Mumbai / New Delhi: New unit-linked insurance plans, or Ulips, that will be launched by life insurers in future may lose their status as tax-saving instruments, if the Indian judiciary accepts the argument of capital markets regulator Securities and Exchange Board of India (Sebi) that Ulips are not pure insurance products as they have a major investment component.
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Sebi wants the investment part of Ulips to be registered with it while the insurance component can continue to be registered with the Insurance Regulatory and Development Authority (Irda).
Following a meeting with the finance ministry, Sebi has kept in abeyance its order for old Ulips, but has barred life insurers from floating new Ulips without its nod.
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Currently, by virtue of being life insurance policies, Ulips are eligible for tax exemption. Financial planners and tax experts said the withdrawal of this exemption could ring the death knell for the product.
Irrespective of the amount set aside for market investments, the whole premium for Ulips is deductable from taxable income.
Sebi has found that out of annual premium of Rs1.5 lakh—for a Rs15 lakh Ulip spread over 10 years—only Rs7,500 goes towards insurance in first year and Rs3,000 in subsequent years. If Sebi’s calculations are right, there will be a dramatic drop in the quantum of tax exemption for Ulips.
According to Sudhir Kapadia, tax market leader at audit and consulting firm Ernst and Young Pvt. Ltd, any contribution made “to effect or keep in force an insurance on life of person is allowed as deduction from taxable income” under section 80C of the Income-tax Act. Investments up to Rs1 lakh are eligible for exemption every year under this section.
If Ulips are segregated into investment and insurance—as suggested by Sebi—and registered separately with the different regulators, it could impact its section 80C status, Kapadia said. “If it’s separate registration, you are delineating mortality charges and investment. The investment part will not qualify for exemption under 80C,” he said.
However, if Ulips are subjected to dual registration without splitting the product, they will continue to be eligible for tax exemption, he added.
Suresh Surana, founder and director, Astute Consulting and Business Services Pvt. Ltd, an audit and tax advisory, said that if the product is split into two then each part will attract the applicable tax provisions separately. “The law is clear on what the treatment is for an insurance scheme and what it is for mutual funds. This will mean the product will no longer remain a hybrid investment.”
According to Surana, one way of getting around this could be by creating a special investment vehicle and getting it registered with Sebi. “The money can be collected compositely. But the investment portion can be routed through this special vehicle. If this is done, it will continue to get tax exemption,” he said.
Insurance companies are not willing to discuss tax implications at this stage. “We will wait for the legal proceedings to be over and clarity to emerge,” said a marketing executive at a private insurance firm, who did not want to be identified.
“Broadly, the taxpayer should not be affected by the dispute or the outcome unless the Income-tax Act is amended,” Vikas Vasal, executive director at audit and consulting firm KPMG India Pvt. Ltd, said.
Tax exemption is the feature that makes Ulips attractive to the salaried class.
Between January and March, in the last quarter of every fiscal year, thousands of insurance agents aggressively sell Ulips to salaried employees and in an attempt to save tax, such investors often end up paying more commission than the tax saved.
According to Harsh Vardhan Roongta, chief executive officer, Apnapaisa.com, a financial planning portal, tax exemption is a key driver of Ulip sales. “It’s a very, very important factor. If you look at the sales of policies, over 45% happens in the last quarter. The key reason is tax (savings).”
Suresh Sadagopan of Ladder 7 Financial Services Ltd, another financial planner, said that removing the tax exemption would be a blow to Ulips. “They are sold as a tax-saving investment. If there is no tax exemption, nobody will buy Ulips.”
In six months between July and December, insurance companies collected Rs76,487 crore worth of premium, of which nearly 68%, or Rs 52,238 crore, was through Ulips.
“I find that the attributes of the Ulips...are different from the traditional insurance products and they are a combination of insurance and investment,” Prashant Saran, a Sebi member, had said last week.
According to him, Ulips launched by insurance firms are akin to mutual funds. There are two components of Ulips—an insurance component where risk lies with the insurer, and the investment component where the risk lies with the investor. “This establishes conclusively that Ulips are a combination product and the investment component need to be registered with and regulated by Sebi.”
Sebi wants the schemes to be registered as mutual funds or collective investment schemes and regulated. At present, the only Sebi-regulated products eligible for 80C deduction are equity-linked savings schemes, or ELSS, launched by mutual funds.
“If the tax exemption has to continue, the investment component of Ulips need to be allowed to be registered as ELSS. It’s not clear at this stage whether Sebi will allow that,” said Sanjay Santhanam, formerly the chief marketing officer at an asset management company.
Tax experts said the tax exemption was given to encourage customers to buy insurance and not promote investment in the garb of insurance.
According to Kapadia of Ernst and Young, even the proposed direct tax code of the Union government takes the view that tax breaks for investment-linked products should go.
“Any payout from the insurance company is tax-free at the time of maturity. However, the code has proposed that only policies where life cover is 20 times that of premium will be eligible for such exemption. For most Ulip policies the ratio is 5-10 times. Otherwise, the arithmetic just does not work,” Kapadia said.
Broadly, the direction of the policy has been towards discouraging investment-linked insurance products, but Sebi’s action has expedited the process, he added.