Direct Tax Alert - No disallowance of reinsurance payments to foreign re-insurers under section 37(1) and/ or 40(a)(ia) of the Income-tax Act, 1961
06 May 2022
Every insurer in consideration of payment of reinsurance premium, re-insures himself against the risks arising out of the conduct of insurance business. However, such payment of reinsurance premium made to foreign reinsurer has always been the subject matter of debate with tax authorities in India. In this regard, recently, the Mumbai Tax Tribunal had an occasion to examine whether such reinsurance payments to foreign reinsurers are entitled to a deduction as a business expenditure and whether such payment of reinsurance premium paid to foreign reinsurers is subject to withholding tax in India.
We, at BDO in India, have summarised the ruling of the Mumbai Tax Tribunal and provided our comments on the impact of this decision.
Facts of the case
- Taxpayer is engaged in the business of general insurance. The taxpayer has ceded/ re-insured part of their risk of entering a reinsurance arrangement with non-resident re-insurers who do not have any taxable presence or branch in India.
- The claim of deduction on account of payment of reinsurance premium made by the taxpayer was disallowed by the tax officer under section 37 of the Income-tax Act, 1961 (‘IT Act’) as the said expense was incurred pursuant to re-insurance arrangement which was in violation and contrary to the provision of section 101A read with section 2(9) of the Insurance Act, 1938 (the ‘Insurance Act’).
- Without prejudice to the above, the tax officer also made a disallowance under section 40(a)(ia) of the IT Act as the aforesaid payment of reinsurance premium has been made without deduction of tax at source (TDS) under the provisions of the IT Act.
- The First-Appellate Authority upheld the disallowance made under section 40(a)(ia) of the IT Act. With respect to deduction for payment reinsurance premium, the First-Appellate Authority while taking into considering the amendment in section 2(9) of Insurance Act, 1938 has provided a relief for the payment made prior to 26 December 2014 however, sustained the additions made by the tax officer post 26 December 2014 in terms of explanation 1 of section 37 of the IT Act.
- Aggrieved by the decision of the First-Appellate Authority, the taxpayer contested before the Mumbai Tax Tribunal.
Mumbai Tax Tribunal ruling
The Tax Tribunal in its ruling, inter alia ruled in favour of the taxpayer based on the following observations:
- The word ‘other Insurer’ provided in section 101A(7) of the Insurance Act enables Indian insurers to re-insure himself with Indian re-insurer or other insurer against the risks that may arise during the course of its business of insurance. The definition of “Insurer” as provided under section 2(9) of Insurance Act, 1938 has been amended pursuant to the Insurance Laws (Amendment) Act, 2015 with effect from 26 December, 2014 and accordingly, a foreign company engaged in re-insurance business through a branch established in India has been included under the definition of “Insurer” in Insurance Act, 1938.
- In view of above, tax authorities made a strong contention that an Indian Insurer cannot have any reinsurance arrangement with reinsurance company other than the Insurer as defined in section 2(9) of Insurance Act, 1938 i.e. Only with a foreign reinsurer having a branch establishment in India.
- The Tax Tribunal while dwelling upon this issues has placed a reliance on the Madras High court decision1 which has dealt with similar issue and reiterated on following points while adjudicating the issue of deduction of payments of reinsurance premium as a business expenditure:
- A reading of the insurance regulations2 show that the objective behind prescribing the percentage of reinsurance to be ceded with the Indian insurers was to maximise the retention of revenue within the country.
- These regulations also clearly show that there is absolutely no prohibition for re-insurance with a foreign re-insurer and therefore, the finding of revenue authorities that the payments of reinsurance premium made to foreign reinsurers are inconsistent with the provisions of the Insurance Act, 1938 is not valid and ought to be rejected.
- In the year 2008, the Standing Committee on Finance3 also noted that there is no bar on foreign re-insurers carrying on re-insurance business in the country without a licence or opening a branch, nor there was a regulation to control the transaction of foreign re-insurer. This ultimately led to the amendment in the Insurance Act, 1938 by amending the definition of the term ‘insurer’ to mean a foreign company engaged in re-insurance business through a branch established in India;
- The view of the tax authorities that unless and until a branch is opened by the foreign re-insurer, the re-insurance business cannot be done in India, is not sustainable. The said contention of tax authorities is answered in the income-tax circular4 which clearly states that at no point of time, the Income-tax department took a stand that the re-insurance business with a foreign re-insurer was a prohibited business;
- As per the changes in the procedures5 made by the Reserve Bank of India (‘RBI’), the Authorised Dealers have been permitted to make remittances falling under the approved reinsurance arrangements without reference to the RBI. This also clearly show that the re-insurance arrangement with a foreign re-insurer is permissible.
- Thus, the definition of “Insurer” as provided in section 2(9) of Insurance Act, 1938 has no role to play while analysing the provisions of section 101A of Insurance Act, 1938.
- In the light of above, the Tax Tribunal has held that the contention of tax authorities to disallow the deduction of payment of reinsurance premium based on the fact that the foreign reinsurer in the instant case does not have a branch or place of business in India is not valid.
- A reliance has also been placed on the letter submitted by the taxpayer with the Insurance Regulatory Development Authority of India (‘IRDAI’) for its approval. The letter as submitted by the taxpayer was exhaustive and contains the details of the reinsurance program for the respective year. In response to the letter of the taxpayer, IRDAI had addressed a letter to the taxpayer approving the entire arrangement of reinsurance program. This shows that the payment of reinsurance premium made by the taxpayer has duly been taken into consideration by the regulator (IRDAI) and they have not found anything adverse or contrary to the provisions of the Insurance Act read with regulations issued thereunder.
- Accordingly, the payment of reinsurance premium made to foreign reinsurer having no taxable presence or branch in India is entitled for a deduction as a business expenditure under section 37 of the IT Act.
- Further, with respect to the disallowance made under section 40(a)(ia) of the IT Act, the Tax Tribunal, placing reliance on various rulings of the co-ordinate bench6 has held that foreign reinsurer in the instant case does not have a branch or business connection or permanent establishment in India and accordingly, the payment of reinsurance premium made to such foreign reinsurer is not chargeable to tax in terms of the provisions of section 195(1) of the IT Act. Hence, there is no obligation on the part of the taxpayer to deduct any tax at source and consequently, there cannot be any disallowance under section 40(a)(ia) of the IT Act.
The decision of the Mumbai Tax Tribunal brings a sigh of relief for the insurance industry. The decision to place a reliance on the decision of Madras High Court in case of Cholamandalam MS General Insurance Co. Ltd, has elaborately dealt with the issue on hand by carrying out a detailed analysis of relevant provisions under the tax and regulatory laws. The decision puts to rest the legality of re-insurance transactions with foreign re-insurers. Further, the issue of disallowance under section 40(a)(ia) of the IT Act for non-deduction of TDS while making payment of reinsurance premium outside India also appears to be put to rest as it is often disputed with tax authorities in India.
1 Cholamandalam MS General Insurance Co. Ltd, Royal Sundaram General Insurance Company Ltd and United India Insurance Company Ltd
2 Regulation 3 and sub-regulations (1) to (10) under regulation 3 of the IRDAI (General Insurance –Reinsurance) Regulations, 2000
3 whish proposed amendments to the Insurance laws
4 Circular No. 38(XXXIII-7) dated 03 October, 1956 [F.No.51(5)-IT/54]
5 As laid down in the Memorandum of Exchange Control regulations relating to general insurance in India (GIM)
6 DCIT v ICICI Lombard General Insurance Co Pvt Ltd ITA No 6837 & 6832/Mum/2014, General Reinsurance AG India Branch vs DCIT ITA No 7433/Mum/2018, Bajaj Alliance General Insurance Co Ltd v DCIT ITA No 2560/PN/2012, Swiss Reinsurance Co Ltd v DCIT (55 taxman.com 520)