Until 2001, insurance was a nationalized activity; the domain of the Government owned insurance companies. Hence, the tax law for the insurance companies was also enacted keeping this in mind. However, with the opening up of the sector many new private insurers have entered into the industry and are now facing certain tax challenges based on the present tax law With the budget coming close and an expectation of an increase in the Foreign Direct Investment (FDI) limit in insurance to 49 percent, the insurance industry is expecting the Government would settle some of the burning issues that insurance companies particularly, the new entrants are facing. This article brings to light some such critical issues, while also discusses the measures that Government may adopt.

Insurance companies and in particular, life insurance companies are presently taxed under a special regime, which has evolved over the period, considering the special nature of the life insurance business. The profits of life insurance business are taxed at a concessional rate of 12.5 per cent (plus applicable surcharge and education cess). The actuarial valuation made in accordance with the Insurance Act, 1938 is deemed to be the profits of life insurance business. Prior to the privatization of the sector in the year 2000, Form I (actuarial report of valuation surplus), was used as a basis for computing the deemed profits from the life insurance business as confirmed by judicial precedents.

With the opening up of the insurance sector in the year 2000 to the private players, a revised set of financial statements and actuarial valuation report was prescribed by The Insurance Regulatory and Development Authority (IRDA), which provided for bifurcation of the shareholders income (non-technical account) and the policyholders income (technical account). A key debate raised by the tax authorities is whether the income reported in the shareholders account would also be a part of profits from the life insurance business and as such, qualify for concessional tax rate of 12.5 per cent. The Form I in its present format only reports the surplus available for distribution to policyholders (as against the earlier Form I, which computed total surplus from the life insurance business). Further, internal transfers are made from shareholders account to policyholders account (as permitted by IRDA) to enable distribution of the bonus.

Life insurance companies have (and rightly), considered both the income in shareholders as well as policyholders account (ignoring internal transfers) as the profits from life insurance business. Though, there are many arguments to support this position, the key argument in support of this position is that only an Indian insurance company can carry on business of insurance in India and its sole purpose should be to carry on life insurance or general insurance or reinsurance business in India. Thus, the income in the shareholders account is only on account of the life insurance business and should be entitled to the concessional tax treatment.

In the recent years, however, the tax authorities have, in the course of the assessment of certain life insurance companies held that the income in 
shareholders account does not constitute income from the life insurance business and therefore, is not eligible for concessional tax treatment. Further, relying on earlier judicial precedents income as per the current format of Form I (which provides only surplus available for distribution to policyholders) has been assessed as the income from the life insurance business. In some cases, the tax neutrality of internal transfers has not been adhered.

The action of the tax authorities has resulted in an artificial computation of taxable income in the hands of the insurance companies and has also affected the cash flows due to recovery of a part of the tax by the tax authorities. The industry is hoping that suitable clarificatory amendments to the scheme of taxation in the current budget make their life easier.

Another wish that the industry players are hoping to be accomplished during this budget relates to carry forward of taxes. Life insurance is a highly capital intensive business with a high gestation period of approximately 10 to 12 years. Given the long gestation period, the combined result so far has been that the life insurance companies have incurred for the first six to seven years of their operation, which they have carried forward. The normal period of eight years for carry forward of losses is not sufficient to absorb the losses against taxable profits, which looks likely only after 10 years of a life insurance companies operations given the global economic slowdown. Accordingly, the Government should seriously consider introducing provisions in the forthcoming budget for extending the period of carry forward for life insurance companies. This should enable these companies to improve cash flows and policyholders get the benefits of the same.

The income of non-life (i.e. general) insurance companies is determined based on published accounts subject to specified adjustments. Profit/loss on sale of investments forms one of the key items of the income of non-life insurance companies. Such profits earned are exempt from tax on a purposive reading of the existing provisions as evidenced by legislative history (including an amendment made in 1988) and a circular issued by the Central Board of Direct Taxes (CBDT). However, the tax authorities have denied the above exemption in various cases. In addition, in some cases, the tax authorities have contended that the exemption is available only to four public sector non-life insurance companies, which existed at the time of 1988 amendments/ issuance of the CBDT circular. Such a position is regressive and does not provide a level playing field to private sector non-life insurance players.

Compared to other jurisdictions, the insurance industry in India is still in its infant years. Clarity in the scheme of taxation of insurance players at this early stage is likely to result in faster growth and relatively higher stability for insurance players. With the proposed amendment to the Insurance Act, almost certain to go through in the coming Budget session, the corresponding amendment to the scheme of taxation to iron out the kinks, would go a long way in encouraging growth in the industry and providing it the requisite development platform.