Published By: muthoot February 04, 2021
For many years now, unit-linked insurance plans were taxed where the cover was less than 10 times the premium. Suppose you paid an annual premium of ₹1 lakh. But the sum assured on the policy was less than ₹10 lakh. The policyholder had to pay tax on the gains. Until now, it was not clear whether such gains would be taxed as capital gains or income from other sources. The recent Budget settles this issue partially and brings clarity on the taxation of such Ulips. According to the Budget proposal, the gains in policies where the sum assured is less than 10 times the premium will be taxed as capital gains.
There have been different views on the issue based on the rationale used. Some tax experts believed that gains from policies where the sum assured is less than 10 times the annual premium should be offered to tax under the head ‘income from other sources’. Typically, an individual’s income is classified under five heads – salary, business income, income from house property, gains from capital assets, and other sources.
For a person to pay capital gains tax, the asset from which he earned the income should be classified as a capital asset. However, many believed that an insurance policy is not a capital asset. That’s why the gains made should be under the head ‘income from other sources’. Some referred to multiple income-tax cases where judgments talked about what constitutes capital asset where the definition is not clear.
For example, in one case, (CIT vs. Tata Services Ltd. [1980] 122 ITR 594), the ruling said: “The word ‘property’, used in section 2(14) of the Act, is a word of the widest amplitude and the definition has reemphasized this by use of the words ‘of any kind’. Thus, any right which can be called property will be included in the definition of capital assets”.
Many other judgments reinstate the same view. Tax experts point out that going by such ruling, gains from insurance policies where the sum assured is less than 10 times the premium, should be offered to tax as capital gains.
The classification is essential as the tax that a policyholder must pay changes depending on whether the income is classified as capital gains or income from other sources. For example, long term capital gains from equity are taxed at 10% if they are over ₹1 lakh in a financial year. Below ₹1 lakh is tax-free. Long term capital gains for equity investments are those where the investor holds the investment a year or more.
Tax liability under the head income from other sources depends on the marginal tax rate. If an individual is in the 30% tax bracket, he will need to pay 30% tax. As the tax liability changes, there are always divergent views.
The proposed changes in the recent Budget make Ulips a capital asset. Therefore, if the sum assured is less than 10 times the premium, the gains will be taxed as capital gains. The jury is still out on how the gains would be taxed if the policy is not a Ulip, and the sum assured is less than 10 times the annual premium.
