Income Tax on Maturity proceeds of Life Insurance Policy- Whether Taxable or not?

This article deals with a very confusing and important issue “Taxability of Maturity proceeds received against life insurance policies”. Most taxpayers are having a misconception that the maturity proceeds of a life insurance policy are tax-free. But it is not completely true. The confusion revolving around the issue becomes aggravated when TDS is deducted by the life insurance company on the maturity proceeds @ 5% as prescribed under section 194DA of the Income Tax Act. Therefore, this article is intended to answer the issues & confusions regarding the taxability of maturity proceeds of life insurance policies. Please note that the taxability of Pension Plans floated by life insurance companies is not covered by this article and shall be discussed by us in some other article in the future.

It is a well-known fact that the amount against any life insurance policy can be received by the policyholder in the following three situations:

• Death claim to the nominee in case of the death of the policyholder
• Maturity claims to the policyholder at the end of the policy term
• Surrender value in case the policy is surrendered before the expiry of the policy term

There are two important points to be noted in this regard before moving ahead in this article:

Income Tax Provision governing the taxability of maturity proceeds of a life insurance policy

Source: www.incometaxindia.gov.in

Analysis of section 10(10D)

Based on a perusal of the above provision, the following possibilities shall prevail regarding the taxability of maturity proceeds of life insurance policies.

We will take an example to understand the above concept:

Suppose Mr. Ram took a life insurance policy on 05-05-2012 for which the sum assured is Rs. 30 Lakhs. The annual premium payable is Rs. 96,000. The policy is having a term of 15 years. On maturity, the policyholder will receive Rs. 30 Lakhs plus accrued bonus. What is the tax treatment of the policy?

Solution: The first important thing to note is the date of issuance of the policy. The policy has been issued after 01-04-2012. Annual Premium payable is less than 10% of Rs. 30 Lakhs:
10% of Sum assured = Rs. 30 Lakhs * 10% = Rs. 3 Lakhs
Annual Premium = Rs. 96,000

Since, the annual premium does not exceed 10% of the sum assured, therefore the entire maturity claim receivable by Mr. Ram will be exempted from tax. Further, a Death claim is completely tax-free.

Note:

• The threshold limit of 10%-20% is only in respect of policies issued on or after 01-04-2003. Further, in the case of death claims, the threshold limit of 10%-20% is not relevant and the entire death claim is non-taxable.
• It is to be noted that insurance premiums may be paid on a monthly/ quarterly/ half-yearly basis also. In such a case, we will have to calculate annualized premium for checking threshold of 20%/10% or 15%. For example, the premium is paid Rs. 1000 quarterly then the annualized premium Rs. 1000 * 4 = Rs. 4,000 shall be considered for checking applicability of 10% / 15% or 20%.

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Before moving ahead, you will be interested in knowing about the concept of “Sum Assured”. So, we shall discuss the term “Sum Assured”.

What is Sum Assured?

• Explanation 2 to section 10(10D) states that- For the purposes of sub-clause (d), the expression “actual capital sum assured” shall have the same meaning assigned to in the Explanation to sub-section (3A) of section 80C.
   
• Explanation to Section 80C(3A)

As per Explanation to Section 80C(3A), “actual capital sum assured” in relation to a life insurance policy shall mean the minimum amount assured under the policy on happening of the insured event at any time during the term of the policy, not taking into account-

(i) The value of any premium agreed to be returned; or
(ii) Any benefit by way of bonus or otherwise over and above the sum actually assured, which is to be or may be received under the policy by any person.

In simple language, “Sum Assured” means the amount of the policy based on which the insurance company decides the amount of insurance premium. ‘Sum Assured’ is the amount that is payable to the policyholder or his nominee in the event of termination of policy term or death of the policyholder without including returnable premium or allocated bonus, if any.

How to calculate the taxable amount of maturity proceeds of a life insurance policy?

Suppose, you have a policy with a sum assured Rs. 10 Lakhs on which premium is paid in 3 equal installments of Rs. 2,50,000 each. Thus, you have paid Rs. 7,50,000 in total and receive Rs. 10 Lakhs as maturity proceeds in FY 2021-22. Net Income on the policy is [10 Lakhs- 7.50 Lakhs] i.e. Rs. 2,50,000. A question comes to our mind: whether the entire amount of Rs. 10 Lakhs will be taxable or the net income of Rs. 2,50,000 will be taxable.

To answer this question, we will explore the background of the amendment made by the Government. We will refer to “Memorandum to Finance Bill, 2003” which explains the taxability of maturity proceeds of life insurance policies.

Thus, we can draw a conclusion from the above reading that the insurance policies with high premium and minimum risk cover are nothing but similar to “deposits” or “bonds”. Thus, the taxability of such life insurance policies shall be similar to deposits or bonds. The Explanation as referred above makes it clear that such insurance policies are to be treated at par with other investment schemes while filing ITR online. We all know that in the case of a fixed deposit, the difference between maturity proceeds and the principal amount is taxable. Similarly, in the case of life insurance policies with high premiums, the net income i.e. difference of maturity proceeds of insurance policy and premium paid shall be taxable. Therefore, in the above example, a net income of Rs. 2,50,000 will be taxable in the hands of the policyholder.

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Head of income for tax on maturity proceeds of Life Insurance Policy

• In the above section of the article, we have come to the conclusion that net income in respect of high premium policies shall be taxable. But, the next question before us is about “What will be the suitable head of income where such income is to be shown while efiling ITR?”
• We all are aware that there are five heads of income in the Income Tax Act where any taxable income could be classified. Under the Income Tax Act, there is no specific head as prescribed for “maturity proceeds of life insurance policy”. So, net income from a life insurance policy should fall in the residual head of “Income from Other Sources”.
• However, there is one more opinion that a life insurance policy should be treated as a “capital asset” and thus, the income therefrom shall be chargeable under the head “Capital Gains”.
• For reaching to a conclusion, we will refer to CBDT Circular No. 07/2003 dated 05.09.2003 which stated that the insurance policies with high premium and minimum risk covers are similar to deposits or bonds.  As we know, in the case of deposits like Fixed Deposits, only the interest amount is taxable under the head “Income from Other Sources”. Taking a hint from the aforesaid circular, we can conclude that “Income from Other Sources” will be a more appropriate head for the classification of income arising from maturity proceeds of the life insurance policy.

Tax on maturity proceeds of life insurance policy in case of negative net income

In the initial years of life policy, the surrender value of the life policy is generally lower as compared to the investment made in the policy. Therefore, if a policy is surrendered in the initial years, net income from maturity of such policy may be ‘loss’. Under the head “Income from other sources”, there cannot be a loss and therefore the amount of such loss incurred shall be ignored.

TDS on Life Insurance Policies

We have made a lot of discussions above to understand the taxability of life insurance policies. But still, if you are stuck in a confusion, then there is an easier way out to decide whether maturity proceeds received on life policy are taxable or not. Friends, there is a provision for TDS deduction u/s 194DA of the Income Tax Act, 1961 on the maturity proceeds of life insurance policies. If TDS has been deducted by the insurance company on a claim paid to you, it means that proceeds of such policy are taxable under Income Tax Act. For better understanding, we shall discuss the provisions of Section 194DA in detail.

The Finance Act, 2014 inserted a new section 194DA which prescribed for deduction of tax at source @ 5% from any payment by an insurance company to a resident person for life policy held by such person with the company, except in a case where the payment amount is exempt u/s 10(10D) or does not exceed Rs. 1 Lakh in a financial year. The payment shall include an allocated bonus on such policy.

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We can analyze section 194DA as below:

• Under section 194DA, the liability to deduct TDS is upon the insurance company.
• TDS shall be deductible on any sum (maturity proceeds/ surrender value/ allocated bonus) as is payable against a life insurance policy.
• TDS shall not be deducted on such policies which are covered by the exemption under section 10(10D) of the Income Tax Act.
• There is a threshold limit of Rs. 1 Lakh for deduction of TDS u/s 194DA. Even in a case where the proceeds of the life insurance policy are taxable, no TDS shall be deducted if the amount paid to a policyholder in a financial year does not exceed Rs. 1 Lakh in aggregate.
• TDS shall be deducted at the prescribed rate of 5%. In case the policyholder fails to provide PAN, the insurance company shall be liable to deduct TDS @ 20%.

Amendment in Section 10(10D) by Finance Act 2021

Tax on ULIP (Unit Linked Insurance Plan)

An important amendment has been introduced by Budget 2021 concerning the taxability of Unit Linked Insurance Plans (ULIP). The effect of the amendment is that the amount received by the policyholder against ULIP shall be taxable in certain cases. The amendment has been made by inserting a proviso to Section 10(10D) of the Income Tax Act, 1961. We will first read the newly inserted proviso and then analyze the effect of the same.

Analysis of amendment:

ULIP is a life insurance policy that is a unit-linked plan like equity-oriented mutual funds, having both investment and insurance components in it.

Tax on ULIP issued till 31-01-2021

 It is to be noted that amount received with respect to ULIP till 31^st January 2021 is totally exempted u/s 10(10D).

Tax on ULIP issued on or after 01-02-2021

Any ULIP issued on or after 1^st February 2021 will be subjected to the following amendment:

• If any person is paying an annual premium against a ULIP of more than Rs. 2,50,000 in any of the years of the policy term, the proceeds (maturity/ surrender value) of the ULIP shall be taxable and should be shown in IT return filing. Only ULIPs issued on or after 1^st February 2021 shall be hit by this amendment.
• But a question arises in mind that if any person holds more than one ULIP issued on or after 1^st February 2021, then what shall be the tax impact. In this respect, it has been clarified by the law that the threshold limit of Rs. 2,50,000 is to be calculated policy-wise and not person-wise. To understand this, take an example:

Suppose, Mr. Ram holds 4 ULIPs issued on or after 1^st February 2021 as below:           

As seen in the above example, only ULIP-A has an annual premium of more than Rs. 2,50,000. Therefore, the maturity proceeds of ULIP-A shall be taxable. Further, in respect of ULIP-B, C & D, the aggregate annual premium of all the 3 ULIPs is more than Rs. 2,50,000 but individually it is less than Rs. 2,50,000. These three ULIPs shall not be affected by the amendment made in section 10(10D) and shall continue to be exempted.

•  In case of the death of the policyholder, the claim received against ULIP shall be exempted. It does not matter whether the annual premium is more than Rs. 2,50,000 or not.
• Section 10(10D) empowers CBDT to frame necessary guidelines for removing difficulties for effective implementation of the amendment so made.

Concluding Remark:

From the above discussion, it is clear that a death claim is always non-taxable whether it is a ULIP or a traditional insurance plan, or an investment plan. However, in case of maturity/ surrender other than death cases, the policyholder should not jump to the conclusion that the amount received against the policy is exempted. Rather, the policyholder should check whether his/her policy falls under the exclusions of section 10(10D) or not. It is very important to decide the taxability of insurance policy as per section 10(10D) of the Act otherwise it might lead to the undue financial burden in the form of interest and penalties under the Income Tax Act.

Disclaimer: The above article is based on the opinion of the author and is meant merely for information purposes. Readers should act diligently in consultation with a professional while applying the information contained in the above article.