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No escape from tax on insurance income
September, 01st 2014

If you assumed that maturity, surrender or bonus proceeds from all insurance policies are tax-exempt, think again: not all policies enjoy this advantage.

While you may have been lucky so far and did not pay taxes on these sums, beginning October, the taxman will be hot on your trail in case the sums you receive do indeed attract tax. What’s more, he will proactively deduct a 2 per cent tax at source (TDS) from amounts you receive from your insurer.

What the new provision says
In the Budget 2014-15, the Government introduced a new provision with respect to taxation of returns from life insurance policies.

The provision states that all life insurance policies that are not eligible for tax exemption under Section 10 (10D), will see 2 per cent tax deducted at source on the sum paid to the policyholder.

“Not all life policies are tax-exempt. Many don’t know this or knowingly evade it. And it is difficult for the income tax department to determine the nature of the policy and check its taxability at the time of assessment.

Now the onus is on the insurer, who has to deduct TDS on all policies where maturity proceeds are taxable. These will automatically come to the notice of the policyholder as also the IT Department then”, says Suresh Sadagopan, CEO of Ladder 7 Financial Advisors.

Note that your tax liability is not over with the 2 per cent TDS. Insurance policy receipts that are not eligible for tax exemption under Section 10 (10D) will be taxed as normal income at the individual’s slab rate.

We all know that contributions toward a life insurance policy are eligible for tax deduction under Section 80C of the Income Tax Act.

This means that the sum paid toward the premium of insurance policies can be deducted from one’s total income for the year to arrive at the taxable income. Further, the proceeds on maturity or upon surrender of the policy are tax-exempt under Section 10 (10D). This means that the proceeds are tax-free income for the individual.

However, Suresh Surana, Founder, RSM Astute Consulting, a tax advisory firm, explains that to be eligible for these tax benefits, the premium paid should not be more than 10 per cent of the sum assured under the policy if it’s a policy issued after April 1, 2012. If it’s a policy issued before April 1, 2012, the premium should not be more than 20 per cent of the sum assured.

In case the premium exceeds the limit prescribed above, you stand to lose the exemption to the extent it exceeds the limit. Harsh Roongta, CEO of Apnapaisa, says that only a premium equivalent to 10 per cent of sum assured under a policy will be eligible for tax deduction under Section 80 C and you cannot claim tax exemption under Section 10 (10D).

Policies that fail the test
It is mostly single premium insurance policies that do not pass the test for tax exemption. Since the mandate is to give a minimum cover of 1.25 times the premium, many insurers do not offer a higher cover.

But regular premium policies have a mandate to give a minimum sum assured of 10 times the premium. The famous single premium money back plan of LIC, New Bima Bachat, for instance, doesn’t qualify for the full tax benefit.

For a ?5 lakh sum assured policy here, a person who is 35 years of age will have to pay a single premium of ?3,68,980.

But since the sum assured is not equal to the mandatory 10 times of premium, he cannot claim the full deduction allowed under Section 80C (?1,50,000). He can claim ?50,000 (that is, 10 per cent of ?5 lakh) and the entire proceeds will be taxable.

Experts like Suresh Sadagopan say many people mistake pension policies to have tax exemption as well. In pension policies, the amount that is commuted is tax exempt, but the annuities received are taxable.

People who have been escaping the tax man by not paying tax on income from policies such as the above are likely to be caught under this new provision.

With the insurer deducting TDS on such policies, there will be a trail that will help the income tax department trace evaders. At the same time, the new provisions spare small investors. The provision will not be applicable in cases where the proceeds from a life policy in a year are less than ?1 lakh.

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