The Hindu Business Line : What's spooky about keyman

THE concept of keyman insurance must be a product of the insurance industry's hard sell because the discerning, leave alone the cynic, finds its rationale — guarding against the loss on account of death of key persons — difficult to stomach.

The policy is of a piece with another insurance product — the loss of profit policy. But while loss of profits due to disruption can be reasonably estimated, can one put a figure on the possible contribution to be made by individuals to the fortunes of an organisation?

Family-owned enterprises and eponymous companies are especially falling over themselves to be one up in the game — if your promoter has been insured for Rs 2 crore, I would insure mine for Rs 5 crore seems to be the refrain.

The very idea of keyman insurance raises some fundamental issues. Is anybody so indispensable to an organisation that his dissociation would bring its activities to a standstill?

At any rate, the compensation received from the insurance company may at best be enough to neutralise the loss to the organisation emanating out of the sad demise of the keyman for a year or two which makes the whole idea illusory and evanescent. What would happen thereafter?

To be sure, the organisation would not have taken a policy to compensate for his loss for all times to come. What happens if the keyman himself, untrammelled by the typical Japanese sentiments of life-long loyalty, switches to or allows himself to be ensnared by another organisation? How would the organisation be compensated in that event?

The definition of the term `keyman insurance policy' given by Explanation to Section 10(10D) of the Income-tax Act 1961 is as follows:

"... 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... "

Section 28 (vi) for good measure makes it explicit that the proceeds of the keyman insurance policy would be taxable as business income.

While this should be the logical culmination of a keyman insurance policy, the income-tax law also contemplates such policies being assigned in favour of the keyman himself when Section 17(3)(ii) thereof brings into the salary tax net the proceeds of such policies received by the keyman.

The definition of the term `keyman insurance policy' given in the Act also raises many issues. Why should it countenance the possibility of an organization taking a policy on an ex-employee or for that matter on anyone who was even remotely connected with it?

The Indian experience has been that the keyman insurance policy is sooner or later assigned in favour of the keyman himself. This strikes at the very roots of the policy.

If the organisation wanted to guard itself against the loss of a precious human resource, how can it be allowed to indulge in such mindless self-abnegation subsequently?

This then exposes the whole exercise as being right from the inception an exercise in self-aggrandisement and tax saving.

The Act should be amended to disallow retrospectively the entire premia thus far paid on policies assigned to others.

Alternatively, fringe benefit tax (FBT) should be payable on such premia which turnout in hindsight to be for individual benefit as opposed to the altruistic interest of the organisation.

In that event, Section 10(10D) must be amended to spare the estate of the deceased keyman from tax liability on proceeds that has already been taxed in the hands of the employer either by way of disallowance or FBT.

This is to ensure that the same amount is not taxed twice over — once in the hands of the employer and again in the hands of the deceased employee.

Another farce that is being enacted by Indian corporates with regard to keyman insurance polices is to use them as a short-term tax saving expedient.

With the lowering of corporate tax rate effective assessment year 2006-2007, corporates have, hot on the heels of Budget 2005, liberally paid keyman insurance premium to reduce their tax bill for the assessment year 2005-2006.

The policies would be surrendered the very next year notwithstanding the resultant tax liability on the proceeds thus received because the savings made in tax liability on account of the premia would be much more than the tax they have to pay on the surrender value the next year, thanks to the lowering of the corporate tax rate.

The IRDA is rightly incensed over this. But can it prevent corporates from surrendering the life policies or for that matter can it stop them from assigning such policies to the keymen themselves?

The Act, too, cannot be amended for neutralising this one-off advantage scored by the corporates.

(The author is a Delhi-based chartered accountant.)

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