Direct Tax Alert

BACKGROUND

Unit Linked Insurance Policy (ULIP) represents a hybrid investment option which consists of a mix of Insurance and investment to serve the needs of respective investors. The amount of premium of a ULIP scheme is partly towards the insurance of the policyholder and partly towards the investment. The investable portion of the premium is invested in equity, debt, money market or a mix of all based on the goals and risk appetite of the investor.

Pursuant to the Finance Act, 2021, an exemption under section 10(10D)¹of the Income-tax Act, 1961 (IT Act) shall not apply to ULIP policies issued on or after 1 February 2021, where the premium or aggregate premium payable for any of the fiscal year (FY) during the term of the policy exceeds INR 0.25mn. Such ULIP policies will be considered as “Capital Asset” as per the provisions of section 2(14) of the IT Act and accordingly, any gain/loss arising thereon will be taxable under the head “Income from Capital Gain”.

In its recent ruling², the Mumbai Tax Tribunal held that proceeds on premature surrender of ULIP policy, wherein exemption under section 10(10D) of the IT Act is not availed, shall be treated as Capital Assets under section 2(14)(a) of the IT Act and consequential mechanism to compute gain/loss, as the case may be will follow under the head “Income from Capital Gain”.

We, at BDO India, have summarised the above ruling and have provided our comments on the impact of this decision here under.

FACTS OF THE CASE

• The taxpayer is an individual policyholder of ULIP product, paying a premium of INR 0.18mn per annum for a period of 8 years

• During FY 2015-16, the taxpayer received proceeds from premature surrender of ULIP policy aggregating to INR 15.52mn

• The taxpayer treated the ULIP Policy as “Capital Asset” and availed indexation benefit for computing the cost of acquisition, which resulted in long-term capital loss amounting to INR 0.4mn

• During the course of assessment proceedings, the first appellate authority held that amount received on premature surrender of ULIP policy after reducing the amount of premiums paid by the taxpayer is taxable under the head “Income from Other Sources” and not under the head “Income from Capital Gain”.

Aggrieved by the said order, the taxpayer preferred an appeal before the Hon’ble Mumbai Tax Tribunal. The Mumbai Tax Tribunal, while ruling that receipts from ULIP are to be treated as a capital asset if the benefit of section 10(10D) of the IT Act is not availed, made the following observations:

MUMBAI TAX TRIBUNAL’s RULING:

• As per the amendment in Finance Act 2021, ULIP will be classified as “Capital Asset” from FY 2020-21 onwards. The said amendment is prospective in nature and thus, cannot be held applicable for the FY 2015-16.

• Reliance placed by the taxpayer on the Mumbai Tax Tribunal’s decision in the case of Mihir K. Jhaveri Vs. CIT³ cannot be accepted as it is distinguishable for the following reasons:

  • In case of Mihir Jhaveri, the policy was a single-premium policy, with a premium of INR 5mn, which exceeds the ceiling limit of INR 0.25mn as provided in the fourth and fifth provisos of section 10(10D) of the IT Act, whereas the amount of premium in the present case is only INR 0.18mn per annum;

  • The amount was received by the policyholder upon completion of term of the policy, whereas in the present case, the taxpayer has received an amount on premature surrender of policy.

•  The first appellate authority’s decision is upheld. However, the provisions of section 2(14)(a) of the IT Act define “Capital Asset” to mean property of any kind held, whether or not connected with his business/profession. Therefore, an Insurance policy, not eligible for the benefit of exemption under section 10(10D) of the IT Act, can fall within the ambit of “Capital Asset” under section 2(14)(a) of the IT Act.

• Therefore, the taxpayer is entitled to treat the said ULIP policy under “Capital Asset” and accordingly, the consequential computation mechanism will follow to treat the amount received as capital gain/loss, as the case may be.

BDO INDIA COMMENTS

This ruling emphasises the prospective nature of the amendment vide Finance Act 2021 applicable to the ULIP policy. However, an interpretation of considering a ULIP policy as a “Capital Asset” before the amendment of the Finance Act 2021 may provide an alternate path for the policyholders to evaluate the tax implications under the head “Income from Capital Gain” vis-à-vis the “Income from Other Sources” and avail a more beneficial mechanism to offer the proceeds received thereunder for taxation.