The general rule is that any amount received by the policy holder from the insurance company, including any bonus on the policy, is totally exempt tax. However, as per Income Tax Act, there are many exception to this rule. Let’s take various Income Tax provisions where policyholder has to pay tax on the life insurance proceed –
1-As per Section 10(10D) any sum received under a life insurance policy including bonus is exempted. But there is small provision as per (Memorandum To clause 6 and 41 In Finance Bill 2003-04) that is – when “the premium paid in any year of the policy exceeds 20% of the amount , in that case whatever you receive on surrender of policy including bonus becomes taxable. Only in case of death , the amount is not taxable.
policy in respect of which the premium paid in any of the years during the term of the policy, exceeds twenty per cent. of the actual capital sum assured. However, any sum received under such policy on the death of a person shall continue to be exempt.
E.g. Aman has a ULIP life insurance policy of Rs. 250,000/-, for which he used to pay Rs. 26,000/- per annum in March every year. Last year, he went to overseas for short term for work, so could not paid his last years premium, which he paid in the same year in the month of July and the again annual premium in March. So total he had paid 52,000 in the current year. But as per section 10(10D), he can claim only 20% of the sum insured, he paid Rs. 54,000/- (26,000+26,000), so he can only claim up to Rs. 50,000/- (20% of 250,000). For remaining Rs. 4, 000/-, he needs to pay tax.
2-Where the policy holder takes the policy for a disabled dependent and this dependent dies before the policy holder does; and the policy holder receives the amount from the insurance company.
3-The amount on claim or maturity under a keyman insurance policy is not exempt under Section 10 (10D) of the Income Tax Act if the company is paying the premiums. However, in case the policy has been assigned to the keyman and the keyman is paying the premiums, then the claim/maturity proceeds are exempt under Section 10 (10D).
Who can be a Keyman?
Anybody with specialized skills, whose loss can cause a financial strain to the company are eligible for Keyman Insurance. For example, they could be –
1.Directors of a Company
2.Key Sales People
3.Key Project Managers
4.People with Specific Skills
4-Where the Life Insurance Policy is issued on or after 01.04.2003 and the premium payable on the policy in any year is more than 20% of the capital sum assured in the policy, any amount received by the policy holder under such a policy (including bonus) is not exempt; e.g. Bima Nivesh, Jeevan Dhara Plans.
In all the above situations, receipts from life insurance are taxable. Also, if the policy was issued before 01.04.2003 in the last scenario above, the receipts from the policy will not be taxable.
Tax on receipts from a Life Insurance Policy is levied not on the entire amount, but only on the difference between the total amounts paid over the years as indexed (i.e. the total cost of the policy); and the receipts from the policy. This is because a life insurance policy is an asset. So tax is levied only on the capital gain and not on the entire income.
Section 10(10D)
10(10D) any sum received under a life insurance policy, including the sum allocated by way of bonus on such policy, other than –
(a) any sum received under sub-section (3) of section 80DD or sub-section (3) of section 80DDA*; or
(b) any sum received under a Keyman insurance policy; or
(c) any sum received under an insurance policy issued on or after the 1st day of April, 2003 in respect of which the premium payable for any of the years during the term of the policy exceeds twenty per cent of the actual capital
sum assured:
Provided that the provisions of this sub-clause shall not apply to any sum received on the death of a person:
Provided further that for the purpose of calculating the actual capital sum assured under this sub-clause, effect shall be given to the
Explanation to sub-section (3) of section 80C or the Explanation to sub-section (2A) of section 88, as the case may be.Memorandum To clause 6 and 41 In Finance Bill 2003-04
Rationalization of the tax concessions in respect of insurance policies having the amount of premium more than twenty per cent of the actual capital sum assured
Under the existing provisions contained in clause (10D) of section 10, any sum received under a life insurance policy, including the sum allocated by way of bonus on such policy, (other than any sum received under a policy for the medical treatment, training and rehabilitation of a handicapped dependant under section 80DDA or any sum received under a keyman insurance policy), is exempt.
Under the existing provisions of section 88, a deduction from the income tax payable is allowed to an individual or a Hindu undivided family (HUF), in respect of any sums paid or deposited in PPF, GPF, NSC, insurance premia, etc. The deduction is allowed at specified percentage of such sums.
The insurance policies with high premium and minimum risk cover are similar to deposits or bonds. With a view to ensure that such insurance policies are treated at par with other investment schemes, it is proposed to rationalise the tax concessions available to such policies. It is therefore, proposed to substitute the clause (10D) of section 10, so as to provide that the exemption available under the said clause shall not be allowed on any sum received under an insurance policy in respect of which the premium paid in any of the years during the term of the policy, exceeds twenty per cent. of the actual capital sum assured. However, any sum received under such policy on the death of a person shall continue to be exempt.
It is also proposed to clarify that the value of any premiums agreed to be returned or 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, shall not be taken into account for the purpose of calculating the actual capital sum assured under this clause.
The new provision also provides that the amounts received under sub-section (3) of section 80DD, shall not be exempt under this clause. It is also proposed to insert a new sub-section (2A) in section 88 which seeks to provide that the deduction in respect of the sums paid or deposited as premium under an insurance policy shall be available only on so much of the premium or other payment made on an insurance policy, other than a contract for a deferred annuity, as is not in excess of twenty per cent. of the actual sum assured.
It is also proposed to clarify that the value of any premiums agreed to be returned or 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, shall not be taken into account for the purpose of calculating the actual capital sum assured under this clause.
The proposed amendment will take effect from 1st April, 2004 and will, accordingly, apply in relation to the assessment year 2004-2005 and subsequent years.
Ref – http://indiabudget.nic.in/ub2003-04/mem/mem1.pdf