Profits from sale of investments by Insurance Company held exempt in view of CBDT Circular

Profits from sale of investments by Insurance Company held exempt in view of CBDT Circular. The income so earned was taxable only from AY 2011-12

 Profits from sale of investments by Insurance Company

ABCAUS Case Law Citation:
ABCAUS 2048 (2017) (08) HC

The Substantial Question of Law framed for determination:

There were three appeals, one preferred by the Assessee and two by Revenue directed against the order passed by the Income Tax Appellate Tribunal (‘ITAT’). The following questions were framed in the appeals:

  1. Whether the ITAT was correct in law in holding that the income earned on sale/redemption of investment is chargeable to tax?
  2. Whether the Tribunal was correct in holding that the provisions of Section 115JB of the Income Tax Act are not applicable to insurance companies?
  3. Whether the ITAT was correct in upholding the decision of the CIT (A) in deleting the addition of Rs. 3,39,60,000/- made by the Assessing Officer (‘AO’) on account of the investment written off?

Assessment Year :  2005-06

Important Case Laws Cited/relied upon by the parties:
CIT v. Karnataka State Co-operative Apex Bank [2001] 251 ITR 194 (SC)
CIT v. Mr. P. Firm, [1965] 56 ITR 67 (SC)
Chryscapital Investment Advisors v. DCIT [2015] 376 ITR 183 (Del).

Brief Facts of the Case:
The assessee (Oriental Insurance Co. Ltd.) was the subsidiary of General Insurance Corporation of India (‘GIC’) and was engaged in the business of General Insurance. The return was picked up for scrutiny. The Assessing Officer (‘AO’) framed the assessment applying book profits under the provisions related to the Minimum Alternate Tax (MAT) under section 115 JB of the Income Tax Act, 1961 (the Act).

The AO, while framing the assessment, inter alia made the following additions to the returned income of the Assessee:

  • Profits/Gains derived by the Assessee from sale/redemption of investments
  • Provision for Diminution in the Value of Investments

 Both CIT(A) and ITAT upheld the additions made by the AO.

Contention of the Assessee:

It was contended that  as held by the Supreme Court, if, by the mandate of statute, investment is to be made as a pre-condition to carrying on banking business then the profits on sale thereof would constitute profits in the same business.

It was pointed out that investments to be made by insurance companies were stipulated under Sections 27 and 28 of the Insurance Act 1938 (IA). Section 3 of the IA prohibits the Assessee from carrying on any other business. In particular, Section 3 (4) (h) of the IA states that the Insurance Regulatory Development Authority (IRDA) can cancel the registration of an insurer if it carries on any business other than the insurance business or any prescribed business.

Contentions of the Revenue:

It was contended that Circular No. 528 did not contain any binding instructions and could not have been deemed to be issued under Section 119 of the Act. It was ultra vires Section 119 of the Act and was not of a binding nature. Moreover, it was issued with reference to the GIC and its subsidiaries. In the AY in question, the Assessee was not a subsidiary of GIC and was, therefore, not covered by said circular. The circular could neither impose a new tax nor grant exemption from payment of tax and was, therefore, not applicable.

It was maintained that the investments made by the Assessee have to be treated as its stock-in-trade. It was contended that the long term capital gains (LTCG) on the investments in equity shares alone qualified for exemption under Section 10(38) of the Act and not investments in debentures, bonds, preference shares and other securities.

Observations made by the High Court:

Whether investments could be considered as stock-in-trade?

The Hon’ble High Court observed that under section 27B(1) of the Insurance Act 1938 (IA) mandates that no insurer carrying on general insurance business shall invest or keep invested any part of his assets otherwise than in approved investments.

It was further observed section 27B(16)(b) of the IA clarifies that “assets” means all assets required to be shown in the balance-sheet as per Form A, in Part II of the First Schedule but excludes any items against the head “Other Accounts (to be specified)”. Section 27D of the IA also specifies the manner and conditions of investment. Section 28 of the IA pertains to statement and return of investment of assets.

The Hon’ble High Court thus observed that the IA leaves no option with a company carrying on general insurance business to treat any part of its investment as “stock-in-trade” as was sought to be contended by the Revenue.

The Hon’ble High Court opined that those investments were at best, “floating assets” and the argument that these constitute “stock-in-trade” was ingenious but did not find resonance in the provisions of the IA.

The Court also noted that the reason the AO proceeded to reject the plea of the assessee that the profit from the sale of investments should not be brought to tax is not because it was stock-in-trade but because, according to him, the entire income of the Assessee is assessable as business income in accordance with Rule 5 of the First Schedule to the Act. However, the assessment order, nowhere treated investment as stock-in-trade.

Accordingly, The Court rejected the argument of the Revenue in this regard as not being consistent with either the factual position or the legal position.

Profits on sale/redemption of investments

The Hon’ble High Court noted that with the Assessee carrying on a general insurance business, it was bound by the provisions of the IA as well as the IRDA Regulations. Even the CBDT, in its Circular No. 5/2010 dated 3rd June 2010, acknowledged that, after the introduction of the IRDA Regulations in 2002, non-life insurance companies are required to credit income from the sale of investments directly to the P&L Account. This requirement, which would make the income so earned amenable to tax, was made applicable only from AY 2011-12. Prior to 1st April 2011, there was no provision which required the Revenue to disallow the deduction of loss on sale of investments.

It was observed that for the AY in question, the AO did not accept the case of the Assessee that the income earned on the sale/redemption was not chargeable to tax because, in the past, the profit on sale of investment was sometimes shown in the balance sheet and sometimes in the P&L account. It was observed that according to the AO, Circular No. 528 dated 16th December 1988 of the CBDT did not create a dent insofar as it stated that both profit and loss on sale of investments will not be taken into account in calculation of insurance profits.

The Hon’ble High Court observed that approach of the AO in relation to Circular No. 528 and its binding nature was flawed. The Revenue could not disown its own Circular No. 528 and contend that it did not apply to the facts of the present case. In view of large number of cases, the well settled position is that, where the CBDT circular has not been withdrawn and is beneficial to the Assessee, it would be binding on the AO and other Revenue authorities.

The Hon’ble Delhi High Court opined that the legislative policy was clear. Where it was intended to bring the profit on sale of investments to tax, the legislature had chosen to re-introduce the earlier provision by virtue of the amendment effective from AY 2011-12. The intention behind omitting Rule 5(b) was clearly expressed in the Circular. If the Circular was not intended to fill the gap brought about by the omission of Rule 5(b), viz., to exempt the profits on sale of investments made by the insurance companies from tax, there was no need to re-introduce Rule 5(b) with effect from AY 2011-12. The resultant position is that for the period during which there was no Rule 5(b) the profits on sale of investments were not taxable in the hands of the Assessee.

The Court did not subscribe to the submission of the Revenue that the Circular No. 528 had no application to the present case.

Disallowance of investments written of

The Hon’ble High Court noted that the assessee had stated that: “When the petitioner is availing the non-taxation of its profits from sale of investments it is also not claiming the loss suffered on these investments. The AO has not only taxed the profits on sale of investment but has also disallowed the losses.”

The Court thus decided the issue in favour of the Revenue observing that even the Assessee had acknowledged that if profit from sale/redemption of investments is held to be exempt from tax, then it could not seek deduction as a result of losses on the write off of such investments.

Applicability of Section 115JB to insurance companies

It was observed that the ITAT had permitted the Assessee to raise this question since, in a large number of judgments of the ITAT, the question had been answered in favour of the Assessee.

It was observed by the Hon’ble High Court that from a reading of Section 44 read with the First Schedule of the Act, it was plain that insurance companies are required to prepare accounts as per the IA and the regulations of the IRDA and not as per Parts II and III of Schedule VI of the Companies Act. The Assessee prepares its accounts as per the IRDA principles. The IRDA Regulations govern the preparation of the auditor’s report.

The the Court decided the issue in favour of the assessee.

Held:

  • It was held that the ITAT erred in holding that the income earned on sale/redemption of investment was chargeable to tax.
  • It was held that CIT (A) erred in deleting the addition of Rs. 3,39,60,000/- by the AO on account of the investment written off.
  • It was held that holding that Section 115JB of the Act does not apply to insurance companies
Profits from sale of investments by Insurance Company

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