Commissioner of Income Tax vs B.N. Exports

D.Y. Chandrachud, J.—The appeal by the Revenue u/s 260A of the Income Tax Act, 1961, raises the following question of law:

(a) Whether on the facts and circumstances of the case and in law, the Income Tax Appellate Tribunal was justified in confirming the order of the Commissioner of Income Tax (Appeals) by deleting the addition of Rs. 31,68,775 being insurance premium paid by the assessee-firm on a Keyman insurance policy?

The issue before the court pertains to the assessment year 2004-05.

By its order dated January 29, 2009, the Income Tax Appellate Tribunal confirmed the findings of the Commissioner of Income Tax (Appeals). The Tribunal held that the expenditure incurred by the assessee, which is a partnership firm, in paying the premium for a Keyman insurance policy obtained by the firm on the life of its partner must be regarded as expenditure incurred wholly and exclusively for the business of the firm. In holding thus, the Tribunal relied upon a circular issued by the Central Board of Direct Taxes on February 18, 1998 (Circular 762--[1998] 230.HR (St.) 12) and on its decision in the case of Income Tax OFFICER Vs. THAKUR VAIDYANATH AIYER AND CO., . Accordingly, the Tribunal deleted an addition of Rs. 31,68,775 towards the insurance premium paid by the firm on a Key-man insurance policy.

The contention of the Revenue before the court is that in law a partnership firm has no separate existence from its partners since a partnership firm is not a juristic entity. Moreover, it has been urged before the court that there is no relationship of employer and employee between a firm and its partners, there being no contract of service.

In order to appreciate the submission which has been made a reference to some of the relevant provisions of the Income Tax Act, 1961, would be in order. Section 2(31) defines the expression "person" to include an individual, a Hindu undivided family, a company, a firm, an association of persons or a body of individuals whether incorporated or not, a local authority and every artificial juridical person, not falling within the previous sub-clauses. Consequently, for the purposes of taxation, a firm is regarded as a distinct assessable entity. Section 10 provides that in computing the total income of any person for the previous year, income falling within any of the clauses of the provision shall not be included. Clause (10D) specifies to any sum received under a life insurance policy, including a sum allocated by way of bonus on such a policy other than, inter alia, "any sum received under a Keyman insurance policy". The. Explanation to Clause (10D) defines what is meant by a Keyman insurance policy thus:

Keyman insurance policy" 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.

The effect of Clause (10D) is that a sum received under a life insurance policy is not to be included in computing the total income of any person. However, a sum received under a Keyman insurance policy forms a part of the total income and is liable to be offered to tax. For the purposes of Clause (10D), a Keyman insurance policy is a life insurance policy taken by a person on the life of another person who is or was the employee of the person who subscribes to the policy of insurance or is or was connected in any manner whatsoever with the business of the subscriber to the policy. In other words, a Keyman insurance policy for Clause (10D) is not confined to a policy taken by a person on the life of an employee, but also extends to an insurance policy taken with respect to the life of another who is connected in any manner whatsoever with the business of the subscriber.

The Central Board of Direct Taxes has issued a circular on February 18, 1998 (Circular 762) which clarifies the scope and purpose of the provision. Paragraph 14.1 of the circular states thus ([1998] 230 ITR (St.) 12, 70) :

14.1 A Keyman insurance policy of the Life Insurance Corporation of India, etc., provides for an insurance policy taken by a business organisation or a professional organisation on the life of an employee, in order to protect the business against the financial loss, which may occur from the employee''s premature death. The ''Keyman'' is an employee or a director, whose services are perceived to have a significant effect on the profitability of the business. The premium is paid by the employer.

The circular notes that there were certain doubts on the taxability of the income, including bonus, received from such policies and as regards whether the premium paid should be allowed as capital or as revenue expenditure. The circular clarifies that the Act lays down the tax treatment for a Keyman insurance policy. The circular clarifies that the premium paid on a Keyman insurance policy is allowable as business expenditure.

The contention of counsel appearing on behalf of the Revenue is that there is no contract of service between a partnership firm and a partner and a partner cannot be regarded as being an employee of the partnership firm. In order to support the submission reliance was sought to be placed on a judgment of the Supreme Court in Commissioner of Income Tax, Madras Vs. R.M. Chidambaram Pillai and Others, . In the case before the Supreme Court, the respondents who were partners of a partnership firm were entitled in addition to their share in the profits, to salaries for service rendered to the firm. The firm owned certain tea estates. The issue before the Supreme Court was whether the sums drawn by the partners as salaries were wholly liable to Income Tax or only to the extent of 40 per cent, which fell within the scope of non-agricultural income. The Supreme Court held that a partnership is only a collective of separate persons and is not a legal person in itself and as a result the salary paid to a partner from the firm is in reality a mode of division of profits of the firm since no person can be his own servant in law. On this principle, the Supreme Court dismissed the appeal filed by the Revenue and held that only 40 per cent, of the salary paid to a partner by a firm which grows and sells tea would be liable to tax whereas 60 per cent, could be exempt from tax under Rule 24 of the Indian Income Tax Rules, 1922. The decision in Commissioner of Income Tax, Madras Vs. R.M. Chidambaram Pillai and Others, was rendered by a Bench of two learned judges. There is a subsequent decision of a larger Bench of these learned judges of the Supreme Court in D.S. Bist and Sons, Nainital Vs. Commissioner of Income Tax, Delhi Central, New Delhi, in which the Supreme Court held that whereas according to the general principles of law a firm is merely a compendious expression for the partners who comprise it, yet for the purposes of taxation a partnership firm is a distinct assessable entity. The Supreme Court held thus (page 134):

We are concerned with provisions for the computation of income of an assessee for the purpose of determining its Income Tax liability. It may be, as is quite often said, that a firm is merely a compendious description of the individuals who carry on the partnership business. But under the Income Tax Act, a firm is a distinct assessable entity. Section 3 of the Indian Income Tax Act, 1922, treats it as such, and the entire process of computation of the income of a firm proceeds on the basis that it is a distinct assessable entity. In that respect it is distinct even from its partners : Commissioner of Income Tax, West Bengal Vs. A.W. Figgies and Co. and Others, .

The effect of Section 10(10D) is that monies which are received under a life insurance policy are not included in the computation of the total income of a person for a previous year. However, any sum received under a Keyman insurance policy is to be reckoned while computing the total income. For that purpose, a Keyman insurance policy means a life insurance policy taken by a person on the life of another person who is or was in employment as well as on a person on who is or was connected in any manner whatsoever with the business of the subscriber. The words "is or was connected in any manner whatsoever with the business of the subscriber" are wider than what would be subsumed under a contract of employment. The latter part makes it clear that a Keyman insurance policy for the purposes of Clause (10D) is not confined to a situation where there is a contract of employment. Clause (10D) relates to the treatment for the purpose of taxation of moneys received under an insurance policy. In this appeal, the court has to determine the question of expenditure incurred towards the payment of insurance premium on a Keyman insurance policy. The circular which has been issued by the Central Board of Direct Taxes clarifies the position by stipulating that the premium paid for a Keyman insurance policy is allowable as business expenditure. In the present case, on the question whether the premium which was paid by the firm could have been allowed as business expenditure, there is a finding of fact by the Tribunal that the firm had not taken insurance for the personal benefit of the partner, but for the benefit of the firm, in order to protect itself against the set back that may be caused on account of the death of a partner. The object and purpose of a Keyman insurance policy is to protect the business against a financial set back which may occur, as a result of a premature death, to the business or professional organization. There is no rational basis to confine the allowability of the expenditure incurred on the premium paid towards such a policy only to a situation where the policy is in respect of the life of an employee. A Keyman insurance policy is obtained on the life of a partner to safeguard the firm against a disruption of the business that may result due to the premature death of a partner. Therefore, the expenditure which is laid out for the payment of premium on such a policy is incurred wholly and exclusively for the purposes of business.

Hence, for the reasons recorded earlier, the appeal by the Revenue does not raise any substantial question of law. The appeal is dismissed. There shall be no order as to costs.