Tuesday, December 19, 2023

Comprehensive Guide to Understanding Recent Changes in Taxation for Life Insurance Policies


Life insurance policies serve as a crucial component of financial planning, providing security and support to individuals and their families. However, it is essential for policyholders to stay informed about changes in taxation, as these can significantly impact the financial outcomes of their investments. The Finance Act of 2023 has introduced noteworthy amendments, effective from 01-04-2024, influencing the assessment year 2024-25 and beyond. This comprehensive guide aims to provide a detailed understanding of these changes, their purpose, and their implications for policyholders.

Overview of Amendments by Finance Act, 2023

1.1 Amendment in Section 10(10D) The Finance Act introduces changes to Section 10(10D), which previously granted exemptions for sums received under life insurance policies. The recent amendments renumber the sixth proviso and introduce a new sixth proviso restricting exemptions for high-premium policies, a seventh proviso limiting exemptions for multiple policies, and an eighth proviso exempting sums received on a person's death. Policies issued on or after 01-04-2023, termed "high premium life insurance policies," are affected.

1.2 Amendment in Section 2(24) Section 2(24) now includes a new sub-clause (xviid), specifying sums mentioned in Section 56(2)(xiii) as income.

1.3 Amendment in Section 56 Section 56 introduces a new clause (xiii) that specifies the taxation of sums received under a life insurance policy not qualifying for exemption under Section 10(10D) as "Income from Other Sources."

Purpose of Amendment

The primary objective of amending Section 10(10D) is to prevent the misuse of exemptions intended for genuine life insurance coverage. Over the years, changes were made to curb misuse, including introducing premium limits and reducing thresholds. The recent amendments aim to extend tax exemptions to those genuinely in need and bring transparency to the taxation of life insurance policies.

Analysis of Finance Act, 2023 Amendments

1. Key Changes by Finance Act, 2023

(a) Exemption for High Premium Policies: The amendment excludes high premium life insurance policies from the Section 10(10D) exemption.

(b) Applicability from 01-04-2023: Policies issued on or after 01-04-2023 are not eligible for the exemption under Section 10(10D).

(c) Treatment as Income: Sums received under non-exempt life insurance policies are considered as taxable income.

(d) Taxable Under "Income from Other Sources": Proceeds from such policies are taxed under "Income from Other Sources."

(e) Taxability Upon Receipt: Tax liability arises when sums, including bonuses, are received during a previous year.

(f) Consideration of Excess Premium: Sums exceeding the aggregate premium paid during the policy term are subject to taxation.

(g) Premium Deductions under Other Provisions: Premiums claimed as deductions under other provisions are not counted in the aggregate premium for tax calculation.

(h) Computation as per CBDT Guidelines: The computation mechanism follows guidelines prescribed by the CBDT.

Understanding High-Premium Life Insurance Policies

2.1 Single Life Insurance Policy The sixth proviso applies if the premium payable for any previous year during the policy term exceeds Rs. 5,00,000.

2.2 Multiple Life Insurance Policies The seventh proviso addresses multiple policies, allowing exemption only for those policies with aggregate premiums below Rs. 5 lakhs in any year.

2.3 Calculation of Monetary Limit for Premium Guidelines for calculating monetary limits for premiums on other life insurance policies are awaited from CBDT.

2.4 Lump-Sum Premium Payment Paying premiums in a lump sum does not affect tax exemption if the premium for any previous year does not exceed Rs. 5,00,000.

2.5 Foreign Insurance Companies Exemption under Section 10(10D) and taxability under Section 56(2)(xiii) are not restricted to Indian insurance companies, covering policies from foreign insurance companies.

Understanding these changes is crucial for policyholders to navigate the tax implications effectively and make informed decisions. Always consult a financial advisor for personalized advice.

Simplified Guide: Understanding Changes in Life Insurance Policies

1. Exemption Conditions for Insurance Policies

From 1st April 2023, there are no exemptions for insurance policies issued on or after this date. Specifically, the sixth proviso to Section 10(10D) applies only to high-premium life insurance policies issued after this date. Existing high-premium policies before April 2023 remain eligible for exemption.

2. The Process of Issuing Insurance Policies

Before issuing a policy, insurers follow underwriting, assessing proposals, and conducting medical tests. The Insurance Act, 1938 ensures no risk is assumed until the premium is received. Once underwriting is complete, and the first premium is received, the insurer assumes the risk, marking the commencement of the policy.

3. Sum Received under a Life Insurance Policy

  • Concept of Income: Income-tax Act defines income in Section 2(24), covering various receipts. Insurance proceeds are considered income unless specifically exempted.
  • Insurance Proceeds Income: High-premium ULIPs and Keyman Insurance Policy proceeds are explicitly included. Other life insurance policy proceeds are income if fitting the general meaning, with a new sub-clause (xviid) introduced in Section 2(24) by the Finance Act, 2023.
  • Scope of Income: Income tax principles, distinguishing between capital and revenue receipts, guide the classification. Life insurance policies are considered capital assets, and the sum received may be subject to tax even if it's a capital receipt.

4. Taxability of Income from Life Insurance Policies

  • Liability of a Non-Resident: Taxability for non-residents is determined based on Section 5 and Section 9 of the Act. If income accrues or arises in India, the non-resident is liable to pay tax in India.
  • Situs of Intangible Assets: The situs of a life insurance policy is crucial. The Delhi High Court's CUB Pty Ltd. v. Union of India case highlights that the owner's situs determines taxability.
  • Foreign Life Insurance Policies: Foreign life insurance policies and their income fall under "foreign assets and income," requiring disclosure under the Undisclosed Foreign Income and Assets Act, 2015.

5. Taxability of Insurance Proceeds as Residuary Income

  • Classification of Income: Exempt proceeds under Section 10(10D) don't form part of total income. The Finance Act, 2023 introduces Section 56(2)(xiii) for taxable insurance proceeds, applicable retroactively to receipts from 1st April 2023.
  • Classification under DTAA: If a Double Taxation Avoidance Agreement applies, taxability follows the DTAA or domestic law, whichever is more beneficial.

6. Taxability on a Receipt Basis

Income from life insurance policies is taxable on a receipt basis, as specified in various sections of the Income-tax Act.

7. Excess of Proceeds over Premium Paid

Section 56(2)(xiii) clarifies that the excess sum received under a life insurance policy over the aggregate premium paid is taxable. The term "premium" includes payments made for insurance coverage.

8. No Deduction for Premium Claimed Elsewhere

Section 56(2)(xiii) excludes any premium already claimed as a deduction under other provisions of the Act from the aggregate premium. Deduction for premiums should be carefully considered under Section 80C.

9. Computation of Income in a Prescribed Manner

The taxable income under Section 56(2)(xiii) is calculated by deducting the aggregate premium claimed under Section 80C from the sum received under the life insurance policy.

Liability of a Non-Resident on Income from Life Insurance Policy

1. Accrual of Income in India:

  • Income from a life insurance policy issued in India accrues in India.
  • As per Section 5, when a non-resident receives a sum under such a policy, the income accrues or arises in India in the previous year when the sum is received.

2. Evaluation under Section 9:

  • Clauses (ii) to (viii) of Section 9 are not relevant.
  • Section 9(1)(i) deems income to accrue or arise in India if it originates directly or indirectly from any asset or source in India.

3. Determining the Source of Income:

  • The source of income needs identification to establish taxability.
  • In the context of a life insurance policy, the policy itself is considered the source.
  • If the policy's situs is in India, income is taxable in India; otherwise, it is not.

Source Location Taxability in India In India Taxable Outside India Not Taxable

4. Intangible Asset and Situs:

  • The situs of intangible assets, like life insurance policies, is not explicitly defined.
  • In CUB Pty Ltd. v. Union of India, the Delhi High Court stated that the situs is where the owner is located, following the principle of 'mobilia sequuntur personam.'

5. Foreign Life Insurance Policies:

  • Policies issued by foreign companies constitute "foreign assets and income."
  • Non-disclosure may violate the Undisclosed Foreign Income and Assets Act, 2015.

6. Taxability of Insurance Proceeds as Residuary Income

7. Classification of Income under Domestic Law (Section 56):

  • Exempt under Section 10(10D) or classified under the relevant head if exemption is not applicable.
  • Finance Act 2023 adds Section 56(2)(xiii) for taxable insurance proceeds, applicable retroactively from 01-04-2023.

Policy Type Sum received before 01-04-2023 Sum received on or after 01-04-2023 High premium (issued before 01-04-2023) Exempt under Section 10(10D) Exempt under Section 10(10D) High premium (issued on or after 01-04-2023) - Taxable under "Income from Other Sources" Other policy (taxable under Section 10(10D)) Taxable under "Capital Gain" Taxable under "Other Sources"

8. Classification of Income under DTAA:

  • DTAA provisions override domestic law.
  • Generally, DTAAs grant taxing rights to the resident country on capital gains.

9. Taxability on Receipt Basis:

  • Income from life insurance policies is taxed on a receipt basis.
  • Dependent on the head of income under which it falls.

10. Excess of Proceeds over Premium:

  • Section 56(2)(xiii) taxes the sum received exceeding the aggregate premium paid.
  • Premium claimed as a deduction under any Act provision is excluded from the aggregate.

11. Meaning of "Premium":

  • "Premium" refers to the payment made for life insurance coverage.

12. Payer of Premium and GST Inclusion:

  • Anyone, including the policyholder, can pay the premium.
  • GST is not included in the premium amount for tax purposes.

13. No Deduction for Claimed Premium:

  • Section 56(2)(xiii) clarifies that premium claimed under any Act provision is excluded from the deductible premium amount.

14. Sequence of Deduction under Section 80C:

  • Section 56(2)(xiii) disallows deduction for premium claimed under Section 80C.
  • Taxpayers should claim life insurance premium deduction under Section 80C only if other investments do not exhaust the limit.

15. Computation of Income under Section 56(2)(xiii):

  • Income is computed as the sum received minus the aggregate premium paid.
  • Chargeability arises only if the sum received exceeds the aggregate premium paid.

Particulars Amount Sum received under life insurance policy *** Less: Aggregate premium paid during the term (***) Taxable Income ***

16. Choosing Policies for Exemption under Section 10(10D):

  • If multiple policies exceed Rs. 5 lakhs in aggregate premium, taxpayers should choose which policies to claim under Section 10(10D) to maximize the exemption.

17. Taxability of Maturity or Surrender Proceeds:

  • Maturity or surrender proceeds from life insurance policies are taxable only if the premium exceeds the prescribed limit.
  • Premium paid for dependents is excluded from this limit.

18. Calculation of Aggregate Premium:

  • The aggregate premium includes premium paid for multiple policies.
  • Deductions under Sections 80C and 80D should not reduce the premium for this calculation.

19. Valuation of Unquoted Equity Shares:

  • Unquoted equity shares' fair market value is determined using the NAV method or a Chartered Accountant's valuation report.
  • Mutual fund units' fair market value is computed based on the lower of NAV or sale price.

20. Period for Complying with the GST Rules:

  • Insurers should comply with the GST rules within six months from the notification date.
  • The Notification 24/2018 date is 01-08-2018, making the deadline 31-01-2019.

21. GST Applicability on Maturity or Surrender Proceeds:

  • GST is not applicable to maturity or surrender proceeds from life insurance policies.

22. Applicability of GST on Premium Paid:

  • GST is applicable to life insurance premiums, including riders, if the premium is paid after the GST introduction date.

23. GST Rate on Insurance Premium:

  • The GST rate on insurance premiums is 18%, applicable to all types of insurance.

24. GST Applicability on Pension Policies:

  • GST is not applicable to the service portion of annuity premiums for pension policies.

25. Meaning of Annuity Premium:

  • "Annuity premium" refers to the payment made by the policyholder for receiving a series of payments.

26. Reverse Charge Mechanism for Unregistered Insurers:

  • Policyholders must pay GST on insurance premiums directly to the government if the insurer is unregistered.

27. Liability of a Non-Resident on Income from Life Insurance Policy:

  • Income from a life insurance policy issued in India accrues in India.
  • Section 9(1)(i) deems such income to accrue or arise in India.
  • The source of income