Taxation of ULIP and LIC – Part I

Introduction: The taxation of ULIPs has changed from AY 21-22. Previously, the taxability of unit-linked insurance plans was governed by section 10(10D) of the Income Tax Act 1961. However, the new act now provides clarity on when the maturity proceeds of this plan are taxable and exempt. Understanding the taxation aspects of ULIPs under the Income Tax Act 1961 is crucial for both investors and financial advisors. This article aims to delve into the intricacies of how ULIPs are taxed, shedding light on the various provisions, exemptions, and considerations that impact the tax treatment of ULIPs in India. Through a comprehensive exploration of ULIP taxation under the Income Tax Act, readers will gain valuable insights into optimizing their investments while ensuring compliance with tax regulations.

Also Read: Taxation of ULIP and LIC- Part II

Also there are some changes in taxability of LIC maturity proceeds from 01-04-2023 onwards therefore this article provide you knowledge about that changes and effect of that changes on taxation.

Section 10 (10D) of income tax act:

 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 20 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 10 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 further that for the purpose of calculating the actual capital sum assured under sub-clause (c), effect shall be given to the Explanation to sub-section (3) of section 80C:

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:

 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:

Following provisos shall be substituted for the existing sixth proviso to clause (10D) of section 10 by the Finance Act, 2023, w.e.f. 1-4-2024:

Provided also that nothing contained in this clause shall apply with respect to any life insurance policy, other than a unit linked insurance policy, issued on or after the 1st day of April, 2023, if the amount of premium payable for any of the previous years during the term of such policy exceeds five lakh rupees:

Provided also that if the premium is payable by a person for more than one life insurance policy, other than unit linked insurance policy, issued on or after the 1st day of April, 2023, the provisions of this clause shall apply only with respect to those life insurance policies, other than unit linked insurance policies, where the aggregate amount of premium does not exceed the amount referred to in the sixth proviso in any of the previous years during the term of any of those policies:

Provided also that the provisions of the fourth, fifth, sixth and seventh 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.

Explanation 1.—For the purposes of this clause, “Keyman insurance policy” means a life insurance policy taken by a person on the life of another person who is or was the employee of the first-mentioned person or is or was connected in any manner whatsoever with the business of the first-mentioned person and includes such policy which has been assigned to a person, at any time during the term of the policy, with or without any consideration.

Explanation 2.—For the purposes of sub-clause (d), the expression “actual capital sum assured” shall have the meaning assigned to it in the Explanation to sub-section (3A) of section 80C.

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 (4 of 1938) and the Insurance Regulatory and Development Authority Act, 1999 (41 of 1999);

From  the above provisions we can conclude that:

Following sums are taxable:

1. Insurance policy obtained between 01-04-2003 to 31-03-2012 and premium exceeds 20 per cent of sum assured. {Not taxable if received on death irrespective of the premium amount.}

2. Insurance policy obtained on or after 01-04-2012 and premium exceeds 10 per cent of sum assured. {Not taxable if received on death irrespective of the premium amount.}

3. Insurance policy obtained on or after 01-04-2013 for a person who is suffering from disability or severe disability as referred to in section 80U or suffering from a disease as specified in the rules made under section 80DDB and premium exceeds 15 per cent of the sum assured.

4. If insurance policy issued on or after 01-04-2023 and premium amount exceeds five lakh rupees in any year during the term of policy.(Other than ULIP). {Not taxable if received on death irrespective of the premium amount.}

5. If more than one life insurance policies obtained on or after 01-04-2023 then those insurance policies are exempt whose premium amount in aggregate does not exceeds five lakh rupees in any year during the tenure of policy.(Other than ULIP) {Not taxable if received on death irrespective of the premium amount.}

6. If ULIP is issued on or after 01-02-2021 then if the amount of premium exceeds two lakh fifty thousand rupees in any year during the term of policy.

7. If more than one ULIP’s issued on or after 01-02-2021 then those ULIP’s are exempt whose premium amount does not exceed two lakh fifty thousand rupees in aggregate in any of the year during the tenure of policy.

8. If maturity amount of ULIP is received on death of a person then it is not taxable irrespective of amount of premium paid.

9. Maturity proceeds of Keyman insurance policy is always taxable.

Let’s take an example

A. Policy issued after 01-04-2012 and premium amount does not exceed 10 per cent of assured amount therefore not taxable.

B. Policy issued after 01-04-2012 but the premium amount exceeds 10 per cent of the assured amount therefore taxable. Taxable amount is income component. Further income component as per section 56(2)(xiii) is amount received less premium paid and not claimed under section 80C (W.e.f. 01-04-2023).therefore taxable amount here is 10,00,000-{100000*6=600000}=4,00,000.00

C. Not taxable because ULIP issued before 01-02-2021 and premium amount is not more than 10 per cent of sum assured.

D. Taxable because ULIP issued on or after 01-02-2021 and premium amount exceed 2, 50,000 in a year. Taxable component is amount received first time less aggregate of the premium paid till the receipt of maturity amount.(Rule 8AD).therefore taxable amount 40,00,000-{9*4,00,000=36,00,000}=4,00,000.00

E. If a single person pays premium of E,F,G then he can claim exemption either for E and F because aggregate premium does not exceeds 2,50,000 or can claim exception for G only because premium does not exceed 2,50,000 in a year.

He cannot claim exception for all the three ULIPs as premium amount exceeds in aggregate 2, 50,000 rupees. If he go for E and F then G is taxable and income component is 25,00,000-{250000*9=22,50,000)=2,50,000.00

Or if he go for G then E and F is taxable then income component is {1500000+1000000 }=25,00,000 Aggregate amount received

-{150000*9=1350000+900000)=22,50,000 aggregate premium paid for E and F

Income Component 25,00,000-22,50,000=2,50,000.00

So both options give same results here he can choose any one of them.

H. Taxable even if Premium amount does not exceed 10 per cent of sum assured but exceed five lakh rupees in a year therefore taxable. Income component is 60,00,000-38,50,000=21,50,000.00

I. Not Taxable because premium amount does not exceed 10 per cent of sum assured and also rupees five lakh therefore maturity proceeds are exempt.

Some Important aspects:

Income component for taxability of maturity proceeds of LIC-

1. Section 56(2) (xiii) Any some received including bonus at any time during the PY under life insurance policy other than KIP and ULIP which is not exempted under section 10(10D) the sum received as exceeds the aggregate of the premium paid during the term of such life insurance policy and not claimed as deduction under any other provisions of this act computed in such a manner as may be prescribed.

Therefore remember while calculating income component deduction claimed under section 80C not eligible for deduction.

2. Rule 8AD Computation of capital gain on ULIP:

Amount received first time –

Taxable amount = A-B

A= The amount received for the first time

B=Aggregate of the premium paid till the date of receipt of amount referred in ‘A’ above

Amount Received subsequent time

Taxable amount =C-D

C= The amount received excluding amount already considered in point ‘A’

D= Aggregate of the premium till the date of receipt of the amount referred in ‘C’ above excluding amount already considered in ‘B’ above.

3. The Capital Gain from ULIP is always deemed to be capital gains arising from the transfer of units of an equity oriented fund and taxable u/s 112A(LTCG).

Conclusion: it’s evident that both Unit Linked Insurance Plans (ULIP) and Life Insurance Corporation (LIC) policies carry distinct tax implications that investors and policyholders should carefully consider. ULIPs offer the dual benefit of insurance coverage and investment growth, with tax exemptions on the maturity amount under Section 10(10D) of the Income Tax Act, 1961. On the other hand, LIC policies also provide tax benefits under various sections of the income tax laws, including Section 80C for premium payments and Section 10(10D) for maturity proceeds.

It is crucial for individuals to assess their financial goals, risk appetite, and tax planning needs before opting for either ULIPs or LIC policies. Understanding the tax implications associated with these financial instruments is essential for making informed decisions and maximizing the benefits of tax-saving investments.

Hope this article is helpful for you. Thank You!