Insurance sector rules permit outsourcing costs absent formal regulatory penalties, and Section 44 overrides standard Section 14A exempt income disallowances.

By | June 19, 2026
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Insurance sector rules permit outsourcing costs absent formal regulatory penalties, and Section 44 overrides standard Section 14A exempt income disallowances.

Issue

Whether the outsourcing fees paid to service aggregators by an insurance firm can be disallowed under Explanation 1 to Section 37(1) as an “expenditure prohibited by law” without an official regulatory finding of a violation, and whether standard disallowances under Section 14A apply to insurance companies governed by the special provisions of Section 44.

Facts

  • Outsourcing Costs vs. Insurance Commissions (Section 37(1)): For the Assessment Year 2012-13, the assessee (a general insurance company) paid service aggregators for outsourced core operations like KYC verification and Anti-Money Laundering (AML) documentation. The Assessing Officer (AO) alleged that these funds were indirectly routed to motor car dealers as disguised commissions, breaching the statutory commissions ceiling under Section 40(1) of the Insurance Act, 1938. The AO disallowed the expenses, invoking Explanation 1 to Section 37(1) (expenses incurred for a purpose prohibited by law).

  • Exempt Income Disallowance in Reassessment (Section 44 vs. Section 14A): The case was reopened under Section 147. During reassessment, the AO added back ₹76.67 lakhs under Section 14A read with Rule 8D, tracking expenses alleged to be tied to tax-exempt income.

  • Appellate Relief: The Commissioner (Appeals) deleted the Section 14A addition, noting that insurance business profits are evaluated using specialized rules that circumvent general business tax mechanics.

Decision

  • Explanation 1 to Section 37(1) Requires Legal Conviction/Finding: Held in favour of assessee. To trigger the disallowance under Explanation 1 to Section 37(1), there must be a definitive finding of an ‘offence’ or a ‘prohibited act’ by a competent statutory authority. Since the revenue could not show that the IRDA or any other regulatory body had penalized or prosecuted the assessee for violating the Insurance Act, the AO cannot unilaterally apply the disallowance.

  • Section 44 Completely Overrides Section 14A: Held in favour of assessee. The computation of income for an insurance business is strictly governed by the non-obstante clause of Section 44 read with the First Schedule of the Income-tax Act. This special regime completely overrides general computation sections (Sections 28 to 43B). Because Section 14A serves as a general provision, it has no legal application when determining the taxable income of an insurance company.

Key Takeaways

  • AO Cannot Assume Regulatory Violations: Tax officers cannot perform the role of non-tax regulators. Unless a specific watchdog body (like IRDA, RBI, or SEBI) formally passes an order penalizing a company for an illegal act, the AO cannot disallow business expenditures under the guise of an alleged legal infraction.

  • Insurance Companies Exempt From Section 14A: Insurance companies operate under a code-unto-itself tax framework via Section 44. The income statement generated as per sectoral regulatory mandates forms the base for taxation, shielding insurance firms from routine corporate tax adjustments like Section 14A expense disallowances.

IN THE ITAT MUMBAI BENCH ‘E’
DCIT
v.
HDFC Ergo General Insurance Company
SANDEEP SINGH KARHAIL, Judicial Member
and Om Prakash Kant, Accountant Member
IT Appeal No. 9517 (MUM) OF 2025
CO No. 96 (MUM) OF 2026
[Assessment year 2012-13]
APRIL  6, 2026
Punit Shah for the Appellant. Ritesh Misra, CIT-DR for the Respondent.
ORDER
Om Prakash Kant, Accountant Member. – This appeal by the Revenue and Cross-objection by the assessee are directed against order dated 09.10.2025 passed by the Ld. Addl. / Jt. Commissioner of Income Tax (Appeals), Kolkata [in short ‘the Ld. CIT(A)’] for assessment year 2012-13. The Revenue’s appeal challenges the deletion of additions made under Section 37(1) and Section 14A of the Income Tax Act, 1961 [‘the Act’]. The Assessee, through its Cross-Objection, challenges the legal validity of the reassessment proceedings initiated under Section 147. The grounds raised by the Revenue are reproduced as under:
1. Whether on the facts and circumstances of the case and in law, the ld. CIT(A) was justified in allowing expenditure claimed by the assessee u/s 37(1) despite the same being in excess of the commission ceiling prescribed under Section 40(1) of the Insurance Act, 1938?
2. “Whether on the facts and circumstances of the case and in law, the Ld. CIT(A) erred in restricting the addition done by the AO u/s 14A of the Act as per Rule 8D of the Income- tax Rules without appreciating the fact that if section 14A is not applicable to insurance companies by virtue of falling u/s. 44 of Income Tax Act, then, it cannot take refuge of section 10 also selectively.?”
3. “Whether on the facts and circumstances of the case and in law, the Hon’ble ITAT erred in restricting the addition done by the AO u/s 14A of the Act as per Rule 8D of the Income tax Rules without appreciating the fact that the arrangement given in section 44 is only applicable on insurance company being a non obstante clause and has an over-riding effect on other sections and the assessee cannot take the benefit of section 10 as well as section 44.”
4. “Whether on the facts and circumstances of the case and in law, the Ld. CIT(A) erred in restricting the addition done by the AO u/s 14A of the Act as per Rule 8D of the Income- tax Rules without appreciating the fact the CBDT Circular No. 5 of 2014 dated 11/02/2014 which has clarified that the disallowance u/s 14A is to be made even if no exempt income had been earned by the assessee during the year under consideration?”
5. “The Appellant crave, leave to add, alter, amend or modify any or all ground of appeal on or before the date of hearing.”
2. The grounds raised by the assessee in cross objection are reproduced as under:
1. The learned Commissioner of Income-tax (Appeals) [Addl./JCIT (A)-7, Kolkata) (hereinafter referred to as CIT(A)) erred in not quashing the order under section 147 r.w.s. 143(3) of the Act (“the order”) passed by the Assistant Commissioner of Income Tax 1(1)(2) Mumbai, (hereinafter referred to as the “AO”) having failed to appreciate that the order was illegal, void and otherwise bad in law.
2. The CIT(A) erred in not quashing the order passed by the AO having failed to appreciate that it was passed beyond the time limit for completion of reassessment proceedings as prescribed under section 153 of the Act.
3. Briefly stated that the facts are that the assessee filed its return of income for the year under consideration on 28.09.2012 declaring total income under regular provisions at (-) Rs. 62,39,56,475/- and book profit at (-) Rs. 39,69,57,826/-. The assessment u/s 143(3) of the Income Tax Act, 1961 [in short ‘the Act’] was completed on 06.02.2016 assessing total loss at (-) Rs. 60,95,80,360/-.
4. On the basis of information in possession of the AO, the case was reopened u/s 147 of the Act and notice u/s 148 of the Act was issued on 31.03.2017 which was duly served upon the assessee. The reassessment proceedings u/s 147 were completed on 05.12.2018 total income assessed at loss of (-) Rs. 50,27,65,760/- and book profit of Rs. 38,92,90,350/-.
4.1 On further appeal, the Ld. CIT(A) allowed relief to the assessee on merit addition but rejected the challenge to validity of reassessment. Aggrieved, both the Revenue and assessee are before us by way of grounds raised in their respective appeal / cross objection herein above.
5. The ground No. 1 of the appeal of the Revenue relates to disallowance of commission of expenses invoking the Explanation (1) below Sec. 37(1) of the Act considering the said expenses in violation of the provisions of law.
5.1 Facts qua the issue in dispute are that during the reassessment, the Assessing Officer (AO) observed that the Assessee, a general insurance provider, had outsourced core activities such as KYC verification and AML documentation to service aggregators. The AO contended that such outsourcing is expressly prohibited by IRDA Guidelines. Furthermore, the AO alleged that payments made to motor car dealers via these aggregators were essentially “commissions” disguised as “professional charges,” exceeding the statutory caps prescribed under Section 40(1) of the Insurance Act, 1938. Consequently, the AO invoked Explanation 1 to Section 37(1), which prohibits deduction of expenditure incurred for any purpose which is an “offence” or “prohibited by law,” and disallowed Rs.11,35,23,239/-.
5.2 The Ld. CIT(A) deleted the addition by following the binding precedent of this Tribunal in the Assessee’s own case for several other assessment years (consolidated order dated 30.07.2025). The relevant finding of ld. CIT(A) is reproduced as under:
5.3 Ground of appeal no. 4 is against disallowance of expenses u/s 37 treating these at being penal in nature. The facts involved in the issue has already been discussed in brief, supra and not repeated here. The appellant has submitted by their submission dated 01.09.2025 that on identical issue and facts, in their own case, ITAT, Mumbi Bench, by their consolidated order dated 30.07.2025 involving assessments for AYs 2010-11, 2011-12, 2013-14, 2014-15, 2015-16 and 2016-17 in ITA Nos.2836, 2837, 2838, 2839, 2840, 2841/Mum/2025 allowed relief to the appellant on this issue. While delivering judgment on this issue, ITAT has observed in Para-21 of the order as under:-
“21. Though, the Departmental Authorities have not accepted the aforesaid claim of the assessee, however, there is no material on record to demonstrate that any action has been taken by the competent authorities under the Insurance Act. As per our understanding, Sections 102, 103, 104, 105, 105A and 105B contain provisions to impose penalty for default in complying with or acting in contravention of any provisions of the Act. Whereas, Section 105A deals with offences by company and awarding of punishment in case a company is found to be guilty of any offence. No material has been brought on record by the Department to demonstrate that the competent authority under the Insurance Act or the IRDAI has taken any punitive or penal action against the assessee for violation or contravention of any of the provisions of Insurance Act, as alleged by the AO. Thus, when the assessee has not been declared to be guilty of any offence nor there is any penal action initiated against the assessee for violation of the provisions of the Insurance Act or IRDAI guidelines, in our humble opinion, the exceptions provided under Explanation-1 to Section 37(1) of the Act would not apply. In this context, we respectfully agree with the observations made by the coordinate Bench in case of Milestone Real Estate Fund (supra).
Pertinently, in case of M/s Cholamandalam MS General Insurance Co. Ltd.  (Mad.), identical issue of disallowance of payment made to motor vehicle dealers u/s. 37(1) of the Act came up for consideration. While deciding the issue, the Hon’ble Court upheld the decision of the Tribunal restoring the issue to the AO to decide afresh. Keeping in view the order of CESTAT in case of the same party. The decision taken by the Tribunal to restore the issue was for the fact that the CESTAT decision was not available before the Departmental Authorities. However, in the facts of the present appeal, the material on record do establish that the orders of CESTAT, though, were furnished before learned First Appellate Authority, however, they were completely ignored. Therefore, we do not intend to remit the issue to the Departmental Authorities. Thus, on overall consideration of facts and materials on record, we are inclined to accept assessee’s claim and hold that the payment made is allowable as deduction u/s. 37(1) of the Act. In view of our decision on merits as above, other grounds raised by the assessee have become infructuous hence, dismissed.”
Relying on the above judgment of ITAT in appellant’s own cases of assessment for other years on identical issue, I hold the impugned expenses incurred as not falling within Explanation 1 to section 37(1) and therefore direct the addition of Rs.11,35,23,239/- to be deleted. This ground of appeal is allowed.
6. We have perused the findings of the Coordinate Bench, which held that for Explanation 1 to Section 37(1) to be triggered, there must be a definitive finding of an “offence” or a “prohibited act” by a competent authority. In the present case, the Revenue has failed to demonstrate that the IRDA or any other regulatory body has taken any punitive or penal action against the Assessee for the alleged contravention of the Insurance Act.
6.1 Further, we find that the learned Commissioner (Appeals) has merely followed a binding precedent rendered in the assessee’s own case on an identical issue. It is not the case of the Revenue that the said decision has been reversed or stayed by any higher judicial forum. In the absence of any distinguishing feature brought on record, judicial discipline demands that a consistent view be followed. We, therefore, find no infirmity in the order of the learned Commissioner (Appeals) in deleting the disallowance. Accordingly, Ground No. 1 of the Revenue’s appeal stands dismissed.
7. The ground Nos. 2 to 4 of the appeal of the Revenue relate to disallowance u/s 14A of the Act. The Assessing Officer had made a disallowance under Section 14A read with Rule 8D to disallow Rs. 76,67,474/- relating to expenses incurred to earn exempt income. The Revenue argues that even if the Assessee is an insurance company governed by the special provisions of Section 44, it cannot selectively claim exemptions under Section 10 while ignoring disallowances under Section 14A.
7.1 The learned Commissioner (Appeals) deleted the same by following the decision of the Tribunal in the assessee’s own case, holding that the provisions of Section 14A are not applicable to insurance companies whose income is computed under Section 44 of the Act read with the First Schedule. The relevant finding of the Ld. CIT(A) is reproduced herein below:
5.4 Grounds of appeal no. 5 to 11 are against the disallowance u/s 14A. Facts involved in the issue is that the appellant is a general insurance service providing company and has earned income to the extent of Rs.10,32,52,169/- in the form of interest and dividend which are exempt from tax. The assessing officer therefore disallowed expenses claimed and attributable to earning such exempt income u/s 14A of the Act. While doing so, he applied the calculation as provided in Rule 8D of the I.T. Rules and arrived at amount not allowable as deduction at Rs.76,67,474/-. This issue is also covered by ITAT, Mumbai’s order dated 30.07.2025 supra where while confirming the deletion of such disallowance by CIT(A), ITAT, in Paras 22 and 23 held as under:-
“22. Insofar as the appeals by the Department are concerned, the common issue arising in all the appeals relate to deletion of disallowance of expenditure u/s. 14A of the Act read with Rule 8D. As could be seen from the facts on record, learned First Appellate Authority deleted the disallowance made u/s. 14A r.w.r. 8D of the reasoning that since the income of an assessee engaged in insurance business has to be computed u/s. 44 of the Act read with first schedule the provisions of Section 14A would not be applicable.
23. Having considered rival submissions, we find that issue is squarely covered in favour of the assessee by various judicial precedents of Hon’ble High Courts and Coordinate Benches of the Tribunal as could be seen from the case law compilation furnished before us. In that view of the matter, we do not find any valid reason to interfere with the decision of learned First Appellate Authority. Grounds raised by the Revenue are dismissed.”
Relying on the above judgement of ITAT in appellant’s own cases of assessment for other years on identical issue, I hold the impugned disallowance of Rs.76,67,474/- to be deleted. These grounds of appeal are allowed.
7.2 We have heard the rival submissions of the parties and perused the material placed on record. This issue is no longer res integra. It is a settled position of law across various High Courts and Coordinate Benches that for an assessee engaged in the insurance business, the computation of income is governed by the Non-Obstante clause of Section 44 read with the First Schedule of the Act. This special provision overrides the general provisions of Sections 28 to 43B. Consequently, Section 14A, which falls within the general computation provisions, has no application to insurance companies.
7.3 Further, We find that the issue is squarely covered in favour of the assessee by binding judicial precedents, including decisions of Coordinate Benches in the assessee’s own case. The Revenue has not brought any contrary authority or distinguishing facts on record. In such circumstances, we see no reason to interfere with the well-reasoned findings of the learned Commissioner (Appeals). Accordingly, Ground Nos. 2 to 4 of the Revenue’s appeal are dismissed.
8. The assessee has challenged the validity of reassessment proceedings. However, since we have upheld the deletion of additions on merits, the issues raised in the cross-objection have been rendered academic. It is well settled that academic or infructuous issues do not warrant adjudication. Accordingly, the cross-objection filed by the assessee is dismissed as infructuous.
9. In the result, the appeal filed by the Revenue as well as the cross-objection filed by the assessee are dismissed.