If you plan to invest in unit-linked insurance policies (ULIPs), merely for their tax-free maturity proceeds, you need to think again.
Budget 2021 has decided to roll back this exemption to ULIPs if their annual premiums exceed Rs 2.5 lakh. This will be applicable to ULIPs bought on or after February 1, 2021. “Such ULIPs will now be treated as capital assets and profits and gains from such ULIPs will now be taxable as capital gains,” says Mayur Shah, EY India.
Tax parity with equity funds
That is, gains made on such policies will now attract short-term or long-term capital gains (LTCG) tax at redemption or maturity, at par with other equity-oriented investments. “The provisions of section 111A and 112A would apply on sale/redemption of such ULIPs and it would attract 15 percent short-term capital gains tax (STCG) or 10 percent LTCG depending on the holding period,” says Chetan Chandak, Director, TaxBirbal.in. Equity investments qualify as long-term assets if held for more than one year. However, proceeds received by the policyholder’s dependents on her death will continue to be tax-free.
As per current income tax laws, maturity proceeds of life insurance policies are exempt from tax under section 10 (10D). Now, ULIPs are investment-cum-insurance policies that allow exposure to equities, besides corporate debt and government securities. In this sense, they are comparable to mutual funds. Under the old, with-exemption tax regime, both equity-linked saving schemes (ELSS) and ULIPs are eligible for tax deductions on investments made under section 80C. ULIPs come with a lock-in period of five years, and you can surrender your policies after this period, without attracting any charges.
Section 10(10D) exemption gave ULIPs the edge over equity mutual funds, as the latter are subject to long-term capital gains tax (LTCG) on equity-oriented investments introduced in Union Budget 2018. The 10 percent LTCG tax is applicable on gains of over Rs 1 lakh made in a financial year.
Now, however, ULIPs with annual premiums over Rs 2.5 lakh will not enjoy this tax advantage. “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 ULIPs 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,” the Union Budget 2021 memorandum notes.
In doing so, the Rs 30-trillion MF industry has got their demand for tax parity between ULIPs and MFs, at least partially fulfilled.
“This a welcome move. A couple of years back, when long-term capital gains tax (LTCG) was introduced for MFs, ULIPs did not get the same treatment. ULIPs and MFs are both similar wealth creation products,” said Radhika Gupta, managing director and chief executive officer of Edelweiss AMC.
MF industry experts say, due to the tax differential enjoyed by ULIPs, investor interest in ULIPs grew more. “These products were sold to high networth investors because of the tax advantage they offered on the gains. Now, MF products can compete with ULIPs on the basis of investment returns, with tax arbitrage taken away to some extent,” said another executive at a fund house.