This year the Union Budget proposes to remove the exemption on new unit-linked insurance plans (ULIPs) with higher premiums. Its purpose is to eliminate the taxable arbitrage of income from equity oriented mutual funds and to remove income from ULIP that is completely tax free again. How do the new regulations work and what are the issues?
As per the revised rules, if ULIP is issued on or after February 1, 2021, and the premium for any year is higher ₹2.5 lakhs, income from that policy is not exempt. Such a policy is treated as capital property and the tax on the policy is taxed as capital gains. If it is an equity based ULIP (average monthly 65% of assets are in equities), long-term capital gains from the policy are taxed at 10% without expense index, while short-term capital gains are subject to 15% tax. The sale, surrender or redemption premium of an Equity Oriented ULIP issued on or after 1 February 2021 is subject to a 0.001% security transaction tax. Exemption will continue for the amount received under ULIP on death.
Tax will be paid if the annual premium is exceeded ₹2.5 lakhs, you can get multiple ULIPs for less than the premium ₹2.5 lakhs each? By law, such a division does not help, as the total amount of the annual premium for such ULIPs issued on or after February 1, 2021 must be taken into account. Should the insurance company consider the amount of the annual premium, or the amount to the taxpayer? The language of the regulations implies that the sum of all companies must be taken into account and not only the premium to the insurance company.
How to calculate taxable capital gains? The law provides that the method of calculating such profits should be indicated in the income tax regulations. It will probably be announced once the law is passed and notified.
What is the position of ULIPs issued before 1 February 2021 or less than the annual premium? ₹2.5 lakhs? Income from such ULIPs will continue to be the same as for other life insurance policies, the annual premium for any year should not exceed 10% of the guaranteed amount.
If the premium for any year exceeds 10% of the guaranteed amount, the income will be taxable. Even in such cases, there is an opinion that profits are taxed as capital gains, because ULIP is the taxpayer’s capital asset, although the definition is not specifically provided. In fact, in such cases, long-term capital gains are taxed at 20% with the expense index and not at the 10% discounted rate.
What is the position of ULIPs other than equity based ones? The amended provision for exemption withdrawal does not distinguish between equity based ULIP and other ULIPs. If the annual premium is exceeded, all ULIPs issued on or after February 1, 2021 will be subject to income tax. ₹2.5 lakhs. Income from such ULIPs (other than equity-based) is taxed as capital gains, while the long-term capital gains tax rate is 20% of the normal rate, while the short-term slab is the tax rate.
In such cases it will be known whether the index of expenditure will be available only after the announcement of the new rules for the calculation of capital gains.
How long does it take for ULIPs to qualify as long-term capital assets? This is 12 months for equity oriented ULIPs and 36 months for other ULIPs.
How to calculate this period-from the date of commencement of the policy or separately for each annual installment premium? This is clearly considered from the date of commencement of the policy. However, the question to be resolved by the proposed terms is whether each premium installment should be treated as an acquisition cost or an improvement cost.
Of course, this makes no difference where the index of cost is not available, but the indexation only affects the available cases, because the index from the acquisition cost is derived from the year of acquisition, while the index of development cost is available from the year of development.
All in all, these new tax regulations will definitely affect the popularity of ULIPs, as most taxpayers now prefer to keep insurance and investments separate, have only a pure term insurance policy and invest in mutual fund units rather than ULIPs.
Gautam Nayak Partner, CNK & Associates LLP.