2025 (4) TMI 1093 - HC - Income Tax

Assessment of Insurance business - Profit on sale of investment - HELD THAT - The issues are to be answered in favour of the assessee by virtue of judgement of United India Insurance Co. 2020 (5) TMI 755 - SC ORDER (LB) affirming the decision of this Court in United India Insurance Co. 2019 (7) TMI 387 - MADRAS HIGH COURT as held prior to 1st April 2011 there was no provision which required the Revenue to disallow the deduction of loss on sale of investments.Decided against revenue. Disallowance u/s 14A - Tribunal has concluded the issue adverse to the assessee holding that Rule 5(a) militates against the grant of expenses which are not for the purposes of insurance business and directing that the same are to be added back -Section 14A states that no deduction shall be allowed in respect of the expenditure incurred by the assessee in relation to income which does not form part of the total income under the Act. However in framing of assessments in the case of insurance companies it is purely Section 44 read with Rule 5 of the First Schedule that would apply. This position is made clear by Section 44 itself which says that the methodology for computation shall be as per Rule 5 of the First Schedule that excludes specifically the application of Sections 28 to 43B and Section 199 of the Act. We are thus of the considered view that in a specialised assessment of this nature where the methodology for computation is not as stipulated under Section 28 to 43B there is no role for Section 14A at all. The fact that such an assessment would stand outside the ambit of application of Section 14A is made clear by the non-obstante clause contained in Section 44 which states that notwithstanding anything to the contrary contained in this Act relating to the computation of income chargeable under the heads of interest on securities house property Capital gains or other sources or Section 199 or Sections 28 to 43B dealing with the computation of business income the assessment of insurance business would be in accordance with the Rules contained in the First Schedule alone. Barring the aforesaid adjustments there can be no other adjustments contemplated to the scheme of computation of profits and gains of other insurance businesses. Reference to Section 14A thus does not arise in the context of such computation. In the scheme as we have set out above the legislative intent is clear to put in place a distinct and different scheme for computation of profits from other insurance businesses. The substantial question of law in relation to this issue is thus answered in favour of the assessee and against the revenue. Disallowance of the provisions made on account of the expenditure incurred but not reported (IBNR) and incurred but not enough reported (IBNER) - The scheme of taxation that governs Insurance Companies has its genesis in Section 44 of the Act a special provision touching upon the taxation of the Insurance business. Incidentally the IRDA had issued Insurance Regulatory and Development Authority of India (Assets Liabilities and Solvency Margin of General Insurance Business) Regulations 2016 (in short IRDA 2016 Regulations) effective from 01.04.2016 where there are procedural differences in the reporting of claims and creation of claim reserves. However there is no effective difference as far as the appellant companies are concerned in that the mandate to have a transparent disclosure of the claims and the manner in which such claims are to be crystallized continues to be the same even in the 2016 Regulations. Thus for all practical purposes the appellants would be equally entitled to the grant of provision both under the 2002 as well as 2016 Regulations. Ultimately the assessment and valuation of risk has been made by a Registered Actuary and in our view this would amount to a sound and scientific basis for the claim of expenditure. Hence we find that there is a scientific basis for the claim of the provisions based on the stipulations under the applicable statutory and other prescriptions. We answer the substantial questions of law in regard to claim in regard to IBNR and IBNER in favour of the assessee and against the Revenue. Disallowance of payments made to Motor vehicle dealers - Statements had been recorded from the employees of those companies to the effect that no service had been rendered by them based on which the expenditure claim was disallowed. That very issue being the claim of input tax had been the subject matter of adjudication by the service tax authorities that had travelled before the Customs Excise and Service Tax Appellate Tribunal (in short CESTAT) which had held that the motor vehicle dealers had indeed rendered services. That order of the CESTAT had been produced before the Tribunal relying on the factual findings therein that services had been rendered by the automobile manufacturers. Tribunal has thus remitted the matter to the file of the Assessing Officer since the order of the CESTAT is dated 24.02.2021 which order was not available before the Assessing Officer when the orders of assessment had been passed. In fact the Tribunal has in remanding the matter stated that the remand was for the limited purpose of enabling the Assessing Authority to verify the issue with reference to the CESTAT order. We find nothing untoward in the order of remand and hence the conclusion of the Tribunal in this regard is affirmed. This substantial question of law is answered against the assessee.

Summary

The core legal questions considered in these appeals pertain to four principal issues: the validity and tax treatment of reinsurance premium payments to non-resident reinsurers under the Insurance Act, 1938 and related IRDA regulations; the taxability of profit on sale of investments by insurance companies; the allowance or disallowance of provisions for 'Incurred But Not Reported' (IBNR) and 'Incurred But Not Enough Reported' (IBNER) claims; and the applicability of Section 14A disallowance provisions to insurance companies. An additional question relates to the disallowance of payments made to motor vehicle dealers.

Regarding the reinsurance premium payments, although multiple substantial questions of law were framed concerning the jurisdiction of the Tribunal to adjudicate on legality of such payments under the Insurance Act, 1938 and IRDA (General Insurance-Reinsurance) Regulations, 2000, the appellants expressly chose not to press these issues. Consequently, these questions remain unanswered and were not further analyzed by the Court.

The issue of profit on sale of investments arose from the deletion and later reintroduction of Rule 5(b) of the First Schedule to the Income Tax Act, which governs the computation of profits and gains of insurance businesses. The Court relied heavily on authoritative precedents, including the Supreme Court's decision affirming this Court's earlier ruling, which clarified that prior to 1st April 2011, profits on sale of investments by general insurance companies were not taxable due to the omission of Rule 5(b). The Court noted the explanatory memorandum to the Finance Bill, 1988 and CBDT Circular No. 528 dated 16.12.1988, which explicitly recognized that the deletion aimed to exempt such profits. The Court held that the Tribunal's contrary view was erroneous and perverse, affirming that the profit on sale of investments for the relevant assessment years is not taxable. The Court also emphasized that the IRDA regulations require non-life insurance companies to include such profits or losses in their profit and loss accounts only from AY 2011-12 onwards, consistent with international accounting standards.

In relation to disallowance under Section 14A, which prohibits deduction of expenditure incurred to earn exempt income, the Court held that this provision does not apply to insurance companies whose income is computed under the special scheme of Section 44 read with Rule 5 of the First Schedule. The Court analyzed Section 44's non-obstante clause, which excludes the application of Sections 28 to 43B and Section 199, and the detailed computation methodology under Rule 5. The Court concluded that the scheme for insurance companies is self-contained and excludes the applicability of Section 14A. The Tribunal's failure to consider this and its adverse finding against the assessee were set aside, and the question was answered in favor of the assessee.

The most detailed analysis concerned the disallowance of provisions for IBNR and IBNER claims. The Assessing Officer disallowed these provisions on the ground that they were contingent and unascertained liabilities, not crystallized during the relevant assessment years. The CIT(A) allowed the provisions, holding that the liability crystallizes upon the occurrence of the insured event, with only the quantification remaining to be determined. However, the Tribunal reversed this, restoring the disallowance.

The appellants contended that the provisions were computed on a scientific basis by appointed actuaries in accordance with the IRDA (Preparation of Financial Statements and Auditor's Report of Insurance Companies) Regulations, 2002, and subsequent IRDA regulations, which prescribe the methodology for claim reserves and presentation of financial statements. They relied on actuarial certificates and multiple judicial precedents from various High Courts supporting the allowance of such provisions. The Department argued that the claim crystallization requires more than the occurrence of an event and that the actuarial certificates were self-serving without sufficient supporting material.

The Court undertook a comprehensive examination of the statutory scheme governing insurance companies' taxation under Section 44 and the First Schedule, emphasizing that the IRDA regulations are incorporated by reference into the computation of profits and gains. It recognized that the provisions for IBNR and IBNER are mandated by these regulations and supported by actuarial valuation, which constitutes a scientific and sound basis for the claim. The Court rejected the Department's oversimplification that the claim is merely contractual and held that the detailed actuarial and regulatory framework sufficiently evidences crystallization of liability. The Court also noted that the IRDA Chairman had sought clarification from the CBDT on this issue, underscoring its regulatory significance.

Consequently, the Court answered the substantial questions of law regarding the allowance of IBNR and IBNER provisions in favor of the assessee and against the Revenue.

On the question of disallowance of payments made to motor vehicle dealers, the Assessing Officer had disallowed expenditure claims based on statements alleging no services were rendered by dealers, despite the availability of input tax credit on service tax paid. The Tribunal remanded the issue to the Assessing Officer for reconsideration in light of a subsequent Customs, Excise and Service Tax Appellate Tribunal (CESTAT) ruling that the dealers had indeed rendered services. The Court found no infirmity in the Tribunal's remand and affirmed the decision, answering this question against the assessee.

In summary, the Court's significant holdings include the following:

On profit on sale of investments, the Court preserved the reasoning that "prior to 1st April, 2011, there was no provision which required the Revenue to disallow the deduction of loss on sale of investments," and that the deletion of Rule 5(b) was intended to exempt such profits, as supported by the Finance Bill memorandum and CBDT Circular No. 528. The Court emphasized that "the changed norms... required a non-life insurance company to include in its Profit and Loss Account 'profit or loss on realisation/sale of investment'... applicable only from AY 2011-12."

Regarding Section 14A, the Court held: "In a specialised assessment of this nature, where the methodology for computation is not as stipulated under Sections 28 to 43B, there is no role for Section 14A at all." It further stated that "the legislative intent is clear, to put in place a distinct and different scheme for computation of profits from other insurance businesses," and thus "reference to Section 14A does not arise."

On IBNR and IBNER provisions, the Court concluded that "the IRDA guidelines stand incorporated into the very scheme of taxation of an insurance business," and that the actuarial valuation "would amount to a sound and scientific basis for the claim of expenditure." It rejected the Department's position that the claim was merely contractual and unsubstantiated, emphasizing the statutory and regulatory framework mandating such provisions and the scientific basis provided by actuaries.

The Court affirmed the Tribunal's remand of the motor vehicle dealers' payment disallowance for verification in light of the CESTAT order, finding no fault in this procedural decision.

Ultimately, the Court disposed of the appeals as follows: the reinsurance premium issues were not pressed and left unanswered; the profit on sale of investments and disallowance under Section 14A were decided in favor of the assessee; the allowance of IBNR and IBNER provisions was upheld in favor of the assessee; and the disallowance of payments to motor vehicle dealers was upheld in favor of the Revenue.