Life Insurance Current tax issues August 28, 2009

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1 Life Insurance Current tax issues August 28, 2009 August PricewaterhouseCoopers

Litigation issues & its effects Other tax issues Reasons for

2 Presentation outline Overview - Indian life insurance Governing tax provisions Determination of taxable income Tax Litigation issues & its effects Other tax issues Reasons for change in tax law Direct Tax Code August PricewaterhouseCoopers

3 Overview - Indian life insurance August PricewaterhouseCoopers

4 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 26:74 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 August PricewaterhouseCoopers

5 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 never implemented Tax provisions not kept pace with regulatory changes August PricewaterhouseCoopers

6 Governing tax provisions August PricewaterhouseCoopers

7 Governing tax provisions Provisions governing Life insurance business Section 44 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 Rule 2 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. Section 115B Profits & gains from life insurance business subject to 12.5%* Profits & gains from other than life insurance 30%* * Applicable surcharge and education cess will be additionally levied August PricewaterhouseCoopers

8 Governing tax provisions S. 44 read with First Schedule Separate code for taxation Basis of taxation different from basis that is generally applicable to other corporate entities Provides for taxation of insurance companies & computation of profits thereof Overrides other tax provisions relating to business profits/ capital gains/ other income Specific provisions dealing with deductions/ disallowances of expenditure applicable to other corporate entities do not apply S. 115B Special rate of 12.5% for profit from life insurance business Other income - normal tax rate August PricewaterhouseCoopers

9 Governing tax provisions Rule 2 of First Schedule Provides for computational methodology of life insurance profits Plain reading suggests o Surplus/ deficit of prior inter-valuation period to be excluded from surplus/ deficit of current intervaluation period o 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 August PricewaterhouseCoopers

10 Basis of Taxable Profits August PricewaterhouseCoopers

11 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 ( PHA ) & Shareholders account ( SHA ) forms part of single life insurance business Different approaches present in life insurance industry August PricewaterhouseCoopers

12 Basis of taxable profits Approaches Aggregate Segregate Form I based Determination of taxable profits - No uniformity in approach followed August PricewaterhouseCoopers

13 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 o 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 12.5%* SHA not to be taxed as income from insurance business and should be taxable as Income from other 30%* * Applicable surcharge and education cess will be additionally levied August PricewaterhouseCoopers

14 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 Results arrived in all 3 approaches further subject to certain tax adjustments such as Exemption for pension income - S.10(23AAB) Exemption for dividend income - S. 10(34) Disallowance for expenditure pertaining to exempt income - S.14A August PricewaterhouseCoopers

15 Tax Litigation Issues & Effects August PricewaterhouseCoopers

16 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, 12.5%* SHA profits - considered as income from other business/ income from other sources, 30%* (corporate tax rate) Lack of clarity No precedents Issue pending at Tribunal level * Applicable surcharge and education cess will be additionally levied August PricewaterhouseCoopers

17 ...Tax Litigation Issues Computation of taxable profits of life insurance company Policyholders account Actuarial surplus (reflected in Form I) considered taxable as PHA profits & not as per financials Transfer of funds from SHA considered income in PHA Other issues Shareholders account Profits as per financials considered taxable as SHA profits No deduction allowed for transfer of Funds to PHA resulting in double taxation Effectively fresh capital introduced by Shareholders becomes taxable Incremental Negative Reserves (reflected in Form I) representing potential income considered taxable Set off of brought forward losses not allowed Dividend income considered as business income Higher disallowance of expenses to earn exempt income August PricewaterhouseCoopers

18 Tax Litigation - Effects Traverse views adopted by tax authorities across cities Reassessment proceedings likely to be initiated as most years open High exposure on account of levy of penalty and interest Degradation of financial position in annual accounts Results in immediate cash outflows, thereby hampering working capital Huge gamut of tax litigation awaiting involving millions of rupees & causing of financial hardships Huge gamut of tax litigation awaiting August PricewaterhouseCoopers

19 Other Tax Issues August PricewaterhouseCoopers

20 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] Carry forward of losses beyond 8 years August PricewaterhouseCoopers

21 Reasons for Change in tax law August PricewaterhouseCoopers

22 Reasons for change in Rule 2 Computational provision (Rule 2) capable of different interpretations Not kept pace with major regulatory changes brought about by IRDA No amendment since 1976 To provide for uniform methodology for computation of profits from life insurance business August PricewaterhouseCoopers

23 Direct Tax Code August PricewaterhouseCoopers

24 Direct Tax Code Pass thru status accorded to life insurance company Will not be required to pay any tax on actuarial surplus in policyholder s account Taxable profits of Insurance business Profits determined in Shareholder s account (+) Specified income taxable as Income from business but not included in Shareholder s account (-) Losses in respect of life insurance business, for any FY immediately preceding relevant FY Taxable profits to be treated as NIL, if negative Tax rate 25% Surcharge and education cess removed Carry forward of losses Permitted perpetually no restriction on number of years Applicability of MAT to life insurance company 2% of gross assets August PricewaterhouseCoopers

25 August PricewaterhouseCoopers

Union Budget 2014 Analysis of Major Direct tax proposals

RATES OF INCOME TAX Union Budget 2014 Analysis of Major Direct tax proposals Basic exemption limit has been increased from Rs 2 lacs to Rs 2.50 lacs for resident individuals or HUF. Income slabs Income