There is no clarity on how the gains should be calculated on life insurance policies, points out Tinesh Bhasin.
Illustration: Uttam Ghosh/Rediff.com
The Budget proposal to change the tax deduction at source (TDS) on some life insurance policies has confused tax experts.
Unless the Central Board of Direct Taxation provides clarity, tax experts feel that the new proposal can lead to assessing officers interpreting the regulations in a way that suit them, causing problems to the taxpayer.
According to the existing regulations, when an insurer is making a pay-out on life insurance policies where the annual premium exceeds 10 per cent of the sum assured, it needs to deduct tax at the rate of 1 per cent on the total pay-out.
The government now wants insurance companies to deduct tax at the rate of 5 per cent only on the gains (or income from the policy) that a policyholder makes.
But that there is no clarity on how the gains should be calculated on such life insurance policies.
"Currently, there is ambiguity on the characterisation of taxable maturity benefit received on such policies -- whether the income should be considered as capital gains or income from other sources," says Amarpal S Chadha, tax partner and India Mobility Leader, EY.
The method of calculating the gains will determine the amount of TDS payable.
"The provisions of Section 194DA, which are amended, do not prescribe any mechanism for computation of taxable income in case of insurance proceeds," says Naveen Wadhwa, a chartered accountant with Taxmann.com.
Say, an individual bought a single premium life insurance policy with Rs 50 lakh cover in 2013 and paid Rs 10 lakh as one-time premium.
He surrenders the policy in 2019, and the insurance company is paying him a total of Rs 15 lakh.
As the premium exceeds 10 per cent of the sum assured, the insurer will need to deduct tax when it makes a pay-out.
If it's income from other sources, the insurer will deduct 5 per cent as withholding tax on the gains (Rs 5 lakh).
The TDS will be Rs 25,000.
But if it's considered as capital gains, the amount of TDS payable will change.
In the example, the period of holding is more than 36 months.
The investor can get the benefit of indexation.
The long-term capital gains will be Rs 1,86,364 lakh and the TDS will be Rs 9,350 based on the Budget proposals.
Court judgments have held that if a person surrenders the policy, the resultant gains should be considered as capital gains.
"It would be good if the department clarifies how the gains would be taxed as there are multiple interpretations at present. Otherwise, it could give rise to litigation," says Kuldip Kumar, partner and leader, personal tax, PwC India.
According to Chadha, one needs to look at the nature of the insurance policies to decide on the type of income.
For guaranteed return policies with a high premium and minimum risk cover (which are similar to deposits or bonds), it can be arguably considered taxable as income from other sources.
In market-linked plans, the gains or losses in such cases will be comparable to gains or losses made on mutual fund units or shares, and therefore assessable as capital gains.
In such a case the benefit of indexation can be availed.
