How to get maximum income tax benefit for premium paid on taxable life insurance policies

In the case of policies issued on or after April 1, 2012, the maturity proceeds from life insurance policies will be taxable if the premium amount exceeds 10%

How to get maximum income tax benefit for premium paid on taxable life insurance policies
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By Keval Sonecha

Taxpayers are not required to pay tax on proceeds from maturity proceeds of Life insurance policies as it is exempt under Section 10(10D) of the Income Tax Act, 1961. However, in the case of policies issued on or after April 1, 2012, the maturity proceeds from life insurance policies will be taxable if the premium amount exceeds 10% of the Capital Assured. In other words, if the capital assured is less than 10 times of premium amount then the maturity proceeds from such policies will be taxable.  

Single premium insurance policies will be taxable because they have one-time premium payments and are designed to give investment opportunities as well as risk coverage to Individuals. In the case of such policies, the person taking the insurance can decide the tenure of the insurance policy. The maturity amount is received at the end of tenure or in case of death. The maturity amount received is generally at par with the rate of interest offered by Fixed Deposits and bonds. Therefore, an individual can get a minimum assured return plus life coverage. 

Normally, the maturity proceeds, if taxable, are considered as Income from other sources. Even CPC Bangalore and CIT(A), in a decision given by the Kolkata Tribunal on 15th March 2022 in the case of Bishista Bagchi Vs. Deputy Commissioner of Income Tax had considered maturity proceeds from Insurance policies as Income from other sources. However, the Tribunal favoured the taxpayer and considered the maturity proceeds from such life insurance policies as Capital gains. It is because the definition of “Capital Asset” under Section 2(14) of the Income Tax Act unequivocally and categorically includes such policies, and therefore the maturity proceeds from such policies will be taxable under the head “Capital gain”. Further, the Government’s intention in amending Section 10(10D) was to tax such insurance policies in which investment opportunity was embedded along with insurance.  

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It is pertinent to note that by classifying maturity proceeds as capital gain, the taxpayer is availing the maximum possible tax benefit for the premium paid on such policies. To begin with, the deduction under 80C is available to the policyholder in the year in which the premium is paid. But the deduction is restricted to 10% of Capital Assured. This is for the policies issued on or after April 1, 2012. If the policy is issued before 1st April 2012, the deduction is restricted to 20% of Capital assured. For instance, if the capital assured is Rs 10 lakh for a policy issued in 2014, and the premium amount is Rs 2 Lakh, then the deduction of Rs 1 Lakh is only available under Section 80C. 

The question is whether the tax benefit is forgone on the part of the premium paid which is restricted by Section 80C? If not, then what part of the premium paid for such policies does not offer tax benefits? It is relevant to analyse the taxability of maturity proceeds received from such policies under Capital gain. 

Entire Sale Proceeds are taxable – The policyholder may receive certain benefits in terms of a bonus over and above the capital assured at the time of maturity of the policy. As per Section 10(10D), the entire maturity value/gains received at the time of extinguishment of the rights of the policy are taxable under capital gain. Hence, while computing the capital gain the total amount received during maturity including allocated bonus and TDS deduction will be considered as “Sale consideration”. 

It is noteworthy that the insurance companies are liable to deduct TDS on maturity proceeds at 5% if the payment is equal to or exceeds Rs 1 Lakh. The TDS is deducted on Maturity proceeds less the premium paid. Hence, the amount reflected in 26AS of a taxpayer is not a sale consideration for capital gain but it is book gain on which TDS is a deduction under Section 194(DA) of the Income Tax Act.

Cost of Acquisition – Premium paid more than 10% of Capital Assured (for the insurance policy issued after April 1, 2012) is attributable to the component of Investment. Therefore, the premium paid above 10% of Capital assured is the cost of acquisition on which indexation benefit can be claimed. For instance, on Maturity Rs 13 Lakh are received for a policy issued in 2014. The capital assured was Rs 10 Lakh. The premium was Rs 2 Lakh. The deduction is available to the extent of Rs 1 lakh under Section 80C at the time of payment of the premium. The remaining premium of Rs 1 Lakh is the cost of acquisition on which indexation benefits can be claimed against the maturity proceeds of Rs 13 Lakh.

Even though section 80C restricts the deduction of premium to the extent of 10% of the capital assured, the amount of premium paid over and above 10% of Capital assured is allowed as cost of acquisition along with indexation benefit against the maturity value. However, in certain scenarios, a part of the premium may not be available for tax benefit due to the threshold limit of Section 80C of Rs 1.5 Lakh. If the 10% of Capital Assured is above the threshold limit of Section 80C, then the deduction will be restricted to Rs 1.5 Lakh. Therefore, the taxpayer cannot avail of any kind of tax benefit on the component of premium paid if it is greater than Rs 1.5 Lakh and less than 10% of the capital assured. For instance, if the Capital assured is Rs 20 Lakhs and the Premium paid is Rs 6 Lakhs, then Rs 1.5 Lakh can be claimed as a deduction under section 80C and Rs 4 Lakh can be claimed as a cost of acquisition. Ultimately Rs 50,000 is the component of the premium paid on which there is no tax benefit. 

If we sum up the mechanism of taxation, then, a taxpayer having no investment under Section 80C for a particular year can avail of the maximum tax benefit on the whole amount of premium paid if the Capital assured in a policy is up to Rs 15 Lakh and it issued after April 1, 2012. 

If the Capital assured is above Rs 15 Lakh then the certain component of premium payment will not be eligible for tax benefit as even though 10% of the premium paid will be eligible for the deduction, it will be restricted to Rs 1.5 Lakhs under Section 80C and premium which can be considered as the cost of acquisition is the premium amount which is above 10% Capital assured. It is to be noted that the maturity proceeds received on life insurance policies in case of death is exempt. 

(The author is a Chartered Accountant and partner at Sonecha &Amlani Chartered Accountants. Views expressed above are those of the author and not necessarily of financialexpress.com. Please consult your tax advisor for maximum tax benefits)

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