THE insurance sector is going through a challenging phase with regulatory changes significantly impacting the business model of life insurance firms, in particular. On the direct taxes front, from April 1, 2012 when Direct Taxes Code (DTC) will be implemented the sector may also have to deal with a considerably altered taxation model, which may result in additional compliance and potentially leave room for uncertainty as far as the taxation of insurance companies and policyholders are concerned.
The life insurance sector has always experienced an advantageous position when compared to other taxpayers. To date, they were subject to a concessional tax rate of 12.5% (plus surcharge and education cess) on the surplus disclosed by the actuarial valuation as per the Insurance Act, 1938, less the opening surplus disclosed by that valuation. The DTC proposes to do away with this taxation scheme and tax the profits in shareholders account at the normal corporate tax rate of 30% leaving policyholders funds to be taxed in the hands of shareholders or subject to a distribution tax of 5%.
It provides that proceeds on maturity of life insurance policies (in case other than the death of the policyholder) will be taxable in the policyholders hands, except where the premium paid does not exceed 5% of the sum assured. Life insurers would need to withhold tax at specified rates from these proceeds. Approved equity-oriented life insurance schemes are subject to a distribution tax of 5%, which the life insurers will have to pay with the maturity proceeds being tax-exempt in the policyholders hands.
Some other tax issues for life insurers could be treatment of transfer of funds from shareholders accounts to policyholders accounts and vice versa, applicability of minimum alternative tax (MAT) proposed at 20% of book profits, computation of book profits, if at all MAT is indeed applicable, and a potential disallowance of expenses where tax has not been withheld.
For general insurers, the taxation scheme remains largely the same. The profits as per the profit and loss account (P&L a/c), submitted to the insurance regulator Irda, continue to be the basis of computing the taxable income.
However, an important departure from the current position is that a provision for loss in diminution of the value of investments held by them should arguably be allowable and unrealised gains on revaluation, if any, on revaluation could potentially be taxable, if routed through P&L a/c.
Compliance with withholding tax provisions is another challenge that the sector may find increased. In addition to the withholding tax on maturity proceeds of life policies mentioned above, Indian insurers, and even foreign insurers, may be required to withhold tax from payments that they would make to non-resident reinsurers where the risk resides in India.
Non-resident reinsurers would be subject to income-tax on payments for reinsurance received by them for covering any risk in India, as the said payment would be income deemed to accrue or arise in India and be subject to income-tax at 20%. Ironically, the rate of withholding tax for such payments has not been specifically prescribed and so, the rate of withholding tax from any other income of a non-resident (a residuary rate) should apply. This seems to be an unintended consequence. Lastly, insurance firms having eligible assets in excess of `1 crore would also be liable to pay wealth-tax under the DTC.
From a policyholders point of view, the premium that they would pay on life insurance policies would be eligible for a deduction from their gross total income only if the same does not exceed 5% of the sum assured. The limit for this deduction would be `50,000 in addition to the deduction of `100,000 available for contribution to approved funds.
Though there is an overall increase in the deduction limit, it stands reduced for life insurance premium. There are also no proposals to grandfather the existing policies either from the change in the deduction for the premium payment or the exemption of the maturity proceeds (in excess of the premia actually paid) from income tax. Comprehensive and not constrictive was the hope of the insurance industry from the DTC. The sector might just feel that the DTC proposals would further test its resilience in the time of regulatory turmoil.