DCIT 14(3)(2), MUMBAI vs. STAR UNION DAI-ICHI LIFE INSURANCE CO.LTD, MUMBAI

This is an appeal filed by the Revenue. The relevant assessment year is 2012-13. The appeal is directed against the order of the Commissioner of Income Tax (Appeals)-22 [in short ‘CIT(A)’], Mumbai and arises out of the assessment completed u/s 143(3) of the Income Tax Act 1961, (the ‘Act’).

The ground of appeal

We have heard the rival submissions and perused the relevant materials on record. We find that similar issue arose before the ITAT ‘E’ Bench, Mumbai in assessee’s own case for the AY 2009-10 and AY 2010- 11. The Tribunal relied on the order dated 03.04.2013 in Life Insurance Corporation of India v. Addl. CIT, Mumbai (ITA No. 6221/Mum/2012), wherein the addition made by the AO was deleted with the following observations: “Next Ground of Appeal is about confirmation of addition made by the AO in respect of negative reserves shown in Form-I. During the assessment proceedings, on perusal of the actuarial reports in Form-I, AO found that there was an item called ‘Negative Reserve’ amounting to Rs. 38075.39 Crores. He directed the assessee to file explanation in this regard. After considering the submissions of the assessee, especially Insurance Regulatory and Development Authorities (IRDA) (Assets, Liabilities and Solvency margin of Insurers) Regulations, 2000 he discussed the principles governing the negative reserves. He held that the issue in negative reserves to be taken as ‘0’ was specific to situations mentioned in the regulation, that Rule 5(ii) mandated that mathematical reserves should be taken without any modification for the purpose of Section 35 of the Insurance Act, that provisions of Insurance Act clearly indicated that actuary was not mandated to take negative reserves at ‘0’in all situations, that by taking Negative Reserves at ‘0’surplus had been made less than the real actuarial valuation, that in Income Tax assessments real income of an assessee had to be debited, that ignoring negative reserve was in accordance with IRDA Regulations was also not material, that the IRDA guidelines were applicable in specific situations only, that IRDA guidelines provided that the liabilities shall be calculated together with the future premium payments, that in the surplus computation the Negative Reserves were nothing but future premium payments in respect of policies where liabilities were less than the future premium receivable, that liability valuation must not take the figure of Negative Reserve at ‘0’ for the purpose of determining of surplus of a particular Financial Year. After comparing the Actuarial Valuation Reports of 31-03-2008 and 31-03-2009, he observed that figure of Negative Reserve was calculated every year was taken at ‘0’ while reducing the liability from the total fund of the year, that the liability reduced for AY. 2008-09 was not carried in LIC fund on 31-03-2009 that the LIC fund of 31-03-2009 did not include any adjustment by way of Negative Reserves made in the AY. 2008- 09, that there was no question of giving any credit for adjustment Negative Reserve done in earlier AY. Finally, he held that assessee’s contention in respect of taking Negative Reserve at ‘0’ was not tenable as the same were not in accordance with the Insurance Act and IRDA Regulations. Accordingly, the Negative Reserve reported by actuary amounting to Rs. 38,075.39 Crores was added back to the income of the assessee as surplus of Actuarial Valuation of Life Insurance business of the assessee-company. 4.1. Assessee preferred an appeal before the First Appellate Authority (FAA). After considering the submissions of the assessee and the assessment order, FAA held that under IRDA, Negative Reserves were to be taken under specific situations and not as a general rule, that the appellant corporation wanted to take un-due advantage by reducing its taxable surplus by the amount of Negative Reserves, that the value of Negative Reserves was taken as ‘0’, that same had been reduced from the taxable surplus and total income of the assessee, that the total income of the assessee had been under stated, that actuarial had erred in applying Insurance Act correctly and properly in the case under consideration. Referring to Provisions of IRDA he held that negative reserve was to be taken at Zero in specific situations only -under Rule 5(ii) of Schedule IIA, that said mandate was not applicable in all situation as argued by the assessee. Upholding the order of the AO he further held that negative reserves already disallowed in earlier years could not be allowed in the AY under consideration, that negative reserves were calculated by the actuary on year to year basis, that composition of the various types of policies could undergo a change from year to year basis, that there was no provision for incremental addition/set off of negative reserves under the Insurance Act or IRDA Regulations. 4.2. Before us, AR submitted that reasons advanced by the AO and confirmed by the FAA for disallowing the claim were far-fetched and were contrary to the provisions of Sec.44 of the Act r.w. the First Schedule of the Act, that the AO had negated the provisions legislated by Parliament, that IRDA Regulations were the guidelines in this regard, that these regulations had the force of law having been notified by the Insurance Regulatory and Development Authority in exercise of the powers conferred on the Authority by section 114A of the Insurance Act and was binding on the insurer as also the appointed Actuary, that para 5(iii) of IRDA (Assets, Liabilities and Solvency Margin)Regualtions,2000 mandated that for the purpose of section 13 the Appointed Actuary should set the amount of mathematical reserves to zero in the case of negative reserve, that the Appointed Actuary had done the same in arriving at the net valuation surplus, that IRDA to whom the various statements(including From-I)were submitted had accepted the valuation surplus of the life insurance business determined by the Appointed Actuary in accordance with the requirements of Insurance Act and IRDA Regulation was sacrosanct and same could not be tempered with, that the actuarial valuation of liabilities was done in accordance with the provisions of sections 13,15,49 and 64V of the Insurance Act,1938 and in compliance with IRDA regulations. He referred to various regulations of IRDA. He further submitted that method of valuation of surplus after zeroing the negative reserves as required by the IRDA regulations was adopted by the Appointed Actuary since the commencement of IRDA Act and IRDA Regulations, that said method was accepted by the Controller of Insurance(IRDA) and the AO in the earlier AYs., that while completing the assessment for the AY under consideration AO had added the negative reserves to the total income of the assessee, that the AO had tampered with the net valuation surplus as determined by the Appointed Actuary, that action of the AO was contrary to the provisions of section 44 of the Act r.w. First Schedule to the Act. He relied upon the cases of CIT vs. LIC (51ITR773) and GIC vs. CIT (240 ITR 139). He also relied upon the order of the ICICI Prudential Insurance Co.(supra) delivered by the Mumbai Tribunal. He referred to Circular No.202dtd.05.07.1976 issued by the CBDT explaining and scope of effect of the changes made by the Finance Act, 1976 in the First Schedule to the Act. Alternatively, he submitted that treatment to negative reserve should not result in double taxation, that figures of negative reserves should be considered for one AY only, that appropriate deduction should for earlier year’s reserves should be given in subsequent year. DR strongly supported the orders of the AO and the FAA. 4.3. We have considered the rival submissions. We find that similar issue was raised by the AO of the ICICI Prudential Insurance Co.(supra) in the appeal filed by him for AY 2006-07. Ground filed by him read as under: ““On the facts and in the circumstances of the case and in law, the learned CIT(A)erred in not subjecting the negative reserve amounting to Rs.27.27 Crores ignoring the facts that negative reserves has impact of reducing the taxable surplus as per From I.” 4.3.1. We are of the opinion that treatment given to negative reserves by actuary cannot be disturbed by the AO. Here, it would be useful to understand meaning of negative reserve in simple terms. While making actuarial valuation, requirement of reserve to service insurance policies issued is ascertained. Such reserve (called mathematical reserve or value of liability) is equal to present value of future benefits payable and future expenses to be incurred less present value of future premium receivable. When the present value of future premium is more than the present value of future benefits payable and future expenses to be incurred, this amount becomes negative, known as ‘negative reserve’. In simple words, it means that the insurance contracts under consideration do not warrant any provision and is, in fact, an asset. However, in certain circumstances, such as for following IRDA guidelines, insurers may not treat policies as assets and they set any negative reserves to zero.’ For example, if an insurer had two policies, one with a reserve of 100 and the other with a reserve of - ‘10, it might think of its liabilities at 100 rather than 90 to take into account the eventuality in case the second policy lapsed. This process is called eliminating negative reserves. As mentioned earlier, a policy which has a negative reserve is in nature of an asset. 4.3.2. We find that in the case of ICICI Prudential Insurance Co.(supra) AO had disallowed negative reserve related to Life Insurance business of the assessee. In appellate proceedings FAA allowed the appeal of theassessee.AO challenged the order of the FAA before the Tribunal, as stated earlier. Disposing his appeal, Tribunal held as under: “After considering the rival submissions and examining the method of accounting and the mandate given by regulations to appoint Actuarial on the concept of mathematical reserves we do not see any reason to interfere with the order of the CIT(A). The, mathematical reserve is a part of Actuarial valuation and the surplus as discussed in Form-I under Regulation 4 takes in to consideration this mathematical reserve also. Therefore, the order of the order of the CIT(A) is approved. Moreover, the Assessing Officer has no power to modify the amount after actuarial valuation was done, which was the basis for