Clarity is needed when investors switch between equity and debt funds or invest in Ulip debt funds
Clarity is key as it will impact the popularity of Ulips and insurers may need to rework their products
Many investors opt for unit-linked insurance plans (Ulips) as they offer a tax advantage over other equity products, like mutual funds (MFs). Ulips follow exempt-exempt-exempt (EEE) taxation. It means, an individual gets a tax deduction on investment, there’s no tax on accrual and until now there was no tax on withdrawal for all policyholders.
The tax regime is applicable on Ulips where the sum assured is more than 10 times the annual premium. In MFs, an investor has to pay a 10% long-term capital gains tax on withdrawal if the gains are over ₹1 lakh in a financial year. This applies if the holding period is more than one year. For shorter periods, short-term capital gains tax applies at 15%.
In the budget, the finance minister has proposed to bring parity between taxation of Ulips and MFs. However, the gains in Ulips would be taxed only if the annual premiums are ₹2.5 lakh or more. For those who pay annual premiums below that, they would still get the benefit of EEE taxation.
Due to lack of clarity, the proposal has created confusion. The government has not clarified how the taxation would work if an investor switches from an equity to a debt fund during the policy tenure. Ulips offer investors multiple funds, including equity and debt schemes. A policyholder can switch between equity and debt funds without any tax implication.
“The budget does not explicitly provide any guidance for such a peculiar situation. It is proposed that those Ulips which do not qualify for an exemption under Section 10(10D) of the I-T Act (post such amendment) shall be considered at par with equity-oriented MFs," said Parizad Sirwalla, partner and head, global mobility services - tax, KPMG India.
Insurance companies are awaiting clarity on this. “We need clarity on the taxation when investors switch from an equity fund to a debt scheme," said Niraj Kumar, CIO, Future Generali India Life Insurance Company.
According to industry officials and tax experts, there could be three scenarios. One, the government could clarify that irrespective of the underlying fund, long-term gains would be taxed at 10% if they are over ₹1 lakh. It would be a product-level taxation. In the second scenario, the government could look at fund-level taxation where the investor would need to calculate the tax implication on equity and debt funds separately. In another option, the government may not allow switching of funds or allow it after the payment of relevant tax.
But industry officials said this move will complicate things. “It will become too complex to calculate tax at the fund level every time a person switches between equity and debt," said Subhrajit Mukhopadhyay, executive director, Edelweiss Tokio Life Insurance Co. Ltd.
Clarity is needed as it will impact the popularity of Ulips and insurers may need to rework their products. “Currently, there seems to be no specific proposal to deal with the manner of taxation of switches/redemptions of funds in a Ulip that do not meet the definition of equity oriented funds. It is important to note that these changes will be applicable on policies issued on or after 1 Feb 2021. Companies may have to rework their new policies after considering the final tax rules," said Tapati Ghose, partner, Deloitte India.
Although clarity is needed, some financial advisers don’t recommend Ulips as they don’t believe that mixing insurance with investments is a good idea. “Even without this change, I was not recommending Ulips to any of my clients due to the strict withdrawal condition (lock-in of 5 years) and the additional charges such as premium allocation charges, mortality charges and policy administration charges. In case of MFs, there is flexibility to get out anytime in case the fund underperforms, while in case of Ulips, money is locked in for five years," said Melvin Joseph, a Sebi-registered investment adviser and founder of Finvin Financial Planners.