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Capital Gains Tax on Maturity Proceeds of ULIP

capital-gains-tax-on-maturity-proceeds-of-ulip

Finance Bill, 2021 has proposed amendments to provide for taxation of Unit Linked Insurance Plans (ULIP) to bring them at par with Mutual Fund Schemes from FY 2021-22 (AY 2022-23). ULIP is specifically made taxable under fourth and fifth proviso to section 10(10D). Such ULIPs are taxed under the head ‘capital gains’ but all ULIPs are not capital assets.


    Amendment on taxation of maturity proceeds of 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 proceeds 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  fter  01.02.2021. Further, in order to provide parity, the non-exempt  ULIP  shall be provided the same concessional capital gains taxation regime as available to the mutual fund.

    The rationale of introducing such an amendment is specified in the Memorandum explaining the provisions of the Finance Bill, 2021. 



    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.


    ULIP Policies as Investment and Insurance


    ULIP is an investment option that has the elements of both insurance and investment. A part of the premium amount of an ULIP goes towards providing insurance cover, while the rest of the premium is invested in the financial products especially in the equity market.


    ULIP thus provides for both investment as well as insurance. It is argued that ULIP's primary and dominant objective is investment or wealth generation and providing insurance is the secondary objective.


    There are several different types of Unit Linked Insurance Plans that cater to a wide range of financial goals and risk profiles. Various types of ULIP plans are available in the market.


    ULIPs invest the premium amount in the equity and/or debt market instruments to generate wealth. ULIP plans are either single premium or regular premium ULIPs. A single premium ULIP plan requires only one-time premium payment at the time of purchase. No further payment is made towards premium thereafter. On the other hand, a regular premium ULIP requires to pay premiums periodically throughout the term of the plan.


    One more variant of ULIP is popular in the market is Guaranteed ULIP Fund which primarily focuses on capital preservation. These funds invest a major portion of the premium amount in Debt instruments while some portion is invested in the equity market.


    One should keep in mind that Mutual Fund Schemes are subject to regulations of SEBI whereas ULIP being an Insurance embedded investment product comes under the regulation of IRDA.


    The above investment pattern is the same as that of Mutual Fund Schemes except that ULIP also provides life insurance benefit whereas there is no such insurance benefit in case of a mutual fund scheme. However, from the taxation point of view, ULIP carries more tax benefits than mutual funds even though not so different from an investment perspective.


    As a result, ULIP is getting tax arbitrage benefits due to embedded life insurance coverage. Hence, it was a long standing demand to bridge the gap of tax arbitrage between ULIP products and mutual funds.


    Tax arbitrage on ULIP compared to Mutual Fund Schemes


    Prior to the amendments proposed in the Finance Bill, 2021 specifying specifically tax on ULIP, the existing provisions that were providing tax arbitrage to ULIP are discussed below.


    1. Switching between Schemes amounts to transfer: Presently, “switching” of investment between the schemes of a Mutual Fund from Growth Option to Dividend Option or vice-versa, and from Regular Plan to Direct Plan or vice-versa is considered a “transfer” within the meaning of section 2(47) and is liable to capital gains tax, even though the amount invested remains in the mutual fund scheme and there are no realized gains, as the underlying securities/ portfolio remains unchanged within the scheme.


    However, the switching of investments to/from investment plans to another within the same Unit Linked Insurance Plan (ULIP) of insurance companies is not considered as a “transfer” within the meaning of section 2(47) and hence, not subjected to any Capital Gains Tax.


    2. Capital Gains tax on redemption of Mutual Fund Schemes: Redemption of mutual fund units attracts capital gains tax under the Income tax law. In case the equity oriented mutual fund units redeemed are held for 12 months then it qualifies for short term capital gain and taxable at flat rate of 15% u/s 111A. In case of debt oriented mutual fund units, the short term capital gains there from is taxable at slab-rates of income tax. The holding period of debt oriented units to qualify for short term is 36 months.


    Under section 112A, Long-Term Capital Gains (LTCG) arising out of the sale of units of equity-oriented mutual fund schemes are taxed @ 10% without any indexation benefit, if the LTCG exceeds Rs. 1,00,000 in a financial year. However, gains up to January 31, 2018 are grandfathered.


    However, the maturity proceeds as well as proceeds from surrender or partial withdrawals from ULIPs are exempted from income tax under section 10(10D). The only condition is that the premium amount shall not exceed 20% of the sum assured and is matured or surrendered after a lock-in period of 5 years.


    3. Deduction under section 80C: The premium paid for an ULIP is deductible under section 80C of the taxpayer while computing his total income. This is however, subject to 10% of sum assured and has a lock-in period of 5 years. It is immaterial whether the ULIP fund is  equity-oriented or debt oriented, it is always allowed as deduction under section 80C. In case of mutual funds, only ELSS qualifies for deduction under section 80C which is an equity oriented mutual fund.


    4. No Securities Transaction Tax (STT) on ULIP: In respect of Equity Oriented Funds, the Mutual Funds are required to pay STT on every purchase or sale of securities. In addition, the unitholders are required to pay the STT on the redemption value at the time of redemption of units. Thus, there is a double levy of STT for an investor investing in the equities through equity mutual fund schemes. And in respect of Exchange Traded Fund (ETF), the investor of the ETF has to pay STT on the purchase as well as sale of units in the ETF.


    However, there is no STT levied on the withdrawal proceeds from ULIPs. Thus, on this count also there is a clear case of tax arbitrage, whereby mutual funds are at a disadvantage vis-├ávis the ULIPs. 


    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.


    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.


    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 in this article. The amendments not only withdrew the income tax exemption available to ULIP but also proposed how the maturity/surrender proceeds will be taxed and under which head the same will be taxed. 


    Read more on Taxation of maturity proceeds of Life Insurance Policies

    Tax on maturity proceeds from a Life Insurance Policy

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



    Taxation of maturity or surrender proceeds of unit-linked insurance policy (ULIP)


    Amendments are proposed in the following provisions of the Income Tax Act, 1961-


    Sl. No.

    Section

    Particulars

    1.

    Section 10(10D)

    Exemption on maturity and other proceeds withdrawn in certain cases.

    2.

    Section 2(14)

    ULIP is defined as a ‘capital asset’

    3.

    Section 45(1B)

    Proceeds from redemption of ULIPs are taxable under the head ‘Capital Gains’

    4.

    Section 111A

    Tax rate on Short Term Capital Gains (STCG) from the proceeds from redemption of ULIPs

    5.

    Section 112A

    Tax rate on Long Term Capital Gains (LTCG) from the proceeds from redemption of ULIPs

    6.

    Section 97 of Finance Act (No.2) Act, 2004

    Security Transaction  Tax (STT) on redemption of ULIP on maturity or partial withdrawal only


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


    Amendment in Section 10(10D) to provide for tax on ULIP on maturity proceeds


    Section 10(10D) was inserted in the statute by the Finance (No. 2) Act, 1991, w.r.e.f. 1-4-1962 to provide for income-tax exemption from  receipt of any sum received under a life insurance policy, including the sum allocated by way of bonus on such policy. Thereafter, in Finance Act, 2003, the exemption from sum received under a life insurance policy is withdrawn where the premium exceeds 20% of the capital sum assured. The receipts on the death of the policyholder was, however, excluded. Finance Act, 2012 further reduced the ceiling of premium from 20% to 10% of the actual capital sum assured.


    Existing section 10(10D) has three provisos and two Explanations. Finance Bill, 2021 has added 4 new provisos for clause (10D) taking the aggregate total number of provisos to seven and one new Explanation 3. Out of these 4 new provisos, three provisos are related to taxation of ULIPs only. 


    Fourth Proviso

    To provide for taxability of ULIP policies purchased on or after 1.02.2021 and premium exceeds Rs. 2,50,000/-.

    Fifth Proviso

    To provide for taxability of ULIP policies purchased on or after 1.02.2021 and aggregate premium of all the policies exceeds Rs. 2,50,000/-.

    Sixth Proviso

    To provide of applicability of exemption in case of death

    Seventh Proviso

    To empower CBDT to  issue guidelines

    Explanation 3

    To clarify the meaning of ULIP


    Each of the new proviso is discussed below-


    Fourth proviso to Section 10(10D)


    Fourth proviso to clause (10D) of section 10 is proposed to be inserted 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 Rs. 2,50,000.


    The 4th proviso to clause (10D) of section 10 proposed to provide that the exemption provisions of clause (10D) shall not apply to the maturity/surrender proceeds of ULIPs.


    However, this taxability clause will not apply to all the ULIP policies. In other words, proceeds from all the ULIP policies are not taxable. It is taxable only if-

    (i) the ULIP policy is issued on or after 1st February, 2021, and

    (ii) the premium amount of such ULIP policy exceeds Rs. 2,50,000.


    The fourth proviso reads as follows-


    “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.”


    Analysis of the Fourth proviso to Section 10(10D)


    Prospective provisions and not retrospective: The fourth proviso is not applicable to existing ULIP policies which means if the ULIP policies are issued upto 31st January 2021, then, even if the premium is more than Rs. 2,50,000, there will be no tax impact on the maturity proceeds of such ULIPs. The provisions withdrawing tax exemption on proceeds received on redemption of ULIPs are, thus, prospective and have no retrospective operation.


    Only high-premium ULIP policies are covered: Even if the ULIPs are issued on or after 1.02.2021, not all the policies will be subject to tax. Only those ULIP policies whose premium is more than Rs. 2,50,000 is covered. Thus only high-premium based ULIPs are covered.


    In this context it should be noted that the limit of premium amount of Rs. 2,50,000 is on aggregate basis for all the ULIPs issued on or after 1st February 2021. This is specified in the fifth proviso to clause 10(10D). This has been done to prevent the misuse of the provisions by purchasing multiple smaller policies.


    Example: Mr. Rakesh has purchased one ULIP policy on 02.02.2021 and one more on 10.03.2021. The sum assured of the policies are Rs. 20 Lakh and Rs. 10 Lakh having premium of Rs. 2 Lakh and Rs. 1 Lakh respectively. Further, he has an existing ULIP purchased on 10th Oct., 2018 for which he pays an annual premium of Rs. 4,00,000 (SA: Rs. 40 Lakh). He has one more existing ULIP for which he pays a premium of Rs. 35,000 for a sum assured of Rs. 3,00,000. This policy was purchased in 2019. Find out which policies will be taxable in the year of redemption of the ULIPs.


    The taxability of different ULIP policies of Mr. Rakesh are as follows-


    1. Existing ULIP policy having sum assured Rs. 40 Lakh and premium of Rs. 4 Lakh: This ULIP is purchased before 1st Feb., 2021 and hence is not covered by the fourth proviso to Section 10(10D). Further, since the premium is not more than 10% of the sum assured of the policy, it is not hit by the taxability provisions of section 10(10D)(d).


    2. Existing ULIP policy having sum assured Rs. 3 Lakh and premium of Rs. 35,000: This ULIP is purchased before 1st Feb., 2021 and hence is not covered by the fourth proviso to Section 10(10D). However, since the policy is purchased after the 1st day of April, 2012 and since the premium is more than 10% of the sum assured of the policy, it is hit by the taxability provisions of section 10(10D)(d). Hence, the maturity proceeds of this ULIP will be taxed in the year on redemption.


    3. ULIP policies purchased after 01.02.2021: The premium for each policy does not exceed Rs. 2,50,000 but the aggregate premium of all the ULIP policies acquired after 01.02.2021 exceeds Rs. 2,50,000. Hence, it is hit by the fifth proviso to section 10(10D). The aggregate amount of premium is Rs. 3,00,000 in this case for all the ULIPs purchased after 1.2.2021.


    A tricky situation in case of taxation of ULIP policies on or after 1.2.2021.


    Remember, sub-clause(d) of section 10(10D) provides for taxation of all the insurance policies under certain circumstances. It provides that any sum received under an insurance policy issued on or after the 1st day of April, 2012 in respect of which the premium amount exceeds 10 per cent of the actual capital sum assured shall be subject to tax. This sub-clause covers both the ULIP and non ULIP policies.


    The fourth proviso specifically provides for taxation of ULIP policies if the same are issued after 1.2.2021 and the premium exceeds Rs. 2,50,000.


    Illustration 1: Mr. Rakesh purchased an ULIP policy on 10th February 2021 having a sum assured of Rs. 40,00,000 and the premium for such policy is Rs. 3,50,000. The maturity proceeds of this ULIP policy will be taxed as per fourth proviso to section 10(10D); since the premium is more than Rs. 2,50,000 and is purchased after 1.2.2021.


    Illustration 2: Mr. Rakesh purchased an ULIP policy on 10th February 2021 having a sum assured of Rs. 40,00,000 and the premium for such policy is Rs. 4,50,000. The maturity proceeds of this ULIP policy will be taxed as per fourth proviso to section 10(10D) and not as per section 10(10D)(d); since the premium is more than Rs. 2,50,000 and is purchased after 1.2.2021. It is immaterial whether the premium exceeds 10% of the sum assured or not. This is because the fourth proviso specifically states that “nothing  contained  in  this clause shall apply with respect to any unit linked insurance policy……………”. 


    Hence, when the premium of an ULIP policy purchased after 1.2.2021 exceeds Rs. 250000, it will be taxed as per 4th proviso only.


    Illustration 3: Mr. Rakesh purchased an ULIP policy as detailed below-

    Sl. No.

    ULIP Policy

    Date of Purchase

    Sum Assured

    Premium

    1.

    ULIP Policy 01

    01.03.2021

    5,00,000

    60,000

    2.

    ULIP Policy 02

    10.03.2021

    4,00,000

    40,000


    In these cases, the aggregate premium is less than Rs. 2,50,000, hence, fourth and fifth proviso shall not apply. But despite this, the Policy No. 1 will be taxed u/s 10(10D)(d) since the premium is more than 10% of the sum assured. The second ULIP policy (Policy 2)  will remain tax free.


    Illustration 4: Mr. Rakesh purchased an ULIP policy as detailed below-

    Sl. No.

    ULIP Policy

    Date of Purchase

    Sum Assured

    Premium

    1.

    ULIP Policy 01

    01.03.2021

    5,00,000

    60,000

    2.

    ULIP Policy 02

    10.03.2021

    4,00,000

    40,000

    3.

    ULIP Policy 03

    12.03.2021

    20,00,000

    2,00,000


    In these cases, the premium for each of the individual policies is less than Rs. 2,50,000. But the aggregate premium for policy 1 + policy 3 exceeds Rs. 2,500,000 and hence is covered by the fifth proviso shall not apply. Hence, policy 1 and policy 3 will be taxable. Policy 2 will remain tax free.


    Fifth proviso to Section 10(10D)


    Fifth proviso to clause 10(10D) is proposed to be inserted 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 Rs. 2,50,000, for any of the previous years during the term of any of the policy.


    However, this taxability clause will not apply to all the ULIP policies. In other words, proceeds from all the ULIP policies are not taxable. It is taxable only if-

    (i) the ULIP policy is issued on or after 1st February, 2021, and

    (ii) the aggregate premium amount of some ULIP policies exceeds Rs. 2,50,000.


    The fifth proviso reads as follows-


    “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.”


    Analysis of the Fifth proviso to Section 10(10D)


    The fifth proviso intends to prevent the misuse of the provision by purchasing smaller policies with low premium but in aggregate the premium on multiple policies will exceed Ra. 2,50,000.


    However, all the smaller policies are not required to be aggregated or subject to tax. This 5th proviso only intends to tax high premium ULIPs and to spare low premium ULIPs from tax. Thus one needs to use permutations and combinations to find out which low premium ULIPs will be subject to taxation and which such policies will be taken for tax exemption. In this exercise, one should consider that low premium ULIP policies as taxable where the tax incidence will be lower.


    Illustration to explain fourth and fifth proviso and Section 10(10D)(d)


    Illustration 3: Mr. Rakesh purchased a ULIP policy as detailed below-

    Sl. No.

    ULIP Policy

    Date of Purchase

    Sum Assured

    Premium

    1.

    ULIP Policy 01

    15.02.2021

    20,00,000

    2,00,000

    2.

    ULIP Policy 02

    20.02.2021

    10,00,000

    1,00,000

    3.

    ULIP Policy 03

    01.03.2021

    5,00,000

    60,000

    4.

    ULIP Policy 04

    10.03.2021

    4,00,000

    40,000

    5.

    ULIP Policy 05

    12.03.2021

    30,00,000

    3,00,000


    The above case is covered by the fifth proviso to section 10(10D) since more than one ULIP is bought on or after 1.2.2021. The amendment proposed to insert fifth proviso 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 ULIP policies aggregate premium whereof does not exceed Rs. 2,50,000.


    Which policy or policies are taxable as per 4th proviso


    Only ULIP Policy 05 is subject to tax as per the 4th proviso.


    Which policy or policies are taxable as per 5th proviso


    Two combinations of premium of ULIP policies will breach the limit of Rs. 2,50,000-


    ULIP Policy 01 + ULIP Policy 02 = Rs. 2,00,000 + Rs. 1,00,000 = Rs. 3,00,000

    ULIP Policy 01 + ULIP Policy 03 = Rs. 2,00,000 + Rs. 60,000 = Rs. 2,60,000


    But only the first combination [ULIP Policy 01 + ULIP Policy 02] will be hit by fifth proviso since Policy 3 will be subject to tax by sub-clause (d).


    Maturity proceeds for Policy 4 will remain tax free.


    Which policy or policies are taxable as per 10(10D)(d)


    Policy 3 will be subject to tax by sub-clause (d)


    Sixth proviso to Section 10(10D): Proceeds received on death of the policyholder


    Sixth proviso to clause (10D) of section 10 is proposed to be inserted to provide that the provisions of fourth and fifth provisos shall not apply to any sum received on the death of a person.


    Notes: 

     

    1. The fourth and fifth proviso shall apply when the ULIP policy is received by the policyholder himself/herself on maturity or surrender of the policy. In other words, the proceeds are received when the policyholder is alive.

     

    2. The first proviso provides that provisions of sub-clauses (c) and (d) of section 10(10D) shall not apply to any sum received on the death of a person under an Insurance policy.


    Issues in the fourth and fifth proviso


    A careful study of fourth and fifth proviso reveals the followings issues-


    1. It appears that if an ULIP is purchased on or after 1st Feb. 2021, then if in any financial year during the tenure of such policy the aggregate limit of premium of Rs. 2,50,000 will apply. For example, if a policy is acquired on 1st February 2021 for Rs. 2,00,000 premium amount for a tenure of 10 years. In 2030, if another policy having a premium of Rs. 1,00,000 is purchased then both the policy will be hit by fifth proviso to section 10(10D) and would become taxable.


    2.  It appears that if a person buys separate ULIP policies from different insurers with a premium of less than Rs. 2,50,000 for each policy then he can escape from being caught under fifth proviso.


    3. An ULIP policy is first covered by section 10(10D)(d). If the premium of the policy exceeds 10% of the sum assured then such a policy would be subject to tax. The steps to apply section 10(10D)(d) and fourth and fifth proviso on ULIP policies are as follows-


    (i) If the premium of the ULIP policy exceeds Rs. 2,50,000 purchased on or after 1.2.2021, then the taxability of such ULIP will be governed by fourth proviso to section 10(10D). In this case, it is immaterial whether the premium amount exceeds 10% of the sum assured or not, it will become taxable.


    (ii) If the premium of the ULIP policy exceeds Rs. 2,50,000 purchased upto 31.1.2021, then the taxability of such ULIP will be governed by fourth proviso to section 10(10D). In this case, the only material fact is whether the premium amount exceeds 10% of the sum assured or not. If it is so, it will become taxable else not.


    (iii) In case of multiple low premium ULIP policies where the premium of each ULIP does not exceed Rs. 2,50,000, but in aggregate, some of the ULIPs exceed Rs. 2,50,000, then exemption shall be allowed only with respect to low premium ULIPs the aggregate of which is below the limit of Rs. 2,50,000.


    If the premium payable for each ULIP policy does not exceed Rs. 2,50,000 but the aggregate of premium payable for all such policies exceeds Rs. 2,50,000, the exemption under this section would be allowed only in respect of those policies whose aggregate premium is within such prescribed limit.


    4. Maturity or surrender proceeds from the redemption of an ULIP policy will be subject to capital gains tax only if it is covered by fourth and fifth proviso to section 10(10D). If the same is taxable otherwise by virtue of sub-clause (d) [where the premium exceeds 10% of the sum assured] then the law did not prescribe the head under which the same shall be taxable. This is because only an ULIP policy which is subject to fourth and fifth proviso to section 10(10D) is defined as a ‘capital asset’.


    Analysis of the Sixth proviso to Section 10(10D)


    The first proviso and the sixth proviso of section 10(10D) makes it clear that any proceeds from a life insurance policy whether an ULIP or a non-ULIP policy received on the death of the person shall always remain tax-free under any circumstances. It will be irrelevant whether the premium exceeds 10% of sum assured or not and the premium of ULIP exceeds Rs. 2,50,000 or not, such receipt on death will remain exempt from tax.


    Seventh proviso to Section 10(10D): Power to Central Government to issue guidelines


    The seventh proviso to section 10(10D) enables CBDT to issue guidelines with the approval of the 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.


    The seventh proviso reads as follows-


    “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.”


    Analysis of the Seventh proviso to Section 10(10D)


    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.


    This proviso is not limited to ULIP policies only.


    Explanation 3 to Section 10(10D): Clarifying the meaning of ULIP


    It is proposed to 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.


    Note: Regulation 3(ee) of Insurance Regulatory and Development Authority of India (Unit Linked Insurance Products) Regulations, 2019 defines “Units” to mean a specific portion or part of the underlying segregated Unit Linked fund which is representative of the policyholder’s entitlement in such funds.


    Explanation 3 to section 10(10D) reads as follows-


    “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.”


    Explanation 3 to section 10(10D) proposed to define the expressionunit 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. 


    Section 2(14): ULIP defined as ‘Capital Assets’


    Section 2(14) is proposed to amend the definition of ‘capital assets’ to provide that a ULIP [to which exemption under section 10(10D) does not apply on account of the applicability of the fourth and fifth proviso] is a capital asset under section 2(14). It proposed to define capital asset to mean “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.”


    It is, thus, proposed to amend clause (14) of the 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.


    Analysis of section 2(14)(c) to define ULIP as a capital asset


    By including the ULIP policies in the definition of ‘capital assets’, the income therefrom are subject to capital gains tax under the Act. Further all the ULIPs are not capital assets, only those ULIPs are ‘capital assets’ which are subject to tax under the fourth or fifth proviso to section 10(10D). Thus ULIP policies purchased on or after 01.02.2021 and premium whereof exceeds Rs. 2,50,000 are covered under this clause as ‘capital assets’.


    In this context, it should be remembered that not all the ULIP policies are capital assets. Maturity or surrender proceeds from the redemption of an ULIP policy will be subject to capital gains tax only if it is covered by fourth and fifth proviso to section 10(10D). If the same is taxable otherwise by virtue of sub-clause (d) [where the premium exceeds 10% of the sum assured] then the law did not prescribe the head under which the same shall be taxable. This is because only an ULIP policy which is subject to fourth and fifth proviso to section 10(10D) is defined as a ‘capital asset’.


    Section 45(1B): Taxability of maturity proceeds of ULIP under the head capital gains


    Section 45 of the Act provides that any profits or gains arising from the transfer of a capital asset in a previous year 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 the transfer took place.


    In other words, capital gains will be taxed on an accrual basis. It means even if the consideration is not received in the previous year but if the transfer takes place in the previous year, it will be subject to capital gains tax.


    In order to provide relief and to tax the capital gains on ULIP policies, it is provided that such capital gains shall be taxed on receipt basis. Thus, in case of tax on ULIP policies, capital gains shall be computed in the previous year in which maturity proceeds or surrender proceeds are received.


    Section 45(1B) provides 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. This sub-section  also empowers CBDT to prescribe rules for calculation of such capital gains from taxable ULIP policies.


    Section 45(1B) reads as follows-


    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.


    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. 


    As stated earlier, only those ULIP policies are taxable and covered by section 45(1B) which are qualified to be ‘capital assets’ as per section 2(14).


    Rate of Capital Gains Tax on proceeds from ULIP


    As stated above, ULIP funds may be Equity oriented or debt oriented ULIP funds. In simple terms, an equity oriented fund is a fund which invests more than 65% of the fund amount in equity shares. A fund which is not an equity oriented fund is a debt oriented fund.


    Equity Oriented ULIP Funds


    It is proposed to bring the gains on receipt of proceeds from redemption of taxable ULIPs under the head ‘Capital Gains’. Capital gains are of two types-

    (a) Short Term Capital Gains

    (b) Long Term Capital Gains


    A unit of equity oriented mutual fund is said to be a short term capital asset if it is held for 12 months or lower period. In case, it is held for more than 12 months then the same qualifies for long term capital asset. The gain from short term capital assets is termed as short term capital gains whereas the gains from long term capital assets is termed as long term capital gains.


    Section 112A - Long Term Capital Gains from Equity Oriented ULIP Funds


    The tax rate on capital gains from taxable ULIPs is based on the type of fund of the ULIP. In case of an equity oriented ULIP fund, the long term capital gains is chargeable under section 112A of the Act. The rate of tax u/s 112A is 10% without any indexation benefit. There will be no tax if the long term capital gains chargeable to tax does not exceed Rs. 1,00,000. If the LTCG u/s 112A exceeds Rs. 1,00,000 then tax will be payable on such excess amount gain over Rs. 1 Lakh. Hence, there is exemption of Rs. 1,00,000 of LTCG chargeable to tax u/s 112A.


    Section 112A provides for long term capital gains tax inter-alia on the transfer of units of an equity oriented fund. Presently, as per clause (a) of the Explanation of the section, expression “equity oriented fund” means a scheme of a mutual fund having 65%/90% exposure in the equity market.


    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”. 


    Thus, the amendment in section 112A proposed to include taxable ULIPs as per fourth and fifth proviso of section 10(10D) in the definition of equity oriented fund in section 112A so as to provide them the same treatment as the unit of equity oriented fund. Hence, the treatment of taxability on receipt of proceeds upon redemption of taxable ULIPs are at par with that of mutual funds.


    Section 111A - Short Term Capital Gains from Equity Oriented ULIP Funds 


    As section 112A is proposed to be amended to include receipt of proceeds upon redemption of taxable ULIPs in case of long term capital gains, the corresponding section 111A which deals with short term capital gains arising from the transfer of units of equity oriented funds is applicable for taxable ULIPs.


    From the perusal of Finance Bill, 2021 it appears that there is no amendment in section 111A so as to include the taxable ULIPs within its purview. However, there is no such requirement since the expression "equity oriented fund" as per explanation to section 111A refers to the meaning as defined in section 112A where the amendment is proposed to include taxable ULIPs.


    Hence in case of short term equity oriented ULIP fund units, the tax rate under section 112A is 15%.


    Hence, provisions of section 111A and 112A would apply on sale/redemption of taxable ULIPs for the short term and long term capital gains respectively arising from equity oriented ULIP funds.


    Debt Oriented ULIP Funds


    A unit of debt oriented mutual fund is said to be a short term capital asset if it is held for 36 months or lower period. In case, it is held for more than 36 months then the same qualifies for long term capital asset. The gain from short term capital assets is termed as short term capital gains whereas the gains from long term capital assets is termed as long term capital gains.


    Long Term Capital Gains from Debt Oriented ULIP Funds 


    In this case, the long term gains will be taxable @ 20% u/s 112. Indexation benefit will be available to the cost of acquisition. Hence, long term capital gains on redemption of units of debt oriented ULIP funds will be taxed at the rate of 20% after allowing indexation benefit.


    Short Term Capital Gains from Debt Oriented ULIP Funds 


    In this case, the short term gains will be taxable normal slab tax rates of the taxpayer. Short term capital gains on redemption of units of debt oriented ULIP funds will be taxed at the normal rate of tax as applicable to the taxpayer.


    TDS u/s 194DA on maturity proceeds of ULIP


    Section 194DA provides for deduction of tax  from the payment under a life insurance policy which is not exempt from tax u/s 10(10D). In case, the payment from the maturity or surrender proceeds of the life insurance policy which is taxable [as not exempt u/s 10(10D)] exceeds Rs. 1,00,000/-, tax will be deducted @ 5% on the amount of income comprised therein.


    Presently, section 194DA covers those life insurance policies which are paid on maturity or on surrender of a life insurance policy where the premium amount exceeds 10% or 20% of the sum assured based on the date of issue of the policy. Hence, as per extant provision, ULIP is subject to TDS under this section if the premium exceeds 10% (if the policy is issued on or after the 1st day of April, 2012) or 20% (if the policy is issued on or after the 1st day of April, 2003) of the sum assured of the ULIP policy.


    After the proposed amendment in section 10(10D), an ULIP policy if covered by fourth and fifth proviso shall be subject to TDS under section 194DA since such an ULIP is not exempt u/s 10(10D).


    In this case the tax shall be required to be deducted @ 5% on the amount of income in the form of capital gains comprised in the payment of such ULIP, if the ULIP qualifies as capital asset as per section 2(14). 


    In case an ULIP is covered under section 10(10D)(d), then 5% TDS shall apply on the amount of income comprised therein.


    Security Transaction  Tax (STT) on ULIP


    STT was introduced by Union Budget 2004 presented by the then Finance Minister P. Chidambaram. This securities transaction tax was imposed in lieu of a lower tax on the short-term capital gain (STCG) and exemption of  Long-term capital gain (LTCG) tax on equities. STT is levied under Chapter VII of Finance (No. 2) Act, 2004.


    Finance Bill, 2021 proposed to bring high premium ULIPs under tax net by withdrawing the exemption given under section 10(10D) of the Income Tax Act, 1961.


    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 (ULIP) issued by such insurance company on or after the 1st day of February 2021 have been included in the definition of "taxable securities transaction" u/s 97(13)(b) of the Finance (No.2) Act, 2004.


    Note: STT is proposed on all the ULIP policies whether high or low premium. Since, nowhere it is mentioned that STT shall be levied only on ULIP covered by fourth or fifth proviso to section 10(10D). Rather, it is simply proposed that redemption of an unit of ULIP as defined in Ecpalantion 3 to section 10(10D) shall be subject to STT.


    Rate of STT on ULIP


    The rate of STT on taxable ULIP is proposed as 0.001% on the amount of maturity proceeds.


    Taxability of maturity proceeds of ULIP Policies

    ParticularsEquity Oriented ULIP FundDebt Oriented ULIP Fund
    Short TermLong TermShort TermLong Term
    Period of HoldingUpto 12 monthsAbove 12 monthsUpto 36 monthsAbove 36 months
    Capital Gains Rate of Tax15% u/s 111A10% u/s 112A
    (in excess of Rs. 1,00,000/-)
    Applicable Rates20% u/s 112
    Indexation BenefitNANot AvailableNAAvailable



    Read more on Finance Bill, 2021

    Download Finance Bill, 2021 as introduced in Loksabha

    Download Memorandum Explaining the Provisions in the Financial Bill 2021

    Income Tax announcements in Budget Speech:Union Budget 2021

    New Income Tax Slab Rates after Union Budget 2021

    Changes in TDS and TCS Provisions by Finance Bill, 2021

    Changes in Tax Exemption and Taxability on ULIP: Budget 2021

    Security Transaction  Tax (STT) made applicable on ULIP: Budget 2021



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    5 Comments

    1. Are these provisions applicable to UTI ULIP 1971 scheme (a 10 year period scheme) which I had started to invest from 25-01-1999 with an annual premium of Rs.7500/- (Rs.510/- taken towards Life insurance premium and the balance of Rs.6990/- invested in debt instruments for 7 years and the full amount of Rs.7500/- for the remaining 3 years was invested. They have given BONUS Units every year. I want to know how this ULIP is taxed.
      I have not yet redeemed the Units.

      ReplyDelete
      Replies
      1. Since you took the policy prior to April 2003, the entire proceeds from ULIP will be exempt from tax u/s 10(10D)

        Delete
    2. I subscribed to single premium 7 lakhs , monthly guaranteed income plan
      debt fund, with IDBI FEDERAL ON 28 MAR 2011 maturity 27 MAR 2021. (SUM ASSURED 770,000. The company informed there will be TDS of 30% .

      Since subscription is before 2012 and maturity beore 31 March 2021 , is company right is deducting TDS? Am I taxable on gain for AY 2020-21?

      ReplyDelete
      Replies
      1. Yes your policy is taxable as per section 10(10D)(c) as you premium amount exceeds 10% of the sum assured. Hence TDS will apply as per section 194DA. But the rate of TDS will be 5% if you are a resident.

        Delete
      2. In case of non-resident, the rate of TDS is 30%.

        Delete