-- Sandeep Saxena

The tax implications for a person buying insurance would be huge once the Code is implemented.

Sunil Badala Bharat Jain

Life Insurance sector is one of the most important sectors for the Government as it channels the savings of households into the productive sectors of the economy.

Hence, it is important that life insurance sector is given due importance. In India, this sector is still in its infancy and needs help from the Government.
A litigious issue

The taxation of life insurance companies has always been a subject matter of litigation. The industry was hoping that the Direct Taxes Code would bring suitable amendments to clarify the scheme of taxation.

Under the Code, taxation of life insurance companies is governed by the Eighth Schedule, which specifies that profits of life insurance business would be the profits from shareholders' account. Further, it seems that transfer from shareholder account to policyholder account would be deductible and vice versa would be taxed accordingly.

The Code provides that while calculating the profits, a deduction for negative profits of any preceding financial year would be available. While it seems that the intention of the legislature is to allow life insurance companies to adjust negative profits for all the preceding years, it is recommended that to avoid any litigation, the same should be expressly provided for.

Also the Code does not have provision to carry forward losses of life insurance companies prior to enactment of the Code.

Again, the same cannot be the intention of the legislature. Hence, it is suggested that the Code should have specific provisions to allow carry forward of losses incurred up to financial year 2010-11.

Another aspect that merits attention is applicability of tax on gross assets which is akin to Minimum Alternate Tax (MAT). The Code clarifies that even if a person does not prepare accounts as per Schedule VI, the above provisions would still apply and hence the arguments available under the existing provisions regarding non-applicability of MAT to insurance companies, may not be available after enactment of the Code.
Pass thru status

The Code proposes to levy 2 per cent tax on value of gross assets. The Code seeks to give a pass thru status to life insurance companies. To this extent, there is an anomaly in the Code as, at one end, the Code treats a life insurance company as a pass thru entity, however, at the other end, the life insurance companies are made liable to pay tax on gross assets at the close of the financial year.

The Code introduces the scheme of EET (Exempt - Exempt - Tax) for taxation of savings. Under this scheme, where all contributions and accumulations/accretions would be exempt from tax, withdrawals made at any time would be subject to tax subject to certain exceptions.

The Code specifies that any amounts received upon death or maturity of a life insurance policy would be exempt from the EET scheme of taxation provided the premium payable for any of the years during the term of the policy does not exceed 5 per cent of the actual sum assured.

Hence, as a consequence, if the premium paid is more than 5 per cent of the actual sum assured, then the policyholder would be subject to tax even in case of death of the assured. This would be very harsh and, to that extent, the language used under the Code needs to be revisited.

As per the existing provisions, any amount received under a life insurance policy is exempt if the premium payable for any of the years does not exceed 20 per cent of the capital sum assured.

If the Code is enacted as it is, many life insurance products would become taxable and have huge tax implications in the hands of person buying insurance.

In India, where people generally invest in insurance to earn exempt income, this could have a significant impact on life insurance sector.

Also, while the Code provides for grandfathering of exemption for accumulated balances as on March 31, 2011, for Employee Provident Fund and other recognised Provident Funds but does not provide any exemption to life insurance policies issued prior to enactment of the Code.
Extending the exemption

It is suggested to amend the Code to provide exemption for all the life insurance products issued prior to enactment of the Code though premium may be paid after the Code is implemented. It is important to note that the Code specifies that the maximum amount of deduction available to an individual would be restricted to Rs 3,00,000. This would comprise, among other things, contributions made by the employer towards employee provident fund, tuition fees, etc.

As a result, there is a possibility that the limit of Rs 3,00,000 would be exhausted without utilising the amount of insurance premium paid. In such a situation, premium paid by policyholder may get taxed without any deduction for such premium payments.

While the efforts of the Government in simplifying the tax law are appreciated, if the Code is enacted in the current form, it would cause significant hardship to insurance companies and policyholders.