Over the past few weeks, this column has run a series of articles on the Direct Tax Code (DTC), which is due to replace the current Income Tax Act (ITA) from April 1, 2011. So far, apart from a general overview, provisions under the DTC relating to tax deduction at source, capital gains and income from house property have been discussed.

This week, we shall see what the proposed DTC has in store for insurance related investments.

Existing provisions
Let us begin with a look at the existing provisions under ITA:
The premiums paid with respect to any life insurance policy are deductible (Exempt) u/s 80C.

The amount paid by the insurer (insurance company), either at the time of maturity or on demise of the policyholder, is exempt u/s 10(10D). Similarly, amounts paid by the insurer at regular intervals (e.g., Money Back Policy) are also tax-free. In other words, the accretion to the premium paid is tax-free (exempt) as also the total premiums returned are tax-free (exempt). This is the exempt-exempt-exempt (EEE) regime.

Code provisions
Now, let us see what DTC provides: Sec. 57(3)(a) of the Code states that, "The amount of deduction in respect of sums received under life insurance policies shall be --
(a) any sum received under a life insurance policy, including the sum allocated by way of bonus on such policy, if
(i) the premium payable for any of the years during the term of the policy does not exceed 5% of the actual capital sum assured; and
(ii) the sum is received only upon completion of the original period of contract of the insurance or upon the death of the insured.
This is in line with the exempt-exempt-taxed (EET) era ushered in by the Code.

Analysis
1. First and foremost, existing policies will also be slapped by the EET regime after April 1, 2011.

2. Under ITA, any sum received under a life insurance policy, including the sum allocated by way of bonus on such a policy is exempt from tax u/s 10(10D) if thepremium payable for any of the years during the term of the policy does not exceed 20% of the actual capital sum assured. Under the Code, the ratio is reduced to 5% of the actual capital sum assured. Therefore, those who have taken policies where the ratio is much below 20% of the sum assured but is over 5% will suffer tax burden when they receive money as per the terms of their respective policies.

3. Even the amounts received
from policies where the premiums are less than 5% of the sum assured are tax-free if and only if they are received on maturity or death. This would not only make sums received under Money Back polices or return of premiums taxable but also the sum received upon surrendering the policy before maturity.

4. Loan received against insurance policy is also technically 'any sum
received under a life insurance policy'. Since the loan amount is not received on maturity or death, a strict reading makes this amount also taxable, in spite of the fact that this is a capital receipt. Moreover, the repayment of the loan is not associated with any tax benefit.

5. Finally, take the instance of an individual who is below the tax threshold and has taken an endowment insurance policy for protection of his family. The deduction offered by the Code on premiums paid by him is meaningless to him. Nevertheless, he may come in the tax net when the policy matures.

Incidentally, Sec. 57(2g) of the Code brings 'any amount received under a Keyman insurance policy into the tax net including the sum allocated by way of bonus on such policy, if such income is not included under the heads 'Income from employment' or 'Income from business'. ITA also has a similar stipulation.

Conclusion
It is clear that the provisions of the Code need clarifications and amendments in respect of
Whether the Code will apply only to policies bought after the Code comes into force or also to the policies taken before.

Clarify whether any loan taken against life policies is taxable or not u/s 56(2f) of the Code.

The limit of 5% is low and perhaps needs a second look.

Regular readers of my column would be aware that I am no fan of combining investments with insurance and generally suggest opting for term insurance. However, the fact also remains that those who have already bought policies have been ipso facto made a promise regarding the tax benefits applicable to their investments. To change the same midway is unfair and hence one feels the above provisions should be only made applicable to policies purchased after the DTC is made effective.