To comply with the section 101A of Insurance Act, an insurance company must re-insure a specific proportion of the sum assured with another insurance company, commonly known as a “re-insurer”. A certain amount of re-insurance commission is kept by the insurer for this reason, which is termed as “Cession of Re-insurance Commission”.
It is imperative to note that IRDAI’s Notification F. No. IRDAI/RI/6/172/2020, dated 28th December 2020, stipulated that the percentage cession of the sum insured on each General Insurance Policy to be reinsured with the Indian Re-insurer(s) shall be 5%, except for the terrorism premium and premium ceded to Nuclear Pool, wherein the percentage cession is “Nil”. General Insurance Corporation of India (GIC Re), would be the only beneficiary of the whole mandatory cessation payment made.
There are several ambiguities about the tax consequences of the insurer’s retained re-insurance commission. The current article addresses the direct and indirect tax consequences of reinsurance commission ceding.
Direct Tax Implications on Ceding of Reinsurance Commission
Section 194D of the Income Tax Act governs the deduction of TDS on insurance commissions. According to it, TDS is to be deducted by the person who is responsible for providing payment to a resident person as remuneration/rewards, via commission, or for soliciting / procuring insurance business; or for the continuation, renewal, or revival of an insurance policy.
The most significant difference between reinsurance and insurance is that there is no contractual link between the policyholders (insured) and the reinsurer. There are two contracts involved in such type of arrangements: one between the insured and the insurer, and another between the insurer and the reinsurer. The insurer is required to pay any legitimate claims made by the insured, regardless of whether the insurer can collect the same from his reinsurer.
Previously, in the case of General Insurance Corporation of India v. Assistant Commissioner of Income Tax [(2009) 125 TTJ (Mumbai) 779], the tribunal ruled that the reinsurance commission is a deduction allowed by the assessee company to the insurance companies from the original gross rate to compensate the insurance companies for brokerage and other costs incurred. As a result, the commission paid or permitted as a deduction does not qualify as payment for soliciting or procuring insurance business.
As a result, when a reinsurance company receives business from an insurance company for a lower premium than the “Commission,” the “Commission” should not be subject to TDS under section 194D since it is not paid to an agent for procuring insurance business.
Even though the insurance industry uses the terms “ceding commission” or “reinsurance commission” to describe the sharing of such expenses, the author believes that simply using the word “commission” will not make the transaction taxable, and that the underlying nature of the activity must be examined. For this purpose, reliance can be placed on case of Commissioner of Income Tax v. Jai Drinks (P.) Ltd. [2011] 198 Taxman 271 (Delhi), it was held that the provision of section 194H relating to TDS on commission was to be applicable only if the relationship between the assessee-company and its distributors was of the type of ‘principal to agent.’ Those discounts could not be classified as ‘commission’ since the assessee’s relationship with its distributors was previously found to be on a ‘principal to principal’ basis. As a result, it was held that the assessee need not to deduct tax at source on such discount payments under section 194H.
R.L. Carter’s book “Reinsurance” discusses the nature of reinsurance commission, noting that “Reinsurance commission is the fee paid by a reinsurer to a ceding company, represented as a proportion of the premiums ceded.” It is not to be confused with the brokerage paid by the reinsurer when an intermediary introduces the business.
Therefore, we can say that the position is quite clear with regards to the re-insurance commission ceded after the ruling of the Bombay High Court in the case of Principal of Commissioner of Income-tax v. Tata AIG General Insurance Co. Ltd. [2019] 111 taxmann.com 92 (Bombay), wherein the court affirmed the order of tribunal by stating that no tax is deductible under section 194D in respect of payment of reinsurance commission.
Based on the foregoing views, it is clear that the reinsurance commission retained by the insurance firm does not qualify for TDS under section 194D. It is, at best, a discount that results in a reduction in the reinsurance premium owed by the insurance company to the reinsurers.
Indirect Tax Implications on Ceding of Reinsurance Commission
In the erstwhile service tax regime, the department published a circular[1] clarifying that the relationship between the insurance company and the reinsurer is merely a sharing of expenditures and that the insurance company does not provide a service to the re-insurer for a consideration. Also, the policyholder may not even be aware of the re-insurers, insurer’s the payment paid by the re-insurer to the insurance company cannot be claimed to be for the re-insurer’s business promotion. The re-insurer is a firm that provides insurance services to insurance companies.
It may be noted that, under Section 7(1) of the CGST Act, GST is levied on the provision of goods or services. Assuming that reinsurance transactions typically include two parties: the insurance company and the reinsurer. Furthermore, there is no direct communication between the insurance company’s clients (policyholders) and the reinsurer. Secondly, policyholders may be unaware that their insurance policies have been reinsured by the insurance provider.
As a result, the author believes that insurance firms are not involved in providing any services to reinsurers for which the reinsurers get a reinsurance commission as a consideration.
Furthermore, it is widely established that the nomenclature assigned to a transaction has no bearing on the transaction’s real character.[2] In other words, the product’s nomenclature is irrelevant for categorization; what matters is the nature of the products and the method to which the items acquired for processing were exposed.[3]
Similarly, according to the UK VAT Manual, reinsurance commissions and ceding commissions are just deductions to recover costs paid by the insurer in connection with the initial policy and not with any supply, and so are not subject to VAT. In addition, the release of OECD guidelines titled “The Contribution of Reinsurance Markets to Managing Catastrophe Risk” says that reinsurers pay ceding commission to share the cedant’s expenses associated with originating the underlying policy.
Even though the sum is referred to as “reinsurance commission” informally, it is not the same as a brokerage commission paid to arrange supplies between a reinsurer and a customer.
As a result, the reinsurance commission does not apply to any services provided by insurance companies to reinsurers. Given the foregoing explanation, it may be concluded that no GST will be charged on the reinsurance commission retained by the insurance firm because it is not a supply.
Conclusion – In light of the foregoing discussion, it is repeated that the reinsurance commission is just a deduction from the insurance company’s expenditures paid in procuring the insurance policy. In these situations, the insurance company has not delivered any unique service to the reinsurer for which the re-insurance firm is receiving money.
Hence, it can be said that no TDS is deductible on re-insurance, as it is not paid for furtherance of business, similarly, no GST will be applicable on the reinsurance commission retained by insurance company since, no supply is being made by it.
[1] Circular No. 120(a)/2/2010-S.T., dated 16.04.2010.
[2] Super Poly Fabriks Ltd. v. Commissioner of C. Ex., Punjab [2008 (10) S.T.R. 545 (SC).
[3] CCE vs. Sayaji Iron & Engg Co. (P) Ltd. 2000 (116) ELT 300 (Tribunal).
Author: Radhika Sharma – 5th Year Law Student, HNLU
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