Know the tax implications on ULIP schemes

Unit Linked Insurance Policies (ULIP) offer a combined benefit of wealth creation and insurance cover. ULIP schemes allocate a part of the premium towards life cover, and the remaining is assigned to a fund that invests in equity, debt or both. The returns from the ULIP scheme depends on the fund selected, just as in the case of mutual funds. 

The Union Budget, 2021, took away the tax-free benefit enjoyed by the Unit Linked Insurance Policies. Accordingly, ULIP investments with an annual premium of more than Rs.2.5 lakh were brought under the taxability net starting from the 1st of February, 2021. Hence, if an investor holds a ULIP policy bought before the 1st of February, 2021, the policy proceeds will remain tax-free even if the premium amount exceeds Rs.2.5 lakh. In the case of multiple policies issued after the 1st of February 2021, proceeds will remain tax-free only when the aggregate of all the policy premiums is less than Rs.2.5 lakh.  

Further, the Life Insurance Policies enjoy the exemption under Section 10(10D) of the Income Tax Act. As per this section, any amount received, including surrender value for the policies issued after 1st of April 2003 but before 31st of March 2012, shall be exempt from tax if the premium of these policies does not exceed 20% of the sum assured. However, for life insurance policies issued after the 1st of April 2012, the amount received will be exempt only if the premium is not more than 10% of the sum assured. 

If, in any case, the premium paid exceeds the above thresholds, then the lump sum amount received on the surrender of policy will become taxable in the beneficiary’s hands, and no exemption under Section 10(10D) will be available. 

The income tax law has not yet clarified the Unit Linked Insurance Plan (ULIP), which does not qualify for Section 10(10D) exemption. However, the gains could become taxable as capital gains or losses considering the general principles of the ULIP investments. 

Taxability of ULIP

ULIP investors can choose to invest in various funds with different equity and debt instruments exposures under one scheme. However, the finance bill remained silent about the taxability of ULIPs in multiple scenarios like tax treatment in the case of different categories of funds, tax implication in case of switching from one fund to another in ULIP, etc. Considering the standard tax provisions, you should consider the following points about ULIP investments’ taxability:

• Any gains or returns from the ULIP investment with an annual premium up to Rs.2.5 lakh will continue to be exempted from tax.
• If the annual premium is above the threshold of Rs.2.5 lakh, then the question of taxability arises. In such a scenario, the investor first needs to identify the nature of the investment in ULIP.
• Suppose the ULIP fund invests directly in stock. In that case, the fund with at least 65% of the exposure in equity or related instruments will have tax implications similar to that of equity investments. However, suppose the ULIP fund invests indirectly in equity stocks, for instance, through exchange-traded funds (ETFs) or equity mutual funds. In that case, a minimum exposure of 90% will be taxable as equity investments.
• When identified as equity investments, the provision of Section 112A will become applicable. This means ULIP funds with a holding period of one year or more may be regarded as long term and taxed at the rate of 10% on gains exceeding Rs.1 lakh (without indexation).
• If the ULIP fund does not meet the equity mutual fund criteria, then the tax implication would be similar to debt funds as mentioned under Section 112. ULIP funds identified as non-equity will be taxed as long-term gain or loss (LTCG/LTCL) if the holding is more than 36 months at the rate of 20% post indexation. The LTCG or LTCL should be calculated based on a difference between the net sale consideration (after deducting direct expenses for redemption) and the indexed cost of acquisition. The indexed cost of acquisition is derived as the Actual cost of acquisition/Cost inflation index (CII) of the year of acquisition X Cost Inflation Index (CII) of the year of sale. If the holding is less than 36 months, the gains will be considered short-term capital gains and taxed as applicable slab rates.
• Rollover exemption can be availed under Section 54F of the Income Tax Act by purchasing or constructing a residential house in India, subject to the conditions and timelines of the provision.

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For any clarifications/feedback on the topic, please contact the writer at jyoti.arora@cleartax.in