Budget 2021 – All about the Taxation of ULIPs

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What are the new taxation rules with respect to ULIPs and especially after Budget 2021? Even though ULIPs are equity products, they used to enjoy the tax benefits like other traditional products under Section 10(10D).

Taxation of ULIPs

However, to bring equality between ULIPs and Mutual Funds, during the Budget 2021, Finance Minister proposed the changes in the taxation of ULIPs. Let us see the new taxation rules of ULIPs.

All about the Taxation of ULIPs

There are three aspects of taxation that we have to consider while investing in ULIPs. The first one is at the time of investing, the second one is when it mature or surrendered and the third one is at the time of death. Let us see one by one in detail.

# Taxation of ULIPs while investing

There is no change in the rules with respect to the tax benefits while investing in ULIPs. Hence, the deduction under Section 80C is allowed for the investment made in ULIPs (up to the maximum limit of Rs.1,50,000 per year). An Individual can claim a deduction for the investment made for himself, spouse or children (dependent or independent) and HUF can claim a deduction for the investment made for any member of HUF.

The deduction under section 80C is restricted to 10% of the sum assured. It means suppose the sum assured is Rs.10 Lakh, then the premium that you pay under the ULIP should be up to the maximum of Rs.1,00,000. If the premium is beyond 10%, then it is not eligible for deduction under Sec.80C. Any amount of premium paid more than this limit is not deductible under Section 80C.

One more important point to understand here is that, If you stop the premium payment before the expiry of five years or you terminate your participation by notice to that effect, the aggregate of deductions allowed to you in the earlier years shall be deemed as his income and charged to tax in the year in which such termination or cessation occurs as per your income tax slab.

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Hence, discontinuing of ULIPs is like a double-edged sword. One way ULIPs charge you with hefty discontinuation charges and in another way, the reversal of tax benefits what you received under Sec.80C.

Do remember that you can pay the premium as much as possible. However, the benefit in Sec.80C is limited to Rs.1,50,000 a year and the premium must be 10% of the sum assured.

# Taxation of ULIPs at maturity

Here is what the Budget 2021 proposed the changes. Let us try to understand the existing old rules at first.

Taxation of ULIPs (Before the Budget 2021)

Section 10(10D) provides for exemption with respect to any sum received under ULIP, including the sum allocated by way of bonus on such policy. However, if the premium payable for any of the years during the term of the policy exceeds 10% of the actual sum assured, then no exemption is allowed.

Taxation of ULIPs (After the Budget 2021)

Effective from 1st February 2021, no exemption is allowed under Sec.10(10D), if the amount of premium payable for any of the previous year during the term of the policy exceeds Rs. 2,50,000.

However, if the total premium payable during any financial year is less than Rs.2,50,000 (including all the multiple policies), then you still enjoy the tax-free maturity benefits under Sec.10(10D).

The Finance Bill, 2021 proposes to insert a new sub-section (1B) to Section 45 to provide that where any person receives at any time during any previous year any amount under a ULIP, to which exemption under Section 10(10D) does not apply on account of the fourth and fifth proviso thereof, including the amount allocated by way of bonus on such policy, then, any profits or gains arising from receipt of such amount by such person shall be chargeable to tax under the head “Capital gains” in the previous year in which such amount was received. Further, the income taxable under this head shall be calculated in such manner as may be prescribed. Thus, the manner of computation of income shall be notified subsequently.

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The definition of ‘Equity-Oriented Fund’ in Section 112A is proposed to be amended by the Finance Bill, 2021. It is proposed to cover ULIPs to which exemption under Section 10(10D) does not apply on account of the applicability of the fourth and fifth proviso thereof. Thus, the high premium ULIPs shall be considered as Equity Oriented Fund even if a portion of the fund is invested in the debt-based scheme.

Thus, the long-term capital gains, in excess of Rs. 1,00,000, shall be taxable at the rate of 10% without indexation under Section 112A. Whereas the entire amount of short-term capital gains shall be taxable at the rate of 15% under Section 111A. The ULIPs shall be considered as a long-term capital asset if they are held for more than 12 months and short-term capital assets if held for 12 months or less.

One more important aspect to consider here is the taxation about the switching. As of now, switching from one fund to the other provided the maturity/redemption of units of ULIPs are exempt under Section 10(10D). However, as per the new proposal, if the premium is more than Rs.2,50,000, then they are not eligible to claim the exemption under Sec.10(10D). In such a situation, we have to wait for clarity about the taxation on switching of the policies whose premium is more than Rs.2,50,000.

# Taxation of ULIPs at death

In the event of the death of the policy-holder, the exemption shall not be denied under Section 10(10D) from either of the policy, that is, excess premium policy (more than 10% of sum assured) or higher premium policy (more than Rs. 2,50,000).

Hence, irrespective of the premium amount, the death benefit is always tax free in the hands of nominee.

Security Transaction Tax (STT) Applicable on ULIPs

Finance Act, 2021 has proposed to amend various provisions of Finance (No. 2) Act, 2004 to enable levy of STT on the amount received by the policyholder at the time of maturity or partial withdrawal from the ULIPs issued on or after 01-02-2021. Levy of the STT on the ULIPs will bring it at par with the equity-oriented mutual fund units. STT will be levied if all the following conditions are satisfied:

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(a) ULIP is issued on or after 01-02-2021;

(b) Sum received from ULIP is taxable under Section 10(10D) on account of applicability of fourth and fifth proviso thereof;

(c) The policyholder has transferred units of equity-oriented funds issued by the insurer with respect to ULIPs;

(d) The amount is received on sale or surrender or redemption of the units on account of maturity or partial withdrawal.

STT will be levied at the rate of 0.001% on the value of the transaction and is required to be paid by the seller of the units. Amendment in other provisions regarding furnishing of return and collection and recovery of STT has also been proposed.

It should be noted that the STT shall not be levied in the following situations:

(a) On switching of funds from one scheme to another;

(b) On redemption or surrender otherwise than on withdrawal (in case of death);

(c) If the premium is invested in debt-based, money-market or balanced funds.

Conclusion:-I hope this the above points will bring clarity about the taxation of ULIPs after the Budget 2021. Let me know if you have any questions or doubts.

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Basu Nivesh

Basu Nivesh

Basav is a SEBI Registered Investment Adviser (SEBI RIA) practicing the Fee-Only Financial Planning Service. He is a CFP (Certified Financial Planner) and blogger at Basu Nivesh. He services around 300+ satisfied clients.
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