Tax Treatment — Premium as Business Expenditure, Proceeds as Business Income
Two separate tax rules apply to keyman insurance: the premium is generally allowable as business expenditure, and the proceeds are taxable as business income of the employer. This lesson explains each and shows the arithmetic.
Two rules, not one
People often expect life insurance money to be tax-free. Keyman insurance is the exception, and it helps to keep its two tax rules apart: one for the premium going out, another for the proceeds coming in. The second does not depend on the first.
The Income-tax Act, 2025 has applied since 1 April 2026, replacing the 1961 Act. Older material uses the 1961 Act's section numbers.
The premium
Where the policy serves a genuine business purpose, the premium the business pays is generally allowable as business expenditure. A CBDT circular of 18 February 1998 said so under the 1961 Act, where the deduction falls under the general business-expenditure provision, section 37(1) of that Act.
The deduction belongs to the business. It is not a personal deduction of the key person, who neither pays the premium nor owns the policy.
The proceeds
Life policy proceeds are ordinarily exempt under Schedule II of the 2025 Act, the provision older material knows as section 10(10D). Keyman policies are expressly excluded from that exemption.
The proceeds are therefore taxed as business income of the employer. This is so whether or not the premium was claimed as a deduction. Older material makes the taxability conditional on the deduction having been claimed; that is wrong.
Putting the two together
The deduction lowers the cost of the premium each year, and the tax on proceeds reduces what the business keeps from a claim. Looking at only one side gives a misleading picture. Actual tax rates depend on the taxpayer and the year, so the rate in the examples below is an assumption.
Rules at a glance
Premium net of tax, and tax on a claim (assumed figures)
- Assume a company pays a keyman premium of ₹4,00,000 a year, the premium is allowed as a business deduction, and its tax rate is 25.17%. The rate is an assumption for arithmetic only.
- Tax saved on the premium: ₹4,00,000 × 25.17% = ₹1,00,680.
- Premium cost net of tax saved: ₹4,00,000 − ₹1,00,680 = ₹2,99,320.
- Now assume the key person dies and the company receives ₹3,00,00,000. Tax on the proceeds at the same assumed rate: ₹3,00,00,000 × 25.17% = ₹75,51,000.
- Amount left after tax: ₹3,00,00,000 − ₹75,51,000 = ₹2,24,49,000.
Result. The yearly premium costs ₹2,99,320 after the tax saving, and a ₹3 crore claim leaves ₹2,24,49,000 after tax of ₹75,51,000, at the assumed rate.
Key points
- The premium on a keyman policy taken for a genuine business purpose is generally allowable as business expenditure.
- A CBDT circular of 18 February 1998 said so under the 1961 Act's general business-expenditure provision, section 37(1).
- Keyman policies are expressly excluded from the exemption for life policy proceeds in Schedule II of the Income-tax Act, 2025 (old section 10(10D)).
- The proceeds are taxed as business income of the employer.
- Taxability of the proceeds does not depend on whether the premium was claimed as a deduction.
- The 2025 Act has applied since 1 April 2026.
Common misunderstandings
- Keyman proceeds are not tax-free like other life policy proceeds: keyman policies are expressly excluded from the exemption.
- Skipping the premium deduction does not make the proceeds exempt: they are taxable whether or not the deduction was claimed.
- The premium deduction is not the key person's: it is business expenditure of the business that pays.
- 25.17% is not a prescribed rate: it is assumed for the example, and actual rates depend on the taxpayer and the year.
Questions people ask
Under which head are the proceeds taxed?
As business income of the employer.
Who issued the 1998 circular on the premium?
The Central Board of Direct Taxes, on 18 February 1998, under the 1961 Act.
Is every keyman premium deductible?
The premium is generally allowable where the policy serves a genuine business purpose; whether that is so in a given case is a question of fact for the tax assessment.
What this lesson relies on
- Income-tax Act, 2025 — Schedule II (exemption for life policy proceeds; keyman policies excluded)
- CBDT circular of 18 February 1998 on keyman insurance premium
- Income-tax Act, 1961 — sections 10(10D) and 37(1) (old numbering)
This lesson was reviewed independently against these sources on 8 October 2026. Rules change: check the current regulation, scheme document or policy wording before relying on any figure. This is education, not advice.