utilization of this valuable employee benefit.
The Benefits of Employer-Employee Insurance Policies
Companies are increasingly recognizing the value of employer-employee (E-E) insurance policies, not only for top management but for all employees, including junior and mid-level staff. These policies serve as a tool for attracting and retaining talent, providing benefits for both employers and employees. In this article, we will explore the advantages of E-E insurance and its implications for taxation.
Benefit for Employees
Rather than issuing bonuses or salary hikes, employers can deploy company profits to purchase E-E insurance policies for their employees. This is a tax-efficient alternative since the payment for the policy is not considered a perquisite, as the employer is the policy proposer. Once the premium payment term is over, the employer can assign the policy to the employee. The employee then receives a survival/maturity benefit, which is taxable.
While the benefit may be subject to taxation, it is still preferable to receiving a bonus that would incur upfront tax deductions. By opting for E-E insurance, employees can invest the full amount in a savings life plan. For example, if an employer intends to pay an additional ₹10 lakh per annum above the employee’s salary, taking it as a bonus would result in a reduced amount due to income tax. However, purchasing a savings life plan on behalf of the employee and assigning it after the premium payment term allows the employee to utilize the full ₹10 lakh.
It is important to note that if an employee leaves the company before the policy is assigned to them, the surrender/maturity benefit will revert to the employer and be added to its business income.
Advantages for Employers
Insurance premiums, bonuses, and salary hikes are all considered business expenses for employers. Under section 37(1) of the income tax act, companies can claim tax exemption for these expenses. E-E insurance policies offer a tax-efficient way for employers to deploy company profits and enjoy perpetual tax benefits.
Some companies even use E-E insurance policies to defer corporate tax indefinitely, as there is no upper limit under section 37(1). By purchasing a single premium payment policy, where the company is the proposer and the life assured is a key managerial personnel (KMP), the taxable profit is significantly reduced. In some cases, companies may never assign the policy to the employee. Instead, after the policy matures, the proceeds are received by the company and considered business income. The company is then liable to pay tax on this amount. However, by reinvesting the proceeds in one or multiple employer-employee insurance solutions, the company can claim the expenses as business expenses once again.
The practice of utilizing E-E insurance policies for tax purposes is a matter of interpretation, with experts debating whether it falls under tax planning or tax avoidance strategies.
Expanding the Role of E-E Insurance
While E-E insurance is often marketed as a tax solution for small businesses, it can be designed to serve as a social security benefit for all employees. Linking these policies to employee compensation packages can incentivize employees to remain with the company until the payout period starts. This ensures that employees receive their due periodic or lump-sum income.
Furthermore, employers can explore defined contribution plans, where both the employer and the employee contribute to the plan. This approach minimizes the long-term financial obligations of employers while enhancing employee engagement. It operates similarly to a provident fund, with joint funding by both parties.
In addition to individual policies, employers can also consider purchasing E-E insurance in a group construct. With a group insurance policy, neither the premium nor the maturity benefit will be taxable in the hands of the employees.
Employer-employee insurance policies offer a range of benefits for both companies and their employees. These policies provide a tax-efficient way for employers to deploy company profits while offering employees valuable financial security. By understanding the advantages and exploring different design options, companies can harness the full potential of E-E insurance to attract and retain talent while managing their tax obligations effectively.
In the world of employment benefits, companies often provide various perks to retain top talent. Alongside employee stock options (Esops), bonuses, and health insurance, some employers also offer life insurance. Two common types of life insurance policies provided to employees are keyman life insurance and employer-employee (E-E) insurance.
Keyman life insurance focuses on insuring key managerial persons (KMPs) within a company. These individuals are crucial to the functioning of the organization, as defined by The Companies Act, 2013. The employer acts as the proposer and premium payer for this policy, making them eligible for tax exemption on the premium payments.
In the event of the insured employee’s death, the company receives the death benefit. This sum is then added to the company’s business income. However, it’s important to note that the Insurance Regulatory and Development Authority of India (IRDAI) specifies that only pure term plans can be purchased under a keyman policy. Consequently, the benefits can only be claimed if the employee dies while still serving the company. If the employee decides to leave the company before the maturity period, the policy lapses.
The Tax-Saving Loophole Exploited by Some Firms
Some firms take advantage of a loophole to save on taxes through keyman insurance. By structuring the policy as a pure term plan for their key employees, these companies ensure eligibility for tax exemptions on the premium payments made. This serves as a means to not only safeguard the company in case of an untimely demise but also to optimize tax planning strategies.
The Importance of Insurance Regulation
The existence of guidelines issued by the IRDAI is crucial in ensuring the transparency and fairness of insurance practices. By setting clear rules regarding the types of plans and the circumstances in which benefits can be claimed, the regulator protects the rights of policyholders and prevents misuse of insurance policies.
Conclusion
In conclusion, companies provide keyman life insurance to secure the services of indispensable employees and protect their interests in case of unfortunate events. However, it is important to adhere to the regulations set forth by the IRDAI to maintain the integrity of insurance practices. By doing so, both employers and employees can benefit from a system that provides financial security while also optimizing tax planning strategies.
Disclaimer:
Estabizz Fintech compiled the material in this article using the most recent Acts, Rules, Circulars, Notifications, Provisions, Press Releases, and material applicable at the time. They ensured the completeness and correctness of the material through due diligence. When using this material, users must consult the relevant, applicable legislation. The given data may change without prior notice and does not constitute professional advice. Estabizz Fintech disclaims all liability for any results from the use of this material.
