LIFE INSURANCE BUSINESS- provision for solvency margin made as per the directions of is allowable.

[C.A. DEV KUMAR KOTHARI]

Commissioner of Income Tax – 1, Versus Life Insurance Corporation of India Limited, 2011 -TMI - 204940 - BOMBAY HIGH COURT

Section 44 of Income-tax Act, 1961

Rules contained in the First Schedule to the Income Tax Act, 1961.

Insurance Act, 1938 http://www.irda.gov.in/ADMINCMS/cms/frmGeneral_Layout.aspx?page=PageNo107&flag=1&mid=Insurance%20Laws%20etc.%20%3E%3E%20Acts

INSURANCE REGULATORY AND DEVELOPMENT AUTHORITY ACT, 1999

http://www.irda.gov.in/ADMINCMS/cms/frmGeneral_Layout.aspx?page=PageNo108&flag=1&mid=Insurance%20Laws%20etc.%20%3E%3E%20Acts

http://www.irda.gov.in/Defaulthome.aspx?page=H1

CIT Vs. LICI 2011 TMI 204940:

In this case two issues were involved namely allowability of (i)  deduction for provision of solvency margin  made for three years as per directives of the IRDA though it was not required as per the  basis of actuarial valuation under the Insurance Act and (ii)  loss in case of Fund whose income would be exempt under  section  10(23AAB). For the present write-up we are concerned with the first issue only.

Questions before the High Court:

On the above issue with which we are concerned in this write-up, the following substantial questions of law  were formulated (reproduced with the same number as found in the judgment but with highlights:

(a) Whether on the facts and in the circumstances of the case and in law the Tribunal was justified in deleting the addition made on account of provision of solvency margin by the Assessing Officer even though the provision for solvency margin was made as per the directive of IRDA for a period of three years only and does not form the method of actuarial valuation made in accordance with the Insurance Act, 1938 ?  

(b) Whether on the facts and in the circumstances of the case and in law the Tribunal was right in deleting the addition made on account of provision on solvency margin by the Assessing Officer which was not an ascertained liability eligible for deduction ?  

Facts of the case:

In the revised return the assessee (LICI) inter alia claimed deduction from  the actuarial valuation surplus for  the provision for reserve on account of solvency margin amounting to Rs.3,500 crores.  The Assessing Officer disallowed this claim on the ground that the provision for solvency margin was not an ascertained liability, this stand of the AO was confirmed by the  Commissioner of Income Tax (Appeals). On further appeal  the Income Tax Appellate Tribunal  deleted the said additions. Therefore , the revenue has filed these appeals under Section 260A of the Income Tax Act, 1961 before the High Court.  

The Court observed ant found that as regards questions (a) and (b)  it is not in dispute that the provision for solvency margin was made as per the directions given by the Insurance Development Regulatory Authority (IRDA).

 The High Court observed  that “the question is, whether such provision for solvency margin made as per the directions of IRDA constitutes unascertained liability so as to include the same in the actuarial valuation surplus ?  

The High Court referred to Rule 2 of the First Schedule to the Income Tax Act, 1961  and reproduced the same as follows (high lights added by author) :  

“Computation of profits of life insurance business.

        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 intervaluation 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 intervaluation period.”  

The Court considered that plain reading of the above rule makes it clear that the annual average of the surplus from the insurance business has to be arrived at by adjusting the surplus or deficit disclosed by the actuarial valuation made in accordance with the Insurance Act, 1938.  

Communication and directive of IRDA:

The High Court referred to the communication and directives of the IRDA. The same with observations of the High Court  are analyzed below:

1. The Chairman of IRDA by his letter dated 4th September 2002 had directed that the present solvency calculations of the assessee do not conform to the requirements of the regulations that have been stipulated by the Regulatory Authority.
2. IRDA has found that  the deficiency in the solvency margin was to the extent of Rs.10,000 crores.
3. IRDA has further directed that the  said deficiency of Rs.10,000 Crores  in the solvency margin be set right  over a period of three years.
4. The deficiency was to be met  by making a provision which shall be kept apart in the policyholders fund .
5. IRDA also directed that  no part of the said provision would be available for distribution either to the policyholders or to the Government of India.  

In view of the said directions the assessee had set apart Rs.3,500 crores  towards solvency margin in the assessment year in question.  (The sum  is about one/third of total deficiency and assessee is to make further provision of Rs.7000 crores in another two years.)

Observations of the High Court on Tribunals decision (analysed by author):

1. The Income Tax Appellate Tribunal  has considered considering various decisions of the Apex Court  and the Bombay High Court,
2. The Tribunal has also considered  Section 64(VA) of the Insurance Act, 1938
3. The Tribunal had  held that the amounts set apart towards the solvency margin as per the directions given by the IRDA were ascertained liability,
4.  The provisioning was required to be set apart as per the regulations framed by IRDA
5. Therefore,  the provision was liable to be excluded while computing the actuarial valuation surplus.  

The High Courts observations and ruling:

On consideration of the decision of Tribunal, various judgments and provisions referred to by Tribunal the High Court observed and held as follows:

1. It is not  the case of the Revenue that the provision for solvency margin is contrary to the provisions of the Insurance Act, 1938
2. It is also not  the case of the Revenue that the solvency margin has been wrongly or excessively calculated by the actuarial .
3. It was mandatory for the assessee to set apart the funds towards solvency margin
4. hence the amount was excludible while determining the annual average surplus under Section 44 read with the Rules contained in the First Schedule to the Income Tax Act, 1961.
5. The decision of the Income Tax Appellate Tribunal in holding that the funds set apart as solvency margin have to be excluded while determining the distributable profits of the assessee cannot be faulted.  

Accordingly, questions (a) and (b) were answered in the affirmative, that is, in favour of the assessee and against the revenue.

  ^{Present position:}

^{At http://www.taxmanagementindia.com/Print/print_Act_Rule.asp?ID=3509 We find that the Rule 2 and related footnote as follows:}

¹[Computation of profits of life insurance business.

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.]

1. Substituted by the Finance Act, 1976, w.e.f. 1-4-1977.

From above we notice that The  Rules is same since 01.04.1977 and the same was considered by the High Court . Author also reviewed other Changes in other Rules in regard to business of life insurance has also not changed the legal position on the points considered by the High Court.

Authors observations to  further strengthen the case:

The IRDA is a regulatory authority for insurance business. It is an authority not only to regulate business of insurance  but also to keep and watch to safeguard the interest of policy holders. The preamble of the INSURANCE REGULATORY AND DEVELOPMENT AUTHORITY ACT, 1999 reads as follows:

       To provide for the establishment of an Authority to protect the interests of holders of insurance policies, to regulate, promote and ensure orderly growth of the insurance industry and for matters connected therewith or incidental thereto and further to amend the Insurance Act, 1938, the Life Insurance Corporation Act, 1956 and the General Insurance Business(Nationalisation) Act, 1972.

And at the link   http://www.irda.gov.in/ADMINCMS/cms/NormalData_Layout.aspx?page=PageNo1332&mid=1.9   we find the mission statement of IRDA which says as follows:

Ø  To protect the interest of and secure fair treatment to policyholders; 

Ø To bring about speedy and orderly growth of the insurance industry (including annuity and superannuation payments), for the benefit of the common man, and to provide long term funds for accelerating growth of the economy;

Ø To set, promote, monitor and enforce high standards of integrity, financial soundness, fair dealing and competence of those it regulates;

Ø To ensure speedy settlement of genuine claims, to prevent insurance frauds and other malpractices and put in place effective grievance redressal machinery;

Ø To promote fairness, transparency and orderly conduct in financial markets dealing with insurance and build a reliable management information system to enforce high standards of financial soundness amongst market players;

Ø  To take action where such standards are inadequate or ineffectively enforced; 

Ø  To bring about optimum amount of self-regulation in day-to-day working of the industry consistent with the requirements of prudential regulation.

From THE INSURANCE ACT, 1938 we find in definitions.

2. In this Act, unless there is anything repugnant in the subject or context, -

(1)    

⁴[(1A) “Authority” means the Insurance Regulatory and Development Authority established under sub-section (1) of section 3 of the Insurance Regulatory and Development Authority Act, 1999;]

Thus IRDA is a statutory authority appointed under law  and is also supposed to regulate the business of insurance including life insurance business. Therefore, any insurer is required to follow directions of IRDA.

The IRDA has found that there was deficiency of Rs.10,000/- crores. However, for some reasons the IRDA allowed LICI to make this deficiency by making provision in three years. This is a relaxation given by the IRDA. In fact IRDA could have asked the LICI to make provision in one year itself. The deficiency of  Rs.10,000/- crore  could have been claimed in one year.   It is worth to mention that IRDA also directed that  no part of the said provision would be available for distribution either to the policyholders or to the Government of India.   However, this important directive has not found place in the  reasoning  for the  decision of the Tribunal and High Court. This directive of the IRDA has also implication that unless the deficiency is met  to the extent of Rs.10,000 crores, there should not be distribution of profit or dividend that means that there is no income in real sense until and unless the provision of The entire amount is made.

The judgment of the High Court is correct and deserves to be accepted by revenue and revenue should not challenge the same. Besides the reason applied by the Bombay High court author also want to add as follows:

That there was deficiency of Rs.10000 crore as found by IRDA, and therefore the income of the LICI was eroded to that extent. An estimate made by IRDA is a reasonable estimate and that could be provided in accounts or even otherwise claimed as an allowable deduction. In fact, it is surprising as to why the IRDA did not require to make provision of Rs.10,000 crore at one time, and to review position every year. Author hopes that LICI must have disclosed the fact of deficiency and short fall in provisioning.

Readers can have further studies on various websites of LICI and IRDA for relevant provisions.