Tax Planning through Keyman Insurance

What is Keyman Insurance

Keyman insurance is defined as an insurance policy where the proposer as well as the premium payer is the employer, the life to be insured is that of the employee. The employer may be a company, a partnership firm or even a sole proprietorship. The premium paid by the employer is a tax deductible expense and the maturity claims are taxable in the hand of the receiver, which may be the employer or the employee. Keyman insurance gives a 10x insurance cover and in case of any mishappening, the company gets 10x of annual premium paid as compensation.

How it helps in tax planning

For Companies

In India, closely held companies generally have the same set of people as shareholders as well as directors. The directors draw their salary but the shareholders do not receive anything, apart from dividends. Such companies try to avoid paying dividends as they are not tax neutral; the company can’t claim the dividend as expense but the shareholders, who are generally the directors themselves, pay tax on dividends.

Hence, a practical challenge is faced by the companies in relation to return of accumulated earnings to shareholders in the most tax neutral manner. Dividends, as mentioned above, are not tax neutral, and hence are avoided. Similarly, buyback of shares also involves tax cost and is generally avoided by such companies.

To overcome the above challenges, companies can purchase keyman insurance for their directors, which is a tax deductible expense. The directors can receive the proceeds on maturity and pay tax on such maturity claims. Hence, overall, the arrangement becomes tax neutral and also helps in transfer of accumulated profits to shareholders without any additional cost.

For Other Taxpayers

Similarly, other tax payers can use keyman insurance as a legitimate tax planning tool to reduce taxes and manage their funds.  

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