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Tax breaks on short-term insurance policies may go
February, 16th 2010

The Union Budget may remove tax breaks on short-term insurance policies which provide more of investment and less of protection. At present, there is no linkage between tax breaks and the tenure of life insurance products.

The Direct Tax Code has proposed that to be eligible for tax breaks, the premium under a life policy should not be more than 5% of the sum insured and the policy tenure should be for at least 20 years. While there are indications that such severe conditions may not be imposed on life companies, it is likely that the government may ask for a higher component of insurance and a minimum tenure.

In the past, the Budget had removed tax breaks on insurance policies that mimic single premium bonds by introducing amendments to Section 10(10)D of the Income Tax Act, which excluded tax breaks on any policy where the sum insured was less than five times the premium.

The restriction on short-term policies may come through a similar amendment. While life insurers have learned to live with restrictions on short-term policies, they have been lobbying for creation of a separate category of tax-breaks for long-term investments.

Currently, all investments, including life insurance, provident fund, mutual funds, bank deposits, are clubbed together under Section 80(C) where tax relief is provided for investments up to Rs 1 lakh.

The availability of short-term tax saving instruments discourages people from investing money into long-term investments like life insurance and pensions, said SB Mathur, chief executive of Life Insurance Council.

There is, therefore, an urgent need to have a separate block for savings of long-term nature like life insurance, pensions and investment of more than, say, 10 years or those with a minimum lock-in period of five years. These savings are critical to meet the huge demand for investment in infrastructure if the economy is to grow at a rate of 9% or more in future.

Life insurers have also made representations to the government asking it to give companies more time to carry forward their losses. At present, companies are allowed to carry forward losses for eight years for the purpose of avoiding tax. Life companies have sought more time on the ground that the life insurance industry has a long gestation period and it takes a minimum of 8-10 years to break even.

Even when the break-even point is reached, profits in the earlier years are low and not enough to wipe-off losses accumulated in the first 10 years of operation. Hence, the period of eight years for carry forward of losses is not enough, said Mr Mathur.

Furthermore, life insurers are seeking a level-playing field with mutual funds as far as imposition of service tax is concerned. Current regulations require that life companies pay service tax on that portion of the premium which is collected from the policyholder but is not credited to his ULIP account.

A fallout from this is that the service tax is collected even on the stamp duty which is not a service fee but revenue collected on behalf of the government.

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