Tax Implication On Insurance Claim For Capital Assets

Insurance is a means of protection from financial loss. The concept of insurance is such that when a loss or damage occurs, the policyholder invokes the guarantee, and the insurer settles the payment, i.e., provides compensation for the loss or damage. This compensation is known as an insurance claim. 

There are various scenarios when an insurance claim is received. In this article, we will mainly discuss the treatment of insurance claims received against a capital asset and its tax implications. 

What Is A Capital Asset?

Capital Assets are any property held by an assessee, whether for business or not. They can be stocks, properties, machinery, bonds, etc., that an individual or business owns. 

Capital Assets can be classified into two main types based on their holding period as follows:

Tax Treatment Of Capital Asset

The computation of tax on capital assets will depend on their nature, i.e., whether they are short-term or long-term assets.

What Is Insurance Claim For Capital Assets?

As discussed above, an insurance claim is a compensation for loss or damage that the policyholder receives from the insurance company. This compensation can either be in terms of money or an asset in exchange for damaged or destroyed capital assets. This insurance claim received at times can be either more or less than the value of the damaged or destroyed asset. Therefore, if the claim received is more than the value of the asset then it will be a capital gain, else it will be a capital loss. 

Calculation Of Capital Gain And Tax On Insurance Claim

The Capital Gain will be computed as follows:

For this purpose, the value of consideration will be the value of money received.

For Example, Mr Anban, a proprietor, purchased machinery costing Rs. 5,00,000 on 01/07/2015. On 30/09/2024, the machinery was destroyed completely in a fire accident. The WDV of the machinery on that day was Rs. 3,00,000. The damage was covered by an insurance policy, and Mr Anban received Rs. 4,00,000 as an insurance claim. 

SCENARIO - I

As the machinery was held for more than 24 months it will be treated as a long-term asset. 

In this case, the Long-term Capital Gain will be as follows:

SCENARIO - II 

Assuming that the Machinery was destroyed within 6 months from the date of purchase, the Short-term Capital Gain will be computed as follows:

Note: The gain arising will be taxed in the year of receipt.

Treatment Of Capital Loss

What if there is a Capital Loss? In the case of Mr Anban, there was a short-term capital loss when we assumed that the machinery was destroyed within 6 months from the date of purchase. 

In this case, we found the Short-term Capital Loss to be Rs. 1,00,000, but losses are not taxed. Hence, the taxpayer gets to carry forward the loss from capital gains for a period of 8 years and can set off the loss against other capital gains arising in these 8 years. Therefore, Mr. Anban can carry forward this loss for a period of 8 years and claim a set-off in any of these 8 years against a capital gain, if any. 

Click here to learn more about set-off and carryforward of losses.

Conclusion

Therefore, any gain arising from an insurance claim will be treated as capital gain and will be taxed accordingly in the year of receipt. Through this article you will understand the treatment of such capital gain and the tax implications thereof.