Tax on Income from Life Insurance Policy Clarified in Union Budget 2019

tax-on-income-from-life-insurance-policy-clarified-in-union-budget-2019

There was a lot of confusion among the taxpayers about the computation of income on which income tax is payable on maturity proceeds of a non-exempt life insurance policy. Even there were differences in opinion among the tax scholars about the computation of income from a non-exempt life insurance policy maturity proceeds. The Union Budget 2019 has clarified the manner of computation of income from the proceeds of a life insurance policy which is otherwise not exempt u/s 10(10D) of the Income Tax Act, 1961 and amended the TDS u/s 194DA on such policies.

Before discussing the amendment in the union Budget 2019 related to the subject, let us discuss, in brief, on the background of the subject matter.
There is a myth or misconception among the people is that receipt of proceeds from a life insurance policy is always tax-free. However, this is not always true. It is true to a certain extent but not always and the tax exemption comes at certain conditions. The Income-tax law contains certain provisions under which proceeds including bonus received on maturity or surrender of a life insurance policy are taxable.

Proceeds from a life insurance policy are received on the following occasion-
  • On maturity of a life insurance policy, at the end of the term
  • On surrender of a life insurance policy, before the end of the term and,
  • On the death of the policyholder.

It may be noted that prior to 2003, receipt of proceeds from any life insurance policy was tax-free without any riders. 

However, from 2003, the Income Tax law was amended and receipt of proceeds from a life insurance policy on maturity or surrender of the policy including bonus was made taxable in certain circumstances.

Therefore, it is of utmost importance to know those conditions when such proceeds are taxable and when not.

Remember, under any ci
rcumstances, any proceeds received by the nominee on the death of the policyholder is always tax-free and does not come under the taxability purview. Thus benefits received on the death of the policyholder of a life insurance policy is always exempt from tax without any condition.


Legal provisions about the applicability of Income Tax on maturity proceeds from a Life Insurance Policy:


Section 10(10D) of the Income Tax Act, 1961 states that - (extract)

"any sum received under a life insurance policy, including the sum allocated by way of bonus on such policy, other than—

     (a) any sum received under sub-section (3) of section 80DD or sub-section (3) of section 80DDA; or

        (b) any sum received under a Keyman insurance policy; or

       (c) any sum received under an insurance policy issued on or after the 1st day of April, 2003 but on or before the 31st day of March, 2012 in respect of which the premium payable for any of the years during the term of the policy exceeds twenty per cent of the actual capital sum assured; or

       (d) any sum received under an insurance policy issued on or after the 1st day of April, 2012 in respect of which the premium payable for any of the years during the term of the policy exceeds ten per cent of the actual capital sum assured:

          Provided that the provisions of sub-clauses (c) and (d) shall not apply to any sum received on the death of a person:
              .....................

Provided also that where the policy, issued on or after the 1st day of April, 2013, is for insurance on life of any person, who is—

(i) a person with disability or a person with severe disability as referred to in section 80U; or

(ii) suffering from disease or ailment as specified in the rules made under section 80DDB,

the provisions of this sub-clause shall have effect as if for the words "ten per cent", the words "fifteen per cent" had been substituted."


On the basis of foregoing provisions, we can summarize the applicability of Income Tax on maturity proceeds from a Life Insurance Policy is based on the period of issue of the life insurance policy as charted below -

Period of issue of a life insurance policy
Conditions
Tax applicability
Life Insurance Policy issued before 01.04.2003 
None
Always tax-free 
Life Insurance Policy issued between 01.04.2003 and 31.03.2012 (both days inclusive)
Amount of annual(ized) premium is more than 20% of Sum Assured
Maturity proceeds are taxable
Life Insurance Policy issued on or after  01.04.2012
Amount of annual(ized) premium is more than 10% of Sum Assured
Maturity proceeds are taxable
Life Insurance Policy issued on or after  01.04.2013
Amount of annual(ized) premium is more than 15% of Sum Assured - applicable for an insured person who is suffering from a severe disability or disease specified in section 80U of Income Tax Act, 1961 or Section 80DDB read with  Rule 11DD of Income Tax Rules, 1962
Maturity proceeds are taxable


TDS on life insurance policies - The Finance Act, 2014 introduced section 194DA. Under the section, income-tax at the rate of 1% will be deducted from any payment by an insurance company to a resident person for a life insurance policy held by the person with the insurance company, except in a case where the payment amount will remain exempt u/s 10(10D) or does not exceed Rs. 1,00,000 in a financial year The payment shall include allocated bonus on such policy.

The major ingredients for applicability of TDS on a life insurance policy are listed below-
  1. The payment is made by an insurance company.
  2. The payment is made for a life insurance policy held by a policyholder.
  3. The payment is made on the maturity of the policy or on surrender of the policy.
  4. The payment shall include allocated bonus on such policy.
  5. The payment which is made by the insurance company to the policyholder does not constitute income and is tax-free u/s 10(10D). In other words, if the premium amount does not exceed 10% or 15% or 20% of the actual sum assured, as the case may be based on the period in which the policy is issued. It also covers a policy which is issued prior to 01.04.2003.
  6. TDS on a payment made under a life insurance policy shall not apply in case of death of the policyholder since such payments are always tax-free u/s 10(10D).
  7. Even if the payment from a life insurance policy is otherwise taxable, but no income-tax will be deducted if the payment(s) made to the policyholder in a financial year does not exceed Rs. 1,00,000 in aggregate.
However, there is no uniformity or consensus as to what shall be the amount of income in the proceeds received under a life insurance policy. 

According to some experts, the entire or whole amount of proceeds is taxable. No deduction for premium paid shall be allowed. 

Some experts believe that only the surplus of proceeds under a life insurance policy, after deducting all the premiums paid from the maturity proceeds, constitutes income and thus only the surplus of maturity proceeds over the premium paid is taxable.

The objectives of making such policies taxable were set out in the Memorandum explaining the Finance Bill, 2003. Thus the intention of the lawmakers was to bring those policies whose premium is more than 20 percent ( or 10 percent or 15 percent as the case may be) of sum assured is because such insurance policies are akin to investment. They are considered as investment products rather than insurance products where the premium is high but risk coverage is minimum.

A detailed discussion on the topic is available here.

Now coming to the amendment in the Finance (No. 2) Bill, 2019 of section 194DA.

Clause 44 of the Finance (No. 2) Bill, 2019 amends section 194DA in the following manner-

In section 194DA of the Income-tax Act, for the words “one per cent.”, the words “five per cent. on the amount of income comprised therein” shall be substituted with effect from the 1st day of September, 2019.

Before the amendment, section 194DA reads as follows-

194DA. Any person responsible for paying to a resident any sum under a life insurance policy, including the sum allocated by way of bonus on such policy, other than the amount not includible in the total income under clause (10D) of section 10, shall, at the time of payment thereof, deduct income-tax thereon at the rate of one per cent.

After the amendment, section 194DA will read as follows-

194DA. Any person responsible for paying to a resident any sum under a life insurance policy, including the sum allocated by way of bonus on such policy, other than the amount not includible in the total income under clause (10D) of section 10, shall, at the time of payment thereof, deduct income-tax thereon at the rate of five per cent. on the amount of income comprised therein.

Effect of the amendment - The rate of TDS increased from 1 percent to 5 percent but henceforth tax will be deducted on amount of income comprised in the non-exempt proceeds of a life insurance policy, unlike pre-amendment era where the tax was deducted on gross proceeds amount.

Now the moot question is what is the amount of income that comprises in the maturity proceeds of a non-exempt life insurance policy.

The Memorandum explaining the provisions of Finance (No. 2) Bill, 2019 states that under section 194DA of the Act, a person is obliged to deduct tax at source, if it pays any sum to a resident under a life insurance policy, which is not exempt under sub-section (10D) of section 10. The present requirement is to deduct tax at the rate of one percent of such sum at the time of payment. Several concerns have been expressed that deducting tax on gross amount creates difficulties to an assessee who otherwise has to pay tax on net income (i.e after deducting the amount of insurance premium paid by him from the total sum received). From the point of views of tax administration as well, it is preferable to deduct tax on net income so that the income as per TDS return of the deductor can be matched automatically with the return of income filed by the assessee. The person who is paying a sum to a resident under a life insurance policy is aware of the amount of insurance premium paid by the assessee. Hence, it is proposed to provide for tax deduction at source at the rate of five percent. on income component of the sum paid by the person. (Emphasis added).

The legislature is aware that the gross amount of maturity proceeds cannot be treated as income. The income amount comprises is required to be computed after excluding the premium amount. This position is now cleared and there is no ambiguity on the position that in case of maturity proceeds of a non-exempt life insurance policy, it is only the amount after deducting the premium amount paid for the life insurance policy from the gross maturity proceeds received by an Individual. The intention is further fortified from the fact that the tax administration intended to tax only the amount of income therefrom which can be matched from the Form 26AS and the return of income filed by the assessee.

However, the deduction of tax on the amount of income will take effect from 1st September 2019. Any maturity proceeds from such a policy till 31st August will be deducted @ 1% on the gross amount only. However, even then, the policyholder shall offer only the income amount comprised therein as 'income' in his or her return of income.

The Notes on clauses to Finance (No. 2) Bill, 2019 reiterates the same in the following words-

Clause 44 of the Bill seeks to amend section 194DA of the Income Tax Act relating to payment in respect of life insurance policy.

The said section provides for levy of tax deduction at source at the rate of one per cent. on the sum payable by way of a life insurance policy, including the sum allocated by way of bonus on such life insurance policy, excluding the amount exempted under clause (10D) of section 10.

It is proposed to amend the said section so as to provide that the levy of tax deduction at source shall be on the income comprised in the sum payable by way of redemption of a life insurance policy, including the sum allocated by way of bonus on such life insurance policy, excluding the amount exempted under the said clause (10D) of section 10 at the increased rate of five per cent.

This amendment will take effect from 1st September, 2019.

Conclusion:

The amendment is though related to TDS but the reasons given for deduction of income tax establishes the principles to determine the income from the proceeds of a life insurance policy. Such a reason is clarificatory in nature and shall apply retrospectively to those maturity proceeds on which tax was deducted on the gross amount. It establishes the intent of the legislature about the amount to be considered as income in case of receipt of maturity proceeds of a non-exempt life insurance policy.

Though it is now clarified on the amount of income to be liable to tax for receipt of maturity proceeds of a non-exempt life insurance policy, however, the head of income under which it is to be taxed is still a grey area.


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