Mukesh Patel.in
practical tax & investment planning online
international tax expert / columnist / author / speaker

Tax Bombshell hangs on Insurance!

Code Has Not Visualized Many Dreadful Consequences!

Many Insurance Products under Severe Tax Threat

  • Any sum received under a life insurance policy including any bonus thereon will be exempt, only if the premium does not exceed 5% of the capital sum assured and such sum is received only upon completion of the original period of contract or upon the death of the insured.
  • All existing ULIPs, Money Back & Guaranteed Return Plans of Insurance Companies, including surrender values of insurance drawn before maturity to take the tax hit.
  • Even the return of premium payments out of the investor’s own tax-paid capital, would again attract tax in all such cases.

Anand Roy having taken a 10 year Jeevan Aastha policy of LIC in January, 2009, with a premium payment of Rs.19,31,400, is expecting a maturity sum alongwith guaranteed addition of Rs.42,00,000 under the policy, entitled to total exemption u/s. 10(10D) of the Income-tax Act. This works out to 8% annually compounded return on investment over 10 years. Considering that he is in the top tax bracket of 30%, Anand has calculated his effective return at a comparable break even rate of around12% before tax.

Just imagine the plight of Anand if he is now told that on maturity of his policy in 2019, he will have to dish out tax of Rs.12,60,000 at his applicable rate of 30%, not just on his effective return of Rs.22,68,600 (42,00,000 – 19,31,400), but on the entire sum of Rs.42,00,000 received under the policy, including the principal premium payment of Rs.19,31,400 made out of his own tax-paid capital.

Insurance not fully Tax-Secure

Believe it or not, but it is true. The new Direct Tax Code has just not visualized several dreadful consequences of its proposal to tax maturity proceeds in certain cases of life insurance policies taken during the non-EET regime, due to mature on or after 1st April, 2009, during the EET regime.

Section 56(2)(f) of the Code provides that “any sum received under a life insurance policy, including the sum allocated by way of bonus on such policy” shall be taxable under the head ‘gross residuary income.’

Section 57(3) which provides for deductions from ‘gross residuary income’ states that in case of a life insurance policy (other than Keyman Insurance), any sum received including any bonus will be exempt, only if the premium does not exceed 5% of the capital sum assured and such sum is received only upon completion of the original period of contract or upon the death of the insured.  This means that all other insurance proceeds (such as the case of Anand Roy referred above and many others) will be subject to income-tax.

Illogical Stipulation – Need for Correction

The stipulation under the proposed Section 57(3) requiring that maturity proceeds of a policy shall be exempt only ‘if the premium does not exceed 5% of the capital sum assured’ is not only illogical but iniquitous. It needs to be borne in mind that even under the current Section 10(10D) of the I.T. Act, the relevant condition for exemption prescribes that the premium should not exceed 20% of the capital sum assured. Even this restriction, introduced by the Finance Act, 2003, clearly states that it will apply only in respect of an insurance policy issued on or after 1st April, 2003.

It needs to be strongly represented that taxpayers who had taken policies under the I.T. Act, 1961, on the basis of the promise of total exemption u/s. 10(10D), shall not be deprived of the same and that the new provisions of the Code shall apply, if at all, only to policies taken on or after 1st April, 2011.

Premium Payments just can’t be Taxed!

The impact of the new provision as proposed under the Code is so deadly that even the return of premium payments out of a taxpayer’s own capital, would attract tax in several cases. This would virtually be taxing not just any earning or gain, but the even the principal capital employed, which is unheard of in canons of taxation.

Moreover, the Code proposals in regard to taxing life insurance policies on the lines of EET model seem to presuppose that every policy holder has availed the benefit of tax incentive at the payment of premium stage. This is a myth, since so many investors who take insurance policies or other investment products offered by insurance companies are either non-taxpayers or do not even avail any tax benefit from the premium payments made by them. If their premiums get to be taxed on as proposed, it would mean inflicting grave injustice upon them.

YOUR COMMENTS INVITED ON…

Should the new provisions for taxing insurance apply even to old policies taken under the regime which promised tax exemption?

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