How GST may lead to increased tax outgo for insurance companies
An endowment policy is a form of life insurance coverage that combines the benefit of life insurance and savings under a single policy. It not only provides the benefits of sum assured to the insured upon death but also gives a corpus upon the expiry of the term.
Endowment policies, which require insurers to collect a fixed amount of premium over a fixed term period act as a savings and life cover to the insured. Tax laws in India consider only the element of life cover as taxable services to provide tax benefit to the element of savings done by the insured. However, the amount of premium collected by the insurer includes both the elements of savings of the insured and the consideration for the life cover services rendered by the insurer. This leads to the question as to what proportion of the policy premium should be subjected to tax and how just it is to apportion the same in the first place.
The erstwhile tax law levied service tax at a rate of 3.75 per cent on the first-year policy premium and 1.875 per cent on the subsequent premiums received. After the introduction of goods and services tax (GST), the law provided a valuation mechanism that allows the insurer to remit GST at the rate of 18 per cent only on 25 per cent of the insurance premium for the first year and 12.5 per cent of the insurance premium for the subsequent premiums collected.
The nature of operations of the insurance business and the valuation mechanism provided under the GST law have led to certain interpretational issues. For instance, the Insurance Act mandates insurance companies to invest in government securities. Now, the GST law mandates them to perform an input tax credit reversal towards that extent of transaction in securities. Another key issue in relation to endowment policies is the treatment of the 75 per cent or 87.5 per cent (in the first year and subsequent years, respectively) of the insurance premium, which is not subjected to levy of GST.
Under the GST regime, service providers who are involved in both taxable and exempt supplies are liable to avail input tax credit on their procurements in proportion to taxable supplies. The law considers the amount of total turnover (exempt plus taxable) as the denominator and the value of taxable supplies is considered as numerator to arrive at the proportion of credit to be availed.
The GST law states that any element of revenue that is not subjected to tax is an 'exempt supply'. Hence, the question arises as to whether the portion of endowment policy premium, not subjected to levy of GST, is to be treated as an 'exempt supply'. Due to a lack of clarity on the treatment of policy premium not subjected to GST, insurance companies are left with the following options:
a) Consider the amount of premium not subjected to GST as 'exempt supply' and avail input tax credit only to the proportion of taxed premium element. For example, if the first year premium received is Rs 1000, the credit will be availed only to the extent of taxable supplies of Rs 250. For an input tax credit amount of Rs 100, the eligible credit will be Rs 25.
b) Consider the amount of premium not subjected to GST as not a supply, which will not even qualify as 'exempt supply' and hence perform no input tax credit reversal. The entire turnover is considered as taxable supply and the tax levy is only on a proportion due to valuation mechanism.
The above mandate under the GST law causes a double impact on insurance companies, wherein the companies are liable to input tax credit reversal on the value of 'transaction in securities' when the securities are sold and are also required to reverse input tax credit on the value of premium that is collected from the insurer, which in turn is invested in securities.
It is interesting to note that any life insurance company can conduct business under the Insurance Act by investing funds in approved securities of a value that is not less than the sum of its current and expected future liabilities towards its policyholders. Further, all 'controlled funds' available with the insurer have to be necessarily invested in specified investment instruments including securities. Therefore, the investment activity is not just an integral part of the insurance business but is mandated by the Insurance Act, which governs the very way the business is run.
If the value of insurance premium not subjected to tax is treated as exempt, the insurance companies will be liable to substantial tax credit reversals. It will lead to increased costs at a time when they are already under losses. Clarity from the GST Council on the above would help the sector clear the ambiguity lest they face more tax exposures in future.
(The author is Partner-Indirect Tax at BDO India)