The Bombay High Court, in an important case decided last month, clarified the position on the taxation of insurance companies. This was the decision in ICICI Prudential v. ACIT (2010 Bombay High Court).
The controversy stemmed from the implications of the Insurance Regulatory and Development Authority (Actuarial Report and Abstract) Regulations, 2000 and the Insurance Regulation and Development Authority (Preparation of Financial Statements and Auditor's Report of Insurance Companies) Regulations, 2002, under which every insurer is required to prepare (i) a revenue account which is also described as a policyholders account; and (ii) a profit and loss account, which is also described as a shareholders' account, apart from a balance sheet. Prior to these regulations, insurance companies maintained only one balance sheet, which had now been divided into two. In the assessment year in question, ICICI Prudential had a deficit in its revenue account which it claimed as a business loss. Under a circular issued on 23 March, 2004 by the Insurance Regulatory Development Authority, any insurer desirous of declaring a bonus, was required to make good the accumulated deficit in the Policyholders’ account by a transfer of funds from the Shareholders’ account to the Policyholders’ account. Though ICICI Prudential did not declare any bonus in the said assessment year, it still transferred the funds, to bring the balance in the Policyholders’ Account notionally to nil. The issue raised by the Revenue was that such a transfer amounted to income for the assessee, and required a reopening of assessment proceedings.
The assessee, represented by Mr. Soli Dastur, refuted this contention at two levels- First, the Court’s attention was invited to the Regulations passed in 2000 and 2002, which had divided a common set of accounts into two parts. This showed that the two accounts were independent only for the purposes of convenience, and transfers from one account to another could not be considered to be income. Secondly, mention was made of the Circular of 2004, which necessitated such a transfer as a business practice. In the inimitable words of Mr. Dastur, “the transfer of funds from one account to another was done as a matter of prudence, something the assessee cannot be faulted for, especially given that its name is ICICI Prudential!”
The High Court, speaking through Justice Chandrachud, provided a detailed examination of the regulatory regime in place for insurance companies, concluding that such a transfer could not be treated as income. The two accounts were created from a common account which existed prior to the 2000, and a transfer from one to the other could not be treated as income. On this basis, the appeal was allowed.
In the course of arguments, another very interesting argument was made by Mr. Dastur. He argued that while the two accounts were two sides of the same coin, there was a fundamental difference in their natures. The Shareholders’ Account, comprising receipts from subscription to the stocks of the insurance company was capital in nature, while the Policyholders’ Account was revenue in nature. The loss claimed in the Policyholders’ Account was thus a revenue loss, and could not be set aside by the transfer of capital receipts from the Shareholders’ Account. In any event, the transfer of funds, which were in the nature of capital receipts, could not be taxed as income, unless it amounted to capital gains, which it did not. Unfortunately, this issue does not find place in the judgment as finally delivered, possibly due to the complexity of the facts of the case. However, the line of argument provides a useful insight into the age-old capital/revenue receipt debate, and may be a useful line of argument in future cases of a similar nature.