[Opinion] Dilemmas in taxation of amounts received in respect of life insurance policy

Authored by V. K. Subramani – Chartered Accountant

Table of Contents

1. Legal provisions

2. Swati Dyaneshwar Husukale v. Dy. CIT (2022) 143 taxmann.com 375 (Nagpur-Trib)

3. Is it taxable under the head ‘Capital Gain’?

4. Conclusion

The provisions of income-tax law have addressed various requirements of the society in its own way. A taxpayer generally would not embark on an activity purely based on tax incentive by way of relief, rebate, deduction or exemption. However, it is possible that a taxpayer with stable business background may look for possible avenues to channelize his activities in order to optimize his tax liability by availing certain tax benefits/fiscal incentives bestowed by law. It is in this context subscription to life insurance policy became popular investment a few decades ago as the amount paid in pursuance of life insurance policy satisfied the criteria of Exempt – Exempt – Exempt (EEE). Which means the amount paid provides saving in tax (which is equivalent to exempt) and any accretion thereon (by way of bonus on life insurance policies) is also exempt and the amount received finally (on maturity) is also exempt from tax.

As the economy improved after first generation reforms in the 1990s, the legislature in its wisdom wanted to tax certain receipts which were not taxable previously. In this scenario, amounts received under life insurance policies were sought to be taxed by the Finance Act, 2003 w.e.f. 01.04.2004. This refresher takes note of the tax exemption and when such exemption is not applicable/available vis a vis the requirement for tax deduction at source contained in section 194DA of the Act.

1. Legal Provisions

Section 10(10D) says that any sum received under a life insurance policy, including the sum allocated by way of bonus on such policy is exempt from income-tax.
However, the amount so received would not be exempt in the following cases:

(a) Any sum received under section 80DD(3) or section 80DDA(3). It is worthy to note that under section 80DD(3) where a person being an individual or HUF, resident in India, has, during the previous year paid or deposited any amount under a scheme framed by LIC or any other insurer or administrator as the case may be, for the maintenance of dependent, being a person with ‘disability’ it is eligible for deduction up to a maximum of Rs.75,000. Where the dependent is a person with ‘severe disability’ the amount eligible for deduction would be up to a maximum of Rs.1,25,000. It may so happen that the dependent being a person with disability, predeceases the individual or HUF ( being the person who paid the amount) and in which case the amount paid or deposited as the case may be shall be deemed to be the income of the assessee in the year in which the amount is received by him. The Finance Act, 2022 has inserted sub-section (3A) to section 80DD to spare any amount received by a dependent during his life time from taxation. Section 80DDA as it is presently not in statute book, hence does not deserve any explanation.

(b) Any sum received under a keyman insurance policy, is liable to tax. However, it may be noted that the premium paid in respect of keyman insurance policy is deductible under section 37 and the amount received from the insurer subsequently and ultimately is liable to tax.

(c) Any sum received under an insurance policy issued on or after 1st April, 2003 but on or before 31st March, 2012 is liable to tax where the premium payable for any of the years during the term of the policy exceeds 20%of the actual capital sum assured.

(d) Any sum received under an insurance policy issued on or after 1st day of April, 2012 in respect of which the premium payable for any of the years during the term of the policy exceeds 10% of the actual capital sum assured.

The first proviso to section 10(10D) says that the amounts received on the death of a person in respect of life insurance policy is fully tax-free and the clauses (c) and (d) discussed above, would not apply.

The expression ‘actual capital sum assured’ has to be understood by making reference to section 80C(3A) which says that it would not include (i) the value of premiums agreed to be returned; or (ii) of any benefit by way of bonus or otherwise over and above the sum actually assured which is to be or may be received under the policy by any person. This expression is to be adopted both for clause (c) and clause (d) given above.

Section 2(14) defining the term capital asset says “any unit linked insurance policy to which exemption under section 10(10D) does not apply on account of the applicability of the fourth and fifth proviso”. In this context, one may refer to Circular No. 2 /2022 dated 19th January, 2022 for the purpose of determining the tax implication in respect of ULIP.

Section 80C(2)(i) says sums paid or deposited to effect or to keep in force an insurance on the life of persons specified in sub-section (4) is eligible for deduction. Section 80C(3) and section 80C(3A) says that the deduction would not apply ‘only to so much of any premium or other payment’ exceeding the specified percentage of the actual capital sum assured. It could be noted that the cap of 10% or 20% of the capital sum assured would apply only in respect of insurance policy and would not apply to contract for deferred annuity.

Section 80C(4) says that the insurance premium is eligible for deduction to the contributor or payer in the case of payer being an individual when it is for a policy in respect of the individual, spouse and any child of such individual. In the case of HUF, being the payer, any member thereof.

Section 194DA says that any person responsible for paying a resident any sum under a life insurance policy including any sum allocated by way of bonus on such policy, other than the amount not includible under section 10(10D) is liable for tax deduction @ 5% on the amount of income comprised therein.

2. Swati Dyaneshwar Husukale v. Dy. CIT (2022) 143 taxmann.com 375 (Nagpur-Trib)

Having taken a cursory view of the applicable legal provisions, the facts of the above case would throw light on the amount of receipt liable to tax (not exempt under section 10(10D)) vis a vis the amount liable for tax deduction at source under section 194DA of the Act.

The assessee in this case, filed a return of income for the assessment year 2017-18 and had received Rs.12 lakhs by way of premature surrender of life insurance policy in respect of which he had paid premium of Rs.8 lakhs. The policy was subscribed on 30th August, 2011 and the annual premium exceeded 20% of the sum assured. When the return was processed under section 143(1) by CPC a sum of Rs.12.07 lakhs was added to the total income and whereas the assessee had claimed negative interest expenditure of Rs.31,419. In result, the net addition was Rs.11.76 lakhs. The assessee had admitted TDS of Rs.12,075 being 1% of the total amount received. The CIT (Appeals) affirmed the order of CPC, Bengaluru.

Besides the taxability of the amount in the light of the legal provision one of the contentions of the taxpayer was that adjustment under section 143(1)(a)(vi) must be limited to

“addition of income appearing in Form 26AS or Form 16A or Form 16 which has not been included in computing the total income in the return”.

It was held that the amount of premium on the insurance policy exceeded 20% of the capital sum assured and therefore the sum received under such policy would be liable to tax and will not be eligible for exemption under section 10(10D). The obligation to deduct tax at source exists under section 194DA.

The tribunal referred to Circular No.7 of 2003 dated 05.09.2003 which has explained the legal position regarding section 10(10D) in paragraph 10.3 as under.

“The insurance policies with high premium and minimum risk covers are similar to deposits or bonds. With a view to ensure that such insurance policies are treated at par with other investments scheme, amendments have been made in section 88 and clause (10D) of section 10. The existing clause (10D) of section 10 has been substituted so as to provide that the exemption available under the said clause shall not be allowed on any sum received under an insurance policy issued on or after 01.04.2003, in respect of which premium payable in any of the years during the term of the policy, exceeds twenty percent of the actual capital sum assured. In view of this, the income accruing on such policies (not including the premium paid by the assessee) shall become taxable. However, any sum received under such policy on the death of a person shall continue to remain exempt. The new provision also provides that the amount received under sub-section (3) of section 80DD, shall not be exempt under this clause”.

The tribunal accordingly held that where the premium payable during the term of the policy exceeds the specified percentage the income would not be exempt from tax. Thus the amount received from the insurer in respect of the policy is chargeable to tax. However, the quantum of income liable to tax is “the income accruing on such policies (not including the premium paid by the assessee)”. Accordingly, the tribunal held that the amount of amount received on premature surrender of life insurance policy less the amount of premium paid is liable to tax. Accordingly, it was held that the amount Rs. 12.07 lakhs less the amount paid Rs.8 lakhs being Rs.4.07 lakhs is chargeable to tax and it is not exempt under section 10(10D). With negative interest income of Rs.31,419 in Form 26AS the amount liable to tax was Rs.3.76 lakhs.

The tribunal also observed that the tax deduction under section 194DA is contemplated on the gross amount paid on the policy but the income liable to tax is after reducing the amount of premium paid. Section 143(1) provides for adjustment by way of ‘addition of income appearing in Form 26AS’ and not the sum so appearing in the form. Accordingly, it is only the amount of income which is liable to tax to be added while making the adjustment under section 143(1).

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3. Is it taxable under the head ‘Capital Gain’?

Capital asset defined in section 2(14) has list of capital assets and those which are not capital assets. Recently, it has accommodated ULIP as capital asset w.e.f. 01.04.2021. However, there is no whisper about the life insurance policy per se. Thus, life insurance policies which are not exempt under section 10(10D) become chargeable to tax obviously under the head ‘capital gains’ or ‘other sources’. Given the concessional rate of tax and the observation of the CBDT in Circular No.7 of 2003 dated 05.09.2003that insurance policies are to be treated ‘at par with other investments schemes’ tax payers are entitled to claim indexation benefit and concessional rate of tax in respect of amounts received in respect of life insurance policies which are not exempt under section 10(10D).

4. Conclusion

Based on the legal provisions discussed at the outset and the tribunal decision stated above, the following conclusions are drawn:

(i) The amount of premium payable in respect of insurance policy during the term of the policy when exceeds the specified percentage of the capital sum assured (10% or 20%), such amount received in respect of the policy is not exempt under section 10(10D).

(ii) The tribunal has held that the amount received in respect of the policy less the premium paid by the taxpayer is only liable to tax. It is not the amount received as such in is liable to tax. In the above said case the amount received was Rs.12 lakh (approx.) and the premium paid was Rs.8 lakhs and hence the difference alone is not eligible for exemption. The tribunal however has not discussed whether the premium paid by the taxpayer in the above said case is eligible for indexation benefit and taxable under the head ‘capital gain’. To that extent, the decision of the tribunal is not complete.

(iii) Section 194DA uses the expression “other than the amount not includible in the total income under clause (10D) of section 10” and this expression fortifies the argument that the amount which is not includible in total income under section 10(10D) must be spared from TDS. The tribunal with respect did not discuss this crucial expression finding a place in the legal provision. Determination of income assumes significance and such determination when made by treating the life insurance policy as capital asset, only the residue or the portion liable to tax would be covered by section 194DA.

(iv) The tax deduction at source has been enhanced to 5% by the Finance (No.2) Act, 2019 w.e.f. 01.09.2019 and such a sum when deducted it requires proper appreciation of the legal provision by the deductor. The CBDT would do a world of good if it comes out with a circular explaining various fact situations similar to a circular issued in respect of ULIP referred to in the initial part of this write up. Such circular must also put the onus on the deductor to deduct the appropriate portion of income liable to tax (not eligible for exemption under section 10(10D) so that the taxpayers would be definite of the tax consequence arising from the receipt received in respect of life insurance policy.

(v) Where a taxpayer subscribing to a life insurance policy if has not claimed deduction under section 80C consistently and receives the amount upon maturity of the policy (otherwise than by death) would be entitled to claim the benefit of indexation and concessional rate of tax as applicable for long-term capital gains.

(vi) It may be noted that section 80C(3) and section 80C(3A) have used the expression that the eligible amount for deduction shall be limited to the specified percentage of the capital sum assured in respect of such policy. Thus, a life insurance policy subscribed before 31.03.2012 when the annual premium exceeds 20% of the capital sum assured the premium to the extent it exceeds 20% is not eligible for deduction under section 80C. The premium to the extent of 20% of the capital sum assured is eligible for deduction under section 80C read with section 80CCE. Similar parameter to be applied i.e. 10% of the capital sum assured in respect of life insurance policies where the policy is subscribed after 1st April, 2012.

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