How the direct tax code impacts life insurance

They say, "Insurance is never bought. It is sold." A unique selling feature of insurance was the splendid tax concessions it enjoyed under the Income Tax Act (ITA). However, most of these concessions have been withdrawn and yet others have been significantly diluted by the Direct Tax Code (DTC) that is proposed to substitute the ITA from April 2011 onwards.

Sensex @ 17k: What should investors do?

To understand the impact of the Code on life insurance, let us first have a look at the existing provisions under ITA -

1.The premiums paid with respect to any life insurance policy are deductible (Exempt) u/s 80C.

2.The amount paid by the insurer (insurance company) either at the time of its maturity or on demise of the policy holder, is exempt u/s 10(10D). Similarly, amounts paid by the insurer at regular intervals (e.g., Money Back Policy) are also tax-free. Consequently, the accretion to the premium paid is tax-free (Exempt) and also the total premiums returned are tax-free (Exempt). This is the regime of EEE.

Clubbing provisions under income tax

Code Provisions

Sec. 56 of the Code lists all the receipts of the assessee which are exigible to tax under the head 'Residuary Income'. Sub-section 2f brings 'any sum received under a life insurance policy, including the sum allocated by way of bonus on such policy' into the tax net..

Overcoming financial phobia

Sec. 57 of the Code lists the deductions allowed from the aggregate Residuary Income. Sub-section (3a) states, "The amount of deduction in respect of sums received under life insurance policies shall be -

(a) any sum received under a life insurance policy, including the sum allocated by way of bonus on such policy, if

(i) the premium payable for any of the years during the term of the policy does not exceed 5% of the actual capital sum assured; and

(ii) the sum is received only upon completion of the original period of contract of the insurance or upon the death of the insured.

This falls in line with the Exempt Exempt Taxed (EET) era ushered in by the Code.

Incidentally, Sec. 57(2g) of the Code brings 'any amount received under a Keyman insurance policy into the tax net including the sum allocated by way of bonus on such policy, if such income is not included under the heads 'Income from employment' or 'Income from business'. ITA also has a similar stipulation.

Tax incidence on company accommodation

Analysis

1. Existing policies will also be slapped by the EET regime after 1.4.11. It is tantamount to showing a carrot to the victim and withdrawing it after he falls prey to the temptation. This is obviously the injustice of the highest order.

2. Under ITA, any sum received under a life insurance policy, including the sum allocated by way of bonus on such policy is exempt from tax u/s 10(10D) if the premium payable for any of the years during the term of the policy does not exceed 20% of the actual capital sum assured.

Jeevan Aastha: Glorified fixed deposit plan

Under the Code, the ratio is reduced to 5% of the actual capital sum assured. Therefore, those who have taken policies where the ratio is much below 20% of the sum assured but is over 5% will suffer tax burden when they receive money from the life insurance policies for no fault of theirs.

3. The most disturbing aspect is that under the Code, even the amounts received from life insurance policies where the premiums are less than 5% of the sum assured, are tax-free if and only if they are received on maturity or death. This would not only make sums received under Money Back polices or return of premiums taxable but also the sum received upon surrendering the policy before maturity.

4. Loan received against insurance policy is also 'any sum received under a life insurance policy'. Since the loan amount is not received on maturity or death, this will also be taxable, in spite of the fact that this is a capital receipt. Moreover, the repayment of the loan is not associated with any tax benefit. This is what flows from the plain words. It is possibly the worst fall out.

5. We have repeatedly observed that in India, the cost of insurance is so high that those who need it cannot afford it and those who afford it do not need it. The Code has enhanced the cost of insurance further.

6. Finally, the most bizarre situation. Take the instance of an individual who is below the tax threshold and has taken an endowment insurance policy for protection of his family. The deduction offered by the Code on premiums paid by him is meaningless to him. Nevertheless, he may come in the tax net when the policy matures.

Conclusion

It is abundantly clear that the provisions of the Code need clarifications and amendments in respect -

1.Whether the Code will apply only to policies bought after the Code comes into force or also to the policies taken before.

2.The proposal to exempt proceeds received only on maturity or death needs a second look.

3.Clarify whether any loan taken against life policies is taxable or not U/s 56(2f) of the Code.

4.The limit of 5% is so low that it will cover only Term Insurance policies.

Unless these aspects are well addressed before the Bill becomes an Act, it is obvious that many individuals, for whom life insurance is an absolute necessity, will shy away from it.

The authors may be contacted at wonderlandconsultants@yahoo.com