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Changes in Tax Exemption and Taxability on ULIP: Budget 2021

changes-in-tax-exemption-and-taxability-on-ulip-budget-2021

Budget 2021 has amended the tax rules relating to taxability of Unit Linked Insurance Plan (ULIP) policies and curtailed the tax arbitrages that was prevailing between the ULIP and the akin Mutual Fund Schemes by withdrawing the tax exemptions to a certain extent on ULIP policies.


The amendment aimed to rationalise the taxation of Unit Linked Insurance Plan (ULIP). In order to rationalise taxation of ULIP, it is proposed to allow tax exemption for maturity proceed of the ULIP having annual premium up to  Rs. 2.5  lakh.  However,  the amount received on death shall continue to remain exempt without any limit on the annual premium. The cap of Rs. 2.5 lakh on the annual premium of ULIP shall be applicable only for the policies taken on or after  01.02.2021. Further, in order to provide parity, the non-exempt  ULIP  shall be provided same concessional capital gains taxation regime as available to the mutual fund.


It was a long-standing demand of the Association of Mutual Funds in India (AMFI) to bring parity on taxation between units of equity mutual funds and ULIPs offered by insurers.


Finance Act, 2018 introduced long term capital gains tax on the transfer of units of equity-oriented mutual funds. Such changes in the long term capital gains tax (LTCG) on equities and equity mutual funds have given ULIPs a tax edge. A 10% LTCG tax on redemption of units of equity mutual funds was introduced by section 112A of the Income Tax Act, 1961 but the units of ULIPs were not brought under the tax ambit. As such, ULIPs continue to enjoy tax benefits under section 10(10D) which allow gains on maturity or surrender of ULIPs to be exempt from tax.



The disparity was a matter of concern because ULIPs are being sold as an investment product rather than a protection product. Despite being investment products, the taxation structure was not the same for units of Mutual Funds and ULIP policies.


ULIPs follow exempt-exempt-exempt (EEE) taxation. It means, an individual gets a tax deduction on investment, there’s no tax on accrual and until now there was no tax on withdrawal for all policyholders.


Presently, ULIPs have tax advantages in the following cases-


1. Tax benefit on the premium of ULIPs:


The premium paid towards a ULIP policy issued by an insurer is allowed as a deduction under section 80C of the Income Tax Act, 1961 from the total income of the taxpayer. 


For ULIPs purchased before 1 April 2012, the deduction under section 80C can be availed when the premium is less than 20% of the sum assured. If the premium is more than 20% of the sum assured the tax deduction is allowed on the amount equal to 20% of the sum assured. However, if the policy is acquired before April 1, 2012, the limit of the premium amount was restricted to less than or equal to 20% of the sum assured.


In contrast, there is no deduction from total income available for investing in mutual fund schemes except for investing in Equity Linked Savings Schemes (ELSS). There are no debt oriented mutual fund schemes to qualify for deduction under section 80C.


2. Tax benefit on the maturity of ULIPs:


As per section 10(10D) of the Income Tax Act 1961, the maturity proceeds of the ULIPs are exempt from tax and hence such proceeds are tax-free in the hands of the taxpayer. The best part about ULIPs is that it offers tax-free maturity amount. 


For ULIPs purchased before 1 April 2012, the maturity proceeds from ULIP policies are tax-exempt u/s 10(10D) only when the premium is less than 20% of the sum assured. If the premium is more than 20% of the sum assured, then the entire maturity proceeds are subject to tax. If the ULIPs are purchased after 01.04.2012, the limit is reduced to 10% from 20%. 


The death benefit received under ULIPs in case of death of the life assured is always tax-free irrespective of the quantum of the premium amount.



In contrast, the redemption of mutual fund units is subject to capital gains tax under section 112A, subject to exemption limit of capital gains of Rs. 1 Lakh in a year.


3. Exemption from Long Term Capital Gains (LTCG) tax:


The maturity proceeds from ULIPs continue to be exempt from Long Term Capital Gain (LTCG) tax under section 112A of the Income Tax Act, 1961 which was introduced in the Union Budget 2018. In fact, ULIPs are the only market-linked investment product that is out of the purview of LTCG tax.


No capital gains on switching: There is no capital gains tax on switching between equity funds and debt funds. ULIPs offer the benefit of switching between plans and schemes.


No Securities Transaction Tax (STT) is levied on the withdrawal proceeds from ULIPs.


In contrast, the redemption of mutual fund units is subject to capital gains tax under section 112A, subject to exemption limit of capital gains of Rs. 1 Lakh in a year. Even on switching of units of mutual funds from one scheme to another attracts capital gains tax. Section 112A applicable if the gains from transfer of units of mutual funds are long term capital gains.


If the units are held as short term capital assets, the short term capital gains will be taxable @ 15% under section 111A.  A capital asset is a short term capital asset if the same is sold/redeemed or switched within one year from the date of investment.


Further, STT is levied on the amount of redemption of units of Mutual Funds. Even though MF units are subject to STT, however, the proviso to Section 48 specifically excludes deduction for STT paid while computing the capital gain.


“Switching” of investment in units within the same scheme of a Mutual Fund from Growth Option to Dividend Option or vice-versa, constitutes a “Transfer” under the income tax law and is liable to capital gains tax, even though the amount invested remains in the mutual fund scheme and there are no realised gains.


However, the switches to/from various investment plans of the same Unit Linked Insurance Plan (ULIP) of insurance companies does not constitute transfer and is not subjected to Capital Gains Tax. 


Thus, there was a lack of uniformity in tax treatment on switching of investment in Mutual Funds schemes and ULIPs of Insurance companies while both MF units and ULIPs invest in securities.


Hence, in order to remove the anomaly and arbitrage in the taxation of units of mutual funds and ULIPs and to create a level playing field, Finance Bill, 2021 has proposed amendments in the Income Tax Act, 1961 which are discussed below.


Taxation of proceeds of high premium unit-linked insurance policy (ULIP)


Clause  (10D)  of  section  10  of  the  Act  provides  for the exemption  for the  sum received under a life insurance policy, including the sum allocated by way of bonus on such policy in respect of which the premium payable for any of the years during the terms of the policy does not exceed ten per cent of the actual capital sum assured.


Under the existing provisions of the Act, there is no cap on the amount of annual premium being paid by any person during the term of the policy. Instances have come to the notice where high net worth individuals are claiming exemption under this clause by investing in ULIP with huge premium. Allowing such exemption in policy/policies with huge premium defeats the legislative intent of this clause. The intention was to provide benefit to small and genuine cases of life insurance. Hence, it is proposed to provide for the followings:


(i) Insert Explanation 3 to the clause (10D) of section 10 of the Act to define ULIP as a life insurance policy which has components of both investment and insurance and is linked to a unit as defined in clause (ee) of regulation (3) of the Insurance  Regulatory  and  Development  Authority  of  India  (Unit  Linked Insurance Products) Regulations, 2019 dated the 8th day of July, 2019.


(ii) insert fourth proviso to clause (10D) of section 10 of the Act to provide that the exemption under this clause shall not apply with respect to any ULIP issued on or after the 1st February, 2021, if the amount of premium payable for any of the previous year during the term of the policy exceeds two lakh and fifty thousand rupees.


(iii) insert fifth proviso to this clause to provide that, if premium is payable by a person for more than one ULIPs, issued on or after the 1st February, 2021, exemption under this clause shall be available only with respect to such policies aggregate premium whereof does not exceed the amount of two lakh fifty thousand rupees, for any of the previous years during the term of any of the policy.


(iv) insert sixth proviso to this clause providing that the provisions of fourth and fifth provisos shall not apply to any sum received on the death of a person.


(v) insert seventh proviso to this clause to enable CBDT to issue guidelines with the approval of Central Government for the purpose of removing the difficulty and to lay every guideline issued by the  Board before each House of Parliament and to make it binding on the income-tax authorities and the assessee.


(vi) provide that a ULIP [to which exemption under clause (10D) of section 10 of the Act does not apply on account of the applicability of the fourth and fifth proviso] is a capital asset under clause (14) of section 2 of the Act.


(vii) provide for the deemed taxation of profit and gains from the redemption of ULIP  [to which exemption under clause (10D) of section 10 of the Act does not apply on account of the applicability of the fourth and fifth proviso] as capital gains by inserting new sub-section (1B) in section 45 and to take power to prescribe rules for calculation of such capital gains.


(viii) Include such ULIPs [to which exemption under clause (10D) of section 10 of the Act does not apply on account of the applicability of the fourth and fifth proviso] in the definition of equity-oriented fund in section 112A so as to provide them same treatment as unit of equity-oriented fund. Thus provisions of section 111A and 112A would apply on sale/redemption of such ULIPs


These amendments will take effect from 1st April, 2021 and will accordingly apply to the assessment year 2021-22 and subsequent assessment years.


To give the effect of the above, the following amendments were carried out in the various provisions of the Income Tax Act, 1961-


Amendment of section 2.


3. In section 2 of the Income-tax Act,–– 


(i) ….; 


(ii) in clause (14), after sub-clause (b), the following sub- clause shall be inserted, namely:––


“(c)  any  unit  linked  insurance  policy  to  which exemption under clause (10D) of section 10 does not apply on account of the applicability of the fourth and fifth proviso thereof;”; 


Amendment of section 10.


5. In section 10 of the Income-tax Act,–


(c) in clause (10D),––


(i) after the third proviso and before Explanation 1, the following provisos shall be inserted, namely:–– 


“Provided  also  that  nothing  contained  in  this clause shall apply with respect to any unit linked insurance policy, issued on or after the 1st day of February, 2021, if the amount of premium payable for any of the previous year during the term of such policy exceeds two lakh and fifty thousand rupees: 


Provided also that if the premium is payable, by a person,  for  more  than  one  unit-linked  insurance policies, issued on or after the 1st day of February, 2021, the provisions of this clause shall apply only with respect to those unit linked insurance policies, where the aggregate amount of premium does not exceed the amount referred to in fourth proviso in any of the previous year during the term of any of those policies:


Provided also that the provisions of the fourth and fifth provisos shall not apply to any sum received on the death of a person:


Provided also that if any difficulty arises in giving effect to the provisions of this clause, the Board may, with  the  previous  approval  of  the  Central Government,  issue  guidelines  for  the  purpose  of removing the difficulty and every guideline issued by the Board under this proviso shall be laid before each House of Parliament, and shall be binding on the income-tax authorities and the assessee.”; 


(ii) after Explanation 2, the following Explanation shall be inserted, namely:–


‘Explanation 3.— For the purposes of this clause, “unit linked insurance policy” means a life insurance policy which has components of both investment and insurance and is linked to a unit as defined in clause (ee) of regulation 3 of the Insurance Regulatory and Development  Authority  of  India  (Unit  Linked Insurance Products) Regulations, 2019 issued by the Insurance  Regulatory  and  Development  Authority under  the  Insurance  Act,  1938  and  the  Insurance Regulatory and Development Authority Act, 1999.’; 


Amendment of section 45. 


14. In section 45 of the Income-tax Act,–


(a) after sub-section (1A), the following sub-section shall be inserted, namely:–


‘(1B) Notwithstanding anything contained in sub-section (1),  where  any  person  receives  at  any  time  during  any previous  year  any  amount  under  a  unit  linked  insurance policy, to which exemption under clause (10D) of section 10 does not apply on account of the applicability of the fourth and fifth proviso thereof, including the amount allocated by way of bonus on such policy, then, any profits or gains arising from  receipt  of  such  amount  by  such  person  shall  be chargeable to income-tax under the head "Capital gains" and shall be deemed to be the income of such person of the previous year in which such amount was received and the income taxable shall be calculated in such manner as may be prescribed.’; 


Amendment of section 112A.


29.  In  section  112A  of  the  Income-tax  Act,  in  the Explanation, in clause (a), in the opening portion, after the word and figures “section 10”, the words, brackets, figures and letter “or under a scheme of an insurance company comprising unit linked insurance policies to which exemption under clause (10D) of the said section does not apply on account of the applicability of the fourth and fifth proviso thereof” shall be inserted.


The above provisions are explained below-


Clause 3 of the Bill seeks to amend section 2 of the Income-tax Act relating to definitions. 


It is proposed to amend clause (14) of section 2 which defines the expression “capital asset”. It is proposed to insert sub-clause (c) to the said clause so as to include any unit linked insurance policy to which exemption under clause (10D) of section 10 does not apply on account of the applicability of the fourth and fifth proviso thereof. 


Clause 5 of the Bill seeks to amend section 10 of the Income-tax Act relating to incomes not included in total income. 


Clause (10D) of the said section provides for the exemption for the sum received under a life insurance policy in respect of which the premium payable for any of the years during the terms of the policy does not exceed ten percent of the actual capital sum assured. 


It is proposed to insert fourth, fifth, sixth and seventh proviso to the clause. Proposed fourth proviso seeks to provide that the exemption under this clause shall not apply with respect to any unit linked insurance policy, issued on or after the 1st day of February, 2021, if the amount of premium payable for any of the previous year during the term of such policy exceeds two lakh fifty thousand rupees. 


Proposed fifth proviso seeks to provide that if the premium is payable, by a person, for more than one unit linked insurance policies, issued on or after the 1st day of February, 2021, the provisions of this clause shall apply only with respect to those insurance policies, where the aggregate amount of premium does not exceed the amount referred to in fourth proviso in any of the previous year during the term of any of those policies. 


Proposed sixth proviso seeks to provide that the provisions of the fourth and fifth provisos shall not apply to any sum received on the death of a person. 


Proposed seventh proviso seeks to provide that if any difficulty arises in giving effect to the provisions of this clause, the Board may, with the approval of the Central Government, issue guidelines for the purpose of removing the difficulty and every guideline issued by the Board under this proviso shall be laid before each House of Parliament, and shall be binding on the income-tax authorities and the assessee. 


It is further proposed to insert Explanation 3 to the said clause so as to define the expression “unit linked insurance policy” as a life insurance policy which has components of both investment and insurance and is linked to a unit as defined in clause (ee) of regulation (3) of the Insurance Regulatory and Development Authority of India (Unit Linked Insurance Products) Regulations, 2019 issued by Insurance Regulatory and Development Authority under the Insurance Regulatory Act, 1938 and the Insurance Regulatory and Development Authority Act, 1999. 


Clause 14 of the Bill seeks to amend section 45 of the Income-tax Act relating to Capital gains. 


The aforesaid section inter alia, provides that any profits or gains arising from the transfer of a capital asset shall be chargeable to income-tax under the head “Capital gains” and shall be deemed to be the income of the previous year in which such transfer took place. 


It is proposed to insert sub-clause (1B) so as to provide that notwithstanding anything contained in sub-section (1), where any person receives at any time during any previous year any amount under a unit linked insurance policy, to which exemption under clause (10D) of section 10 does not apply on account of the applicability of the fourth and fifth proviso thereof, including the amount allocated by way of bonus on such policy, then, any profits or gains arising from receipt of such amount by such person shall be chargeable to income-tax under the head "Capital gains" and shall be deemed to be the income of such person of the previous year in which such amount was received and the income taxable shall be calculated in such manner as may be provided by rules. 


Clause 29 of the Bill seeks to amend section 112A of the Income-tax Act relating to tax on long-term capital gains in certain cases.  


Explanation to the said section, inter alia, provides for the definition of the expression “equity oriented fund”. 


It is proposed to amend the said Explanation to the section so as to include a fund set up under a scheme of an insurance company comprising unit linked insurance policies to which exemption under clause (10D) of section 10 does not apply on account of the applicability of the fourth and fifth proviso thereof within the definition of “equity oriented fund”. 


These amendments will take effect from 1st April, 2021 and will, accordingly, apply in relation to the assessment year 2021-22 and subsequent assessment years.


Security Transaction  Tax (STT) made applicable on ULIP

Consequential amendment has also been proposed in Finance (No 2) Act, 2004 to make security transaction tax applicable on maturity or partial withdrawal with respect to unit linked insurance policy issued by insurance company on or after the 1 st February, 2021 [to which exemption under clause (10D) of section 10 of the Act does not apply on account of the applicability of the fourth and fifth proviso].

This amendment will take effect from 1st February, 2021.

Amendments in Finance (No. 2) Act, 2004 are proposed in the following manner in the Finance Bill, 2021-

PART XII 

AMENDMENTS TO THE FINANCE (NO.2) ACT, 2004

Commencement of this Part.
154. The provisions of this Part shall come into force and shall be deemed to  have come into force on the  1st day of February, 2021.

Amendment of section 97. 
155. In section 97 of the Finance Act (No.2) Act, 2004, (hereafter in this Part referred to as the Principal Act),–
  
(i)  in  clause  (13),  in  sub-clause  (b),  for  the  words “Mutual Fund;”, the following shall be substituted, namely:–

“Mutual Fund; or

(ba) sale or surrender or redemption of a unit of an equity  oriented  fund  to  an  insurance  company,  on maturity or partial withdrawal, with respect to unit linked insurance policy issued by such insurance company on or after the 1st day of February, 2021;”; 

(ii)  after  clause  (13),  the  following  clause  shall  be inserted, namely:–

 
‘(13A) “unit linked insurance policy” shall have the meaning assigned to it in Explanation 3 of clause (10D) of section 10 of the Income-tax Act, 1961;’

Amendment of section 98.

156. In section 98 of the Principal Act, in the Table, after serial number 5 and the entries relating thereto, the following shall be inserted, namely:–

“5A. Sale or surrender or redemption of a unit [0.001] Seller” of an equity oriented fund to an insurance per company,    on    maturity     or    partial cent. withdrawal,  with  respect  to  unit linked insurance policy issued by such insurance company  on  or  after  the  first  day  of February, 2021 

Amendment of section 100. 

157. In section 100 of the Principal Act, after the words “Mutual Fund” wherever they occur, the words “or insurance company” shall be inserted.

Amendment of section 101.

158. In section 101 of the Principal Act, after the words “Mutual Fund” at both places where they occur, the words “or insurance company” shall be inserted. 

Amended Provisions related to applicability of STT on ULIP explained

Clause 154 and 155 of the Bill seeks to amend section 97 of the Finance Act (No.2) Act,  2004.  

Chapter-VII of the said Act provides for Securities Transaction Tax. 

It is proposed to amend sub-clause (b) of clause (13) of section 97 of the said Act so as to include sale or surrender or redemption of a unit of an equity oriented fund to the insurance company, on maturity or partial withdrawal, with respect to unit linked insurance policy issued by such insurance company on or after 1st February, 2021, under the definition of “taxable securities transaction”. 

It is further proposed to insert clause (13A) to the said section define the expression “unit linked insurance policy”. 

These amendments will take effect retrospectively from 1st February, 2021.

Clause 156 of the Bill seeks to amend section 98 of the Finance Act (No.2) Act, 2004.  

It is proposed to insert serial number 5A and entries relating thereto in the Table in section 98 so to provide that the rate for sale or surrender or redemption of a unit of an equity oriented fund to an insurance company, on maturity or partial withdrawal, with respect to unit linked insurance policy issued by such insurance company on or after 1st February, 2021. 

This amendment will take effect retrospectively from 1st February, 2021. 

Clauses 157 and 158 of the Bill seeks to amend sections 100 and 101 of the Finance Act (No.2) Act, 2004.  

It is proposed to consequentially amend sections 100 and 101 of the said Act so as to include insurance company within their purview. 


This amendment will take effect retrospectively from 1st February, 2021.


The aforesaid amendments can be summarized as below-


1. If the aggregate amount of premium of ULIP policies issued on or after 01.02.2021 exceeds Rs. 2,50,000/- during any previous year in the tenure of the policy then such a ULIP policy will become a capital asset.


2. The ULIP policy which qualifies as a capital asset shall be taxed at the time of receipt of maturity proceeds including bonus.


3. The income from ULIP policy shall be chargeable to tax under the head ‘capital gains’. If the period of holding of the ULIP is less than 1 year, the same will qualify as ‘short term capital gains’ to be taxed u/s 111A @ 15%.


If the ULIP is held for more than a year, the gain therefrom will be counted as ‘long term capital gains’ to be taxed @ 10% u/s 112A subject to exemption limit of Rs. 1,00,000 and without indexation benefit.


4. CBDT will prescribe Rules for computing the capital gains arising from ULIP policies.


5. STT will be applicable on maturity or surrender or partial withdrawal of ULIP from 01.02.2021.


6. Receipt of proceeds under a ULIP policy in case of death is always exempt from tax. 


Note: Gains in ULIPs proposed to be taxed only if the annual premium is Rs. 2.5 Lakh or more. Where the annual premium of ULIP is below Rs. 2,50,000, it still gets the benefit of EEE taxation.


A dilemma - Whether taxability of ULIPs arises on switches


It is not clear how the taxation would work if a ULIP policyholder switches from an equity fund to a debt fund during the policy tenure. ULIP offer investors multiple funds, including equity and debt schemes. A policyholder can switch between equity and debt funds without any tax implication.


Whether switching of funds under a ULIP policy would amount to ‘transfer’ for the purpose of the changeability of capital gains. Either CBDT should clarify the issue or a suitable amendment is required in the Income Tax Act, 1961. 


If we analyze the intention of introducing the amendment for taxing the capital gains on ULIP we find that it has been done to bring parity between the taxation of ULIP and units of Mutual Funds and to end the tax arbitrage between the two akin financial products.


Hence, going by the intention, it appears that like mutual funds units, switching of funds in a ULIP will also attract capital gains. However, this view is subject to any clarification from the CBDT.



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