Comment

With last year’s budget amendment, non-life insurance companies would have been paying taxes on unrealised gains on investments, had the finance ministry not lent its ears to the industry this year.

Under the existing provisions of Section 44 of the Income-Tax Act (the Act), the profits and gains of any insurance business are computed in accordance with the rules contained in the First Schedule to the Act. Under Rule 5 of this Schedule, the taxable income of a non-life insurance company is taken to be the profits as per the annual accounts furnished to the Insurance Regulatory and Development Authority subject to certain adjustments.

Before going into the proposed amendments brought in with Budget 2010 with regard to the non-life insurance sector, let’s have a look at the historical background of Rule 5.

Prior to 1988, one of the adjustments under Rule 5(b) was in respect of any amount either written off or reserved in the accounts to meet depreciation or loss on the realisation of investment, which was allowed as deduction. Similarly, any sum credited to the account, due to appreciation or gain on the realisation of investment, was taken as part of taxable income.

To enable the General Insurance Corporation (GIC) and its subsidiaries (prior to 1988, the insurance sector was not open to the private sector, there were only GIC and its subsidiaries in operation) to play a more active role in capital markets for the benefit of policy holders, the Finance Act 1988 amended the position by deleting the aforesaid Rule 5(b) of the First Schedule.

The CBDT circular containing a memorandum to the Finance Act 1988 explained that amendment was provided for exemption of the profits earned by them on the sale of investment. As a corollary, it has also been provided that the losses incurred by the General insurance companies on the realisation of the investment shall not be allowed as a deduction in computing the profits chargeable to tax.

With the opening of the insurance sector in 2000, the new entrants also relied on deletion of Rule 5(b) of the First Schedule to the Income Tax Act, 1961 (‘Act’) and the CBDT circular to treat profit on sale/redemption of investments as exempt from tax. However the tax department, in many cases at the lower level, did not accept the stance of the industry and started taxing profit on sale of investments.

In some cases, insurance companies have also claimed deduction for diminution in value of investments. In the case of Oriental insurance Co Ltd (assessee), deduction was claimed for the write-off of investments. The deduction was disallowed by the Assessing Officer and the first appellate authority —- CIT(A).

The Delhi Tribunal, while deciding in favour of the assessee, observed that the CIT(A) decision was based on the 1988 CBDT circular. It was argued by the assessee that the discussion in para 45 of the circular in relation to omission of sub-rule 5(b) could at best be elucidation of the intention of the law makers.

The fact of the matter was that such effect was not forthcoming from omission of sub-rule (b). On consideration, the Tribunal was in substantial agreement with this argument. If the intention of the legislature was to exempt profit on sale of investments and to disallow deduction of loss on sale of investments, the fact remains that such intention has not been translated into statute. Omission of Rule 5(b) does not bring about this change in statute. Accordingly, the Tribunal allowed the deduction and decided the case in favour of the Insurance Company.

The Finance Act (No.2) 2009 reintroduced Rule 5(b) in Schedule 1 of the Act. It provided that in the case of non-life insurance companies, any amount credited on account of appreciation on valuation of investments/gains on the realisation of investments shall be taxed as income, and any amount written off or provided for diminution or loss on realisation of investments shall be allowed as a deduction.

The obvious reaction of the companies was to represent before the government against taxation of unrealised gains on investments. It was represented by the Insurance companies that the appreciation in the value of investments, being in the nature of unrealised gain should not be taken into account for determining taxable income.

To provide relief to the insurance companies on this issue, the Finance Bill 2010 has once again proposed to amend Rule 5(b). The explanatory memorandum to the Finance Bill 2010 explains the reason for the amendment. The appreciation in the value of investments, being in the nature of unrealised gain is not taken into account for determining profit or loss of non-life insurance business according to the IRDA regulations. It is therefore proposed that the unrealised gains due to appreciation in the value of investments will not be included in the total income.

Similarly, deduction will not be allowed for provision for losses due to diminution in the value of investments as this is not a realised loss. It has also been provided that any gain or loss on realisation of investments shall be added or deducted for the purpose of computation of the total income, if this amount has not already been credited or debited in the profit and loss account.

This amendment has provided some relief to non-life insurance companies. In addition, certain relief has been granted to insurance agents and insurance companies from a compliance perspective through an increase in the threshold limit for deduction of tax at source from commission payable under section 194D of the Act from Rs 5,000 to Rs 20,000.

Radhakishan Rawal is associate director, Veena Jagnani assistant manager and Pranav Mehendale associate, PricewaterhouseCoopers. Views are personal.