Proposal deposit on the Life Insurance Proposal... Whether liable for Service Tax

Recently the Service Tax department has served notices to almost all the life insurance companies raising demand of service tax, interest on late payment, penalties etc. on the amount of proposal deposit that it collects from the prospective policyholders (proposers) and which does not get converted into a life insurance policy.

The Departments stand contends that insurers are wrongly paying service tax only once the proposals get converted into policies and excluding the proposal deposits which get refunded, thereby causing loss to the exchequer.  

The whole premise of the said notice is based roughly on the following 4-5 points:

• ·   Life Insurer’s accept proposal deposit from the prospective policyholders along with the proposal forms, which is nothing but an advance premium for services to be rendered;
• ·   The said proposal deposit is then adjusted towards the premium once the policy is issued and hence the act of collecting the said proposal deposit from the prospective policyholder is nothing but ‘agreeing to provide’ service which is taxable under the prevailing Service Tax Law;
• ·    The premium so collected in advance is available for the Company to use and invest and hence company has an opportunity to earn money and but still not paying service tax;
• ·   The provisions of Section 65(105)(zx) of the Service Tax Act, while discussing taxability of life insurance, covers not only the concept of ‘policyholder’ but also ‘or any person’ and hence the prospective policyholders whose proposals are not accepted squarely et covered as any person;
• ·    The insurers may first pay the service tax and then in accordance with the provisions of Rule 6.3 of the Service Tax Rules, may claim refund and/or adjustment of the same against then present liability and avoid loss to the exchequer caused on account of delayed payment;   

In my personal opinion the said notice will not stand the test of law on the following grounds:

To analyze the whole issue it becomes imperative that the concept of services under life insurance business is understood vis a vis the provisions of the Service Tax Act, so that it can be analyzed if proposal deposits can be said to be taxable.  

First and the foremost point is that the Service Tax Laws as amended till date levy Service Tax on the basis of amounts received towards taxable service provided or agreed to be provided.

The provisions of Section 2(11) of the Insurance Act, 1938 (Amended till date) the term life insurance business is defined as ‘business of effecting contract of insurance of human life including contract whereby the payment of money is insured on the happening of death of any other event’.

It is pertinent to note here that the provisions of Section 65(61) of the Service Tax Act also recognize the same definition for the term ‘life insurance business’.

Further the provisions of section 65(105)(zx) while discussing Taxable services in relation to life insurance business states ‘to a policyholder  or any person, by an insurer including reinsurer carrying on life insurance business…’  

Now, if we look at the whole process that goes into executing a life insurance contract, it comes to the light that the insurers collect proposal deposit along with proposal forms, which in pure contract term is an offer from the prospective policyholder. It’s important to note that no invoice is issued, but only an acknowledgment of proposal deposit is issued at this point in time.

The insurance company parks said proposal deposit in a separate account till the time it evaluates the proposal. The said evaluation process is called as ‘underwriting’ in insurance parlance. Only once the underwriting is done, the insurer comes to know if proposal is to be accepted or declined.

The proposal deposit for all the declined proposals is refunded in full and the ones which are accepted, their proposal deposit is transferred to premium accounts and policies along with invoices are issued.     

Keeping aforesaid in mind any life insurance company will provide or agree to provide any service only once a contract of insurance is entered into. Infact the contract of insurance being a long term contract is in itself a contract where an insurer agrees to provide services over a period of the policy.

Mere underwriting of a policy cannot be termed as a service or agreement to provide service since, in any ways if policy is declined, entire proposal deposit is refunded. Even if for the sake of argument it is assumed that the underwriting is a ‘Service’, in my view service tax is not chargeable on the services which are provided for free/without charging any service fee/charge.

The second question that arises is that of interpretation of the term ‘any person’ as contemplated under the provisions of Section 65(105)(zx) of the Service Tax.

In my opinion since the life insurance business as per definition itself is a business of providing ‘contracts of life insurance’, the same can by no stretch of imagination be extended to ‘proposal underwriting’ in the garb of saying it’s a service to ‘prospective policyholder‘, who falls within the ambit of ‘any person’.

In a life insurance business the term ‘any person’ can be said to include nominees, legal heirs, life assured (CI Riders) or members and their nominees/legal heirs in a group insurance policy. All these may be separate for a policyholder and as such the act intends to cover all those contracts where the policyholder is not actually served by the insurance company but someone else is being served.

Lastly the argument extended by the department that the insurance companies can make payment of service tax as soon as the proposal deposit is collected and then seek refund of the same if the proposal is not accepted, just goes to demonstrate that the Department in a way admits the fact that proposal deposit on any proposal that is not accepted is not liable for service tax. 

Further in my view the intent of the legislature behind including provisions like Rule 6.3 Service Tax Rule is to provide protection to the assessee in case of erroneous excess payments.

If the service tax is paid on all proposal deposits collected then it would mean payment of service tax is made on the basis of an assumption that the insurer will either provide service or agree to provide service to all the prospective policyholders and not on the actual agreement to provide service.

It is only a matter of time that we will come to know as to which stand holds good before the Courts.

Would love to get views (favour/against) from all the stakeholders going through this blog.