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Need to reconsider taxation of life insurance savings
December, 07th 2010

The new Direct Taxes Code (DTC) Bill, which was introduced in Parliament by the finance minister in the last Budget and has since been referred to the standing committee for detailed examination, has introduced far-reaching changes in the taxation of life insurance savings in the hands of policyholders. The new provisions make a complete departure from the age-old practice of treating all long-term savings on a par and incentivizing these, a practice which was further strengthened in the first draft of the DTC released by the Central Board of Direct Taxes (CBDT) in 2009.

The proposed Bill provides total exemption up to Rs. 1 lakh for investments in long-term savings such as employees provident fund (EPF), Public Provident Fund (PPF) and New Pension System (NPS). No minimum holding period is prescribed for investments in these schemes. A separate window of a much lower amountRs. 50,000has been prescribed for health insurance premiums (section 80D under the present Act), educational expenses and life insurance premiums.

With increasing cost of education and healthcare, most of this small limit would be utilized and would leave very little space for life insurance premium. The average maturity for life insurance policies is 15 years or more and is increasing steadily. Pension policies taken through life companies have even higher holding periods with an average term of 30-40 years before and after investing.

Yet these savings will not be eligible for tax incentives despite the fact that there is a minimum lock-in period of five years. Other long-term savings such as EPF, PPF and NPS with a shorter lock-in or no lock-in period will be eligible for tax incentives with higher qualifying limits. The original draft provided for a common limit of Rs. 3 lakh for all these long-term savings, including life insurance.

No rationale or logic has been given for this discrimination. One does get a feeling that the thinkers in the tax planning divisions feel that long-term savings through life insurance is less important for the economy and needs to be discouraged, while savings through EPF, PPF and NPS are sacrosanct and need to be incentivized through fiscal incentives.

It could also be the result of mistaken belief that long-term savings through life insurance are investments, a dirty word, and should be treated inferior to other long-term savings that are holy cows and need to be given tax incentives.

The proposed treatment of life insurance savings in the draft Bill totally disregards the important contribution made by the life insurance industry in providing long-term funds to the government and contributing to the development of infrastructure.

At least Rs. 7 trillion of life insurance funds are invested in government securities and around Rs. 1.5 trillion in infrastructure alone. During the financial turmoil of 2008-09, when foreign institutional investors withdrew Rs. 47,000 crore from the equity markets, life insurance provided some stability to the market by net buying of equities amounting to Rs. 51,000 crore.

Imagine the plight of the markets if the life insurance industry had not helped in arresting the downside. Moreover, apart from post offices, life insurance is a major sector aggregating the savings in the rural sector with mandatory 18% policies required to be sold in rural areas. The revenue department in the ministry needs to do some serious rethinking and ensure that life insurance premiums are given the same treatment as other long-term savings.

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