CONTRACT OF INSURANCE AND SERVICE TAX

[Mr. M. GOVINDARAJAN]

The general principles for construing a contract of insurance was laid down by a Constitution Bench of the Supreme Court in ‘General Assurance Society Limited V. Chandmull Jain and another’ – AIR1966 SC 1644.  In this case the Supreme Court held as – ‘A contract of insurance is a species of commercial transactions and there is a well established commercial practice to send cover note even prior to the completion of a proper proposal for delivery……….Documents like the proposal, cover note and the policy are commercial documents and to interpret them commercial habits and practice cannot be altogether be ignored………In other respects there is no difference between a contract of insurance and any other contract except that in a contract of insurance there is a requirement of uberrima fides i.e., good faith on the part of the assured and the contract is likely to be construed contra proferentem that is against the company in case of ambiguity or doubt.   A contract is formed when there is an unqualified acceptance of the proposal.   Acceptance may be expressed in writing or it may even be implied if the insurer accepts the premium and retains it.   In the case of assured, a positive act on his part by which he recognizes or seeks to enforce the policy amounts to an affirmation of it’.  The Supreme Court further held that there are four essential in a contract of insurance- 

• The definition of the risk;
• The duration of the risk;
• The premium; and
• The amount of insurance. 

The policy not only defines the risk and its duration but also lays down the special terms and conditions under which the policy may be enforced on either side. 

In ‘LIC of India V. Viswanathan Verma’ –AIR 1995 SC 189 the Supreme Court held that although there is no statutory definition of life insurance but it has been defined as a contract of insurance whereby the insured agrees to pay certain sums, called premiums, at specified times, and in consideration thereof the insurer agrees to pay certain sums of money on certain conditions and in specified way, upon happening of a particular event contingent upon the duration of human life. 

In ‘All India General Insurance Company Limited and another V. S.P. Maheswari’ – AIR 1960 Madras 484 a Division Bench of Madras High Court held that one great principle of insurance law is that a contract of insurance is based upon utmost good faith uberrima fides; in fact it is the fundamental basis upon which all contracts of insurance are made. In respect there is no difference between one contract of insurance and another.  Whether it be life or fire or marine the understanding is that the contract is uberrima fides and though there may be certain circumstances from the peculiar nature of marine insurance which require to be disclosed, and which do not apply to other contracts of insurance, that is rather an illustration of the application of the principle than a distinction in principle. From the very fact that the contract involves a risk and that it purports to shirt the risk from one party to the other, each one is required to be absolutely innocent of every circumstance which goes to influence the judgment of the other while entering into the transaction. 

The general principles of contract are therefore applicable with regard to a policy of life insurance also. The book ‘Formation of Life Insurance Contract’ has given the specific features of a life insurance contract which is as follows:  - “A broad analysis of the policy will show that a life insurance contract is like other types of insurances- 

• an aleatory contract;
• a unilateral contract;
• a conditional contract; and
• a contract of adhesion 

but not a contract of indemnity. It is also sometimes described in its nature as aleatory, executory, synallagmatic, conditional and personal and except as to life and accident that is one of indemnity. 

An aleatory agreement is one in which there is an element of chance of uncertainty, as for instance a wagering contract. A party to such an agreement, depending upon chance, may receive a return out of all proportion to the value which he gives.  

In ordinary contracts, each party expects to give and to receive from the other party fairly equivalent values in exchange, as for example, in the purchase of goods.   This type of contract is called as ‘unilateral contract’, since only the insurer makes an enforceable promise. 

The life insurance contract is also a ‘conditional contract’ since the promise of the insurer is conditioned on the timely payment of premiums subsequent to the first by the insured.  This is a condition precedent to the continuance of the contract under its original promise.  These conditions are of two types either precedent or subsequent.  A condition precedent must be satisfied before legal rights and duties are created or continued whereas a condition subsequent must be fulfilled in order to prevent the extinguishment of rights and duties already created by a contract.  On payment of premium a condition precedent has been satisfied. 

A life insurance contact is said to be a contract of adhesion meaning thereby that the terms of the contract are not arrived at by mutual negotiations between the parties as in the case of ordinary contracts.   The insurer has various types of polices to suit various needs and a person who applies for a policy of life insurance must accept one of these which may be most suitable to him. 

Proposal is one of the requirements for the formation of a contract of insurance. There is a mutual agreement between the insured and the insurer.   There must be an offer by one and an unqualified acceptance of it by the other.            

Premium is the consideration which the insured pays to the insurer for agreeing to undertake the risk.  It may be a single lump sum or a series of periodical payments payable as per terms of the contract.  The gross premium to be charged is made by up of net or pure premium and the amount added to it known as loading.   The net premium is determined from the rate of mortality and the rates of interest expected to be earned on the premiums collected over the period of its policy.  This will be sufficient to pay claims that arise as indicated by the mortality table.  The insurer has also to incur expenses for carrying on the business.  He must also make provision for the mortality and interest rates assumed turning out to be under estimates, bonus for with profit policies, profit for the insurer and for unforeseen contingencies etc.,   The proportionate levy in respect of this on each unit of premium is the loading. 

The insurance service was brought into the service tax from the inception of the service tax ie., from the year 1994. Service tax is a value added tax which in turn is a destination based consumption tax in the sense that it is on commercial activities and is not a charge on the business but on the consumer and it would, logically, be leviable only on service provided within the country. The service tax is to be leviable on insurance service. The premium payable is comprise of three components- 

• a risk charge for extending insurance cover to the customer;
• the expenses which mainly include-

• the acquisition costs such as agent commission, commission for generating and issuing the policy, under writing cost etc.,; and
• the maintenance costs such as expenses incurred in connection with maintenance of the policy, namely, issuing reminder letters, premium notices, executing requests received from customers  post policy insurance, expenses incurred insetting claims etc., 

The service tax is only on the risk charge component of the premium.  

One problem relating to levy of service tax on insurance premium is handled by the Kerala High Court in ‘Max New York Life Insurance Co. Limited V. Insurance Ombudsman’ – 2011 (22) STR 387 (Ker).   In this case the petitioner is an insurance company getting licence to carry life business under a valid registration certificate issued by the Insurance Regulatory Development Authority.  The second respondent is a policy holder.   The policy period is for 20 years.   The date of policy is 30.06.2006.   The mode of payment of premium is annual.  The premium payable is Rs.4810/-.  Till 2009 there was no problem.   The petitioner issued a notice on 24.05.2009 to the policy holder to pay service tax of Rs.495.43 along with the premium amount and the net amount is shown as Rs.5,305.43.  The policy holder objected the same.   He remitted the amount under protest.  He approached the Ombudsman by filing a complaint.  The Ombudsman issued an award in favour of the policy holder.  It held that the model premium payable is Rs.4810/- Service tax was enforced by the Finance Act, 1994.  Therefore even the policy was eligible to service tax and was being paid by the insurer.   It would show that the gross amount would include the service tax payable also.   When the total amount is agreed as Rs.4810/- it can only be presumed that the premium was fixed as inclusive of tax and all the expenses and hence the liability to pay tax was with the service provider. 

The petitioner against the award of Ombudsman filed a writ petition before the High Court. The petitioner put forth the following arguments: 

• The Finance Act will show that service tax is a destination based consumption tax. The same has to be passed on to the consumer;
• In the absence of an express provision prohibiting the passing of the tax to the consumer, the tax can be passed on to the consumer;
• The same is an implied term of the contract between the parties;
• There cannot be any estoppal against the law and the tax is sought to be collected in terms of the provisions of the Finance Act alone;
• In the year 2006 the petitioner decided not to pass on the tax liability and from 2009 onwards they took a policy decision in the matter that the service tax is sought to be collected in addition to the premium amount

The policy holder in his complaint stated that levy of Rs.495.43 in the form of service tax was not loaded at the time when the policy becomes effective, though service tax was there.   It was borne by the insurer and the altogether amount as per their agent was acceptable to him and accordingly the proposal was submitted and the insurer accepted it and the policy became effective.  The levy of service tax after than is violation of the terms of the contact.  As the policy was effective from 22.6.2006 any decision taken by the insurer to impose service tax from May 1, 2009 will not apply to him.

The High Court observed that the Ombudsman relied upon Sec. 67(2) of the Finance Act which provides that where the gross amount charged by the service provider for the services provided or to be provided is inclusive of service tax payable, the value of such taxable service shall be such amount as with the addition of tax payable is equal to the gross amount charged.   The Ombudsman also relied on Section 67(3) which provides that gross amount charged for taxable service shall include any amount received towards taxable service, during or after provision of such service. 

The following issues were framed by the High Court:

• Whether the premium initially collected can safely be presumed to include service tax or not?
• Whether the insurer cannot vary the terms of the contract of insurance unilaterall

The High Court held that being a contract described as having utmost good faith, the parties will have to disclose to each other all the new information.   Once the proposal has been accepted, it cannot be said that all conditions applicable have not been incorporated also.  A liability cannot be said to be an implied condition in a policy document.   Once there is a proposal and acceptance a valid contract has been created.  Evidently the first step is the proposal for insurance and the parties have agreed the terms and when the policy holder tenders the first premium, he has fulfilled his part of the contract and on acceptance the terms have become absolute and unqualified.  At the point of the time the petitioner had not put any additional conditions for payment of any extra amount above Rs.4810/- to meet the service tax element.  The Ombudsman in its award has stated that it was not specifically mentioned by the petitioner in the reply at the time of submitting the proposal, premium was not arrived at as inclusive of service tax and other expenses, by the agent.  This is significant.   No other evidence has been led into the contrary.

The High Court held that the second respondent, viz., the policy holder, is entitled to succeed.   Even two interpretations are possible, an interpretation which favors the conditions of the policy as agreed to the parties alone be taken.  The High Court dismissed the petition.  Any extra amount collected from the second respondent is to be adjusted towards the future premiums.