Life insurance policies with annual premium over ₹5 lakh will not be exempt from taxation under section 10 clause 10(D) of the Income Tax(IT) Act. This much was known from earlier announcements in Finance Act 2023. But the finer details were not clear and even experts recommended applying a conservative (or tougher) approach in tax considerations for multiple policy benefits, old policies and death benefits.
The new circular from CBDT ( https://incometaxindia.gov.in/news/circular-15-2023.pdf) clears most of the confusion and lays out 13 examples or scenarios explaining the tax implications.
However, the circular leaves out lump sum annual premiums. Premiums are paid annually, quarterly or even lump sum. The circular states that premium payment in any one year exceeding ₹5 lakh will not be exempted from taxation. But this leaves lump sum premiums out in the cold. These one-time payments may invariably cross the limit in most of the cases as what can be paid over, say, ten years, could be paid in one go. This may not translate to a high-value insurance policy, which is intended to be brought into the tax net. Policies with lump sum payment continue to be in a grey area as regards taxation.
ULIPs will not be included in this discussion as ULIPs are governed by the already existing ₹2.5 lakh limit on cumulative annual premiums even prior to Finance Act 2023.
The new amendment to section 10 (10(D)) in IT Act applies to life insurance policies issued on or after April 1, 2023. The consideration on which taxation is in question includes any amount received from the policy, including bonus amount. Death benefit received by the nominee will be exempt from taxation and this is a major clarity emerging from the circular. Also, the premium amount that goes into testing the ₹5 lakh limit does not include the GST amount. This also allows greater clarity when it comes to tax planning for insurance policies.
. If the annual premium of an eligible policy (issued on or after April 1, 2023) is ₹5 lakh, even then the consideration received will be tax exempt. Only eligible policies with any annual premium exceeding ₹5 lakh will not get exemptions.
Various scenarios decoded
1) Multiple policies: In case of multiple eligible policies (all issued after April 1, 2023), the policy that tips the total cumulative annual premium over ₹5 lakh limit and all other policies that follow, will not get tax exemption. For instance, Policy A, B, C and D were issued on April 1, 2023, with an annual premium of ₹2 lakh, ₹2.5 lakh, ₹2 lakh and ₹2.5 lakh. In such a case, policyholder can apply for tax exemption on considerations received from Policy B and D and Policy A and C will not get exemption. The combination so chosen is because it is beneficial to policyholder.
2) Matured policies: For eligible policies (issued after April 1, 2023) that have recieved consideration (referred to as old policy), their annual premium will be counted for other outstanding policies’ ₹5 lakh limit rule. This is will hold true if tax exemption was sought for the ‘old policy’. Otherwise, one can construct a ‘high value’ policy by staggering payouts over several years so as not to trigger the ₹5 lakh limit.
For instance, Policy A (annual premium of ₹1 lakh and issued on April 1, 2023) received consideration in 2033 and got an exemption as well on that. For other policies maturing in 2034 and beyond, Policy A’s ₹1 lakh premium will be added to those premia and the policy that tips it over ₹5 lakh will not get exemption. If Policy A had not been exempted and paid taxes on consideration, then the ₹1 lakh premium will never be considered. Also, if the Policy A was issued before April 1, 2023, then the premium would not be considered anyway.
3) Policies not running concurrently: The annual premium limit of ₹5 lakh will be applied on eligible policies running parallelly at any point of time. For instance, Policy A issued on April 1, 2023, and premium of ₹5 lakh for 10 years period. After that, Policy B was issued on April 1, 2033 and premium paid of ₹5 lakh for 10 years. Both the policies can apply for tax exemption as the premium payment was not parallel.
4) Death benefit and ULIP: ULIP plans will not be included in aggregating life insurance premia. For instance, ULIPs X and Y with premium of ₹1 lakh each and issued in April 2021 and 2023 respectively. Life insurance policies issued after that will not consider ULIP premiums for triggering tax exemption limits.
On death benefit, the circular has clarified that these specific provisions do not apply when benefits are paid to a nominee on death of a policyholder in a life insurance. Hence, any consideration will be exempt from taxation under Section 10 10 (D) without considering the premium limit of ₹5 lakh or the date of issuance.