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"Whether the I.T.A.T. was correct in law in deleting the addition made by the Assessing Officer by disallowing the business expenditure claimed in respect of keyman insurance premium?"

12. Mr. N.P. Sahni, learned counsel who appeared for the Revenue submitted that the admitted facts would show that the assessee had been taking keyman insurance policy year after year in the name of its employees/Directors paying huge premia and thereafter assigning the same in the very next year to the said keyman at a very nominal value, said to be the surrender value, though the policies were for a period of five years each. This modus operandi adopted by the assessee was a clear colourable device to benefit the said keymen who were, in fact at the helm of affairs and managing the company. Such an expenditure could not be treated as expenditure wholly or exclusively for the purposes of business. The difference between the premium paid and the surrender value received on assignment is substantial in respect of each policy. The assessee has not been able to justify assigning the policies at a nominal value when the same could be continued for another four years and then acquiring fresh policies again in that year by paying heavy premium.

16. Mr. Sahni further argued that the Tribunal placed reliance upon Circular No.762 dated 18th February, 1998 explaining the tax aspect relating to keyman insurance policy was not appropriate and the Tribunal neither appreciated the import of the said Circular in a proper manner, nor it examined the effect of Sections 2(24)(xi), 10(10D) and 37(1) of the Act in a proper perspective. He argued that as per the aforesaid Circular, the object of a keyman insurance policy is to enable business organizations to insure the life of a keyman in order to protect the business against the financial loss which may occur in the likely eventuality of premature death. It was submitted that the main thrust of argument of the respondent before the CIT (A) as well as the Tribunal was that the payment of keyman insurance premium is allowable as revenue expenditure in view of the aforesaid Circular dated 18th February, 1998. While not disputing that the payment of keyman insurance policy premium paid by the company was allowable in view of the said Circular, he argued that the Tribunal failed to appreciate the true spirit of this Circular as the purpose was to cover the risk of premature death of the key persons of the organization and it could not be applicable in the instant case where the assessee company was assigning these keyman policies in the subsequent years, though the term of the policy was 5 years. According to Mr. Sahni, in such eventuality, payment of excess premium could not be treated as „business expenditure‟ under Section 37(1) of the Act, as there was no commercial expediency on the part of the assessee to make such exorbitant payment. He argued that the test of commercial expediency could not be reduced to the shape of a ritualistic formula, nor could it be put in a water-tight compartment so as to be confined in a straitjacket formula. All that the law requires is that the expenditure should not be in the nature of capital expenditure or personal expenditure of the assessee and it should be wholly and exclusively laid out for the purpose of the business. It is well settled that the items of expenditure are to be considered from the point of view of a normal, prudent businessman. The test would merely mean that the Court would place itself in the position of a businessman and find whether the expenses incurred could be said to have been laid out for the purposes of the business. The ultimate analysis of the transaction would depend on the status of the parties as spelt out and nature or character of the trade or the venture, the purpose for which the expenses were incurred and the object which was sought to be achieved in incurring those expenses. Such an expenditure, however, must not suffer from the vice of collusiveness or colourable device. It was submitted that the instant case is a clear case of colourable transactions which are executed by the assessee at behest of its Directors/employees managing the assessee company.

(iii) The nature of expenditure incurred on keyman insurance policy has even been judicially considered and Bombay High Court has held in B.N. Exports (supra) that this expenditure is to be allowed as business expenditure, in the following words:

"The effect of Section 10(10D) is that monies which are received under a life insurance policy are not included in the computation of the total income of a person for a previous year. However, any sum received under a Keyman insurance policy is to be reckoned while computing the total income. For that purpose, a Keyman insurance policy means a life insurance policy taken by a person on the life of another person who is or was in employment as well as on a person on who is or was connected in any manner whatsoever with the business of the subscriber. The words "is or was connected in any manner whatsoever with the business of the subscriber" are wider than what would be subsumed under a contract of employment. The latter part makes it clear that a Keyman insurance policy for the purposes of Clause (10D) is not confined to a situation where there is a contract of employment. Clause (10D) relates to the treatment for the purpose of taxation of moneys received under an insurance policy. In this appeal, the court has to determine the question of expenditure incurred towards the payment of insurance premium on a Keyman insurance policy. The circular which has been issued by the Central Board of Direct Taxes clarifies the position by stipulating that the premium paid for a Keyman insurance policy is allowable as business expenditure. In the present case, on the question whether the premium which was paid by the firm could have been allowed as business expenditure, there is a finding of fact by the Tribunal that the firm had not taken insurance for the personal benefit of the partner, but for the benefit of the firm, in order to protect itself against the set back that may be caused on account of the death of a partner. The object and purpose of a Keyman insurance policy is to protect the business against a financial set back which may occur, as a result of a premature death, to the business or professional organization. There is no rational basis to confine the allowability of the expenditure incurred on the premium paid towards such a policy only to a situation where the policy is in respect of the life of an employee. A Keyman insurance policy is obtained on the life of a partner to safeguard the firm against a disruption of the business that may result due to the premature death of a partner. Therefore, the expenditure which is laid out for the payment of premium on such a policy is incurred wholly and exclusively for the purposes of business."

33. Mr. O.S. Bajpai specifically refuted the arguments of learned counsel for the Revenue by giving his own analysis to the various provisions of the Act. His submission, in this behalf, was that the concept of assignment is embedded in the very scheme of Keyman Insurance Policy. He submitted that the provisions of Section 10(10D) of the Act were to be read conjointly with Section 17(3)(ii) of the Act.

34. He first sought to highlight distinction between the Keyman Insurance Policy and ordinary policy by submitting that in case of keyman policy there have to be two players, viz., (i) one who pays premium to secure the life of the other and (ii) the other whose life is secures. In contrast, there is only a single player in an ordinary policy, who gets his life secured and pays the premium himself. In the present case, this person happens to be an employee after policy is assigned to him. In this scenario, learned Senior Counsel argued that Section 17(3)(ii) comes into picture when the recipient is to be taxed for the amount of insurance received by him on maturity or he is taxed on surrender value as profit in lieu of salary. In other words, if there is no assignment of Keyman Insurance Policy, there is no question of invoking Section 17(3)(ii) as an employer cannot be taxed under this Section, but only an employee can be taxed. When there is no assignment, Section 37 and Section 28 or Section 56 of the Act will operate. The employer will seek deduction under Section 37 and pay tax under Section 28 or 56 of the Act. Section 17(3)(ii) of the Act comes into play only if an employee is to be taxed and an employee does not come into picture if there is no assignment. If employer does not continue the policy and surrenders it midway, he too would get only surrender value. But when there is assignment, the employee comes into picture and Section 17(3)(ii) of the Act becomes operative. Thus, in the case of an employee, Section 17(3)(ii) of the Act can co-exist only with assignment to the employee. This makes assignment a part of the scheme of the Act itself. He, thus, argued that the assignment leads to conversion and changes the character of keyman insurance policy into an ordinary policy. Further, assignment is a followed transaction between the LIC‟s employer and employee. With this assignment, LIC not only agrees to convert the policy from keyman insurance policy to general insurance policy, it also agrees to receive the premium from the employee. When such a course is legally permissible, there is no question of adoption of colourable device, was the submission of Mr. Bajpai for which he referred to the judgment of the Supreme Court in the case of Union of India Vs. Azadi Bachao Andolan, (2003) 263 ITR 706 (SC) followed in Walfort Share & Stock Brokers P. Ltd. v. CIT [2010] 326 ITR 1 (SC).