Life insurance payouts will be taxable if yearly premium exceeds Rs 5 lakh

The sum received in excess of the premiums paid shall be taxed as income from other sources where all exemption related conditions are not met.

From assessment year 2024-25, sums received under life insurance policies (excluding unit-linked ones) issued after April 1, 2023, won't be exempt if the premium paid during any year exceeds Rs 5,00,000. 

For policies with premiums beyond this limit, the maturity proceeds will be treated as part of the individual's income and will be subject to taxation based on applicable rates.

 If multiple policies are involved, exemption applies only if their total premiums don't exceed this limit. However, these provisions won't apply to death-related sums, as per a circular issued by the Income Tax Department on Wednesday. 

The circular also states that unclaimed sums from such policies will be taxable under "Income from other sources." 

The taxation provision for the amount received on the death of an insured has not been changed, and that remains exempt from income tax.

This taxation change underscores the importance of keeping investment and insurance separate.
 

The Central Board of Direct Taxes (CBDT) has issued new guidelines on August 16, as part of the Income-Tax Act, 1961. These guidelines concern clause (10D) of section 10, dealing with income-tax exemption for sums received from life insurance policies.

Clause (10D) of section 10 of the Income-Tax Act provides exemptions from income tax on sums received under life insurance policies, including bonus amounts, subject to certain conditions. The Finance Act, 2023, has introduced amendments to this clause, specifically affecting policies issued on or after April 1, 2023.

The amendments introduced by the Finance Act, 2023, are as follows:

1. Premium Limit: From the assessment year 2024-25, any sum received under a life insurance policy (excluding unit-linked insurance policies) issued on or after April 1, 2023, will not be exempt if the premium payable for any previous year during the policy term exceeds Rs 5,00,000 (sixth proviso).

2. Aggregate Premium Limit: If multiple life insurance policies (excluding unit-linked insurance policies) are held and issued after April 1, 2023, the exemption will apply only if the aggregate premium for any of the previous years during the policy term does not exceed Rs 5,00,000 (seventh proviso).

3. Death Claims Exemption: The above premium limits (sixth and seventh provisos) will not apply to sums received on the death of the policyholder (eighth proviso).

4. Taxation on Unclaimed Sums: A new clause (xiii) has been introduced in sub-section (2) of section 56. This clause states that any sum received under a life insurance policy, not claimed as a deduction under any other provision of the IT Act, will be taxed under the head "Income from other sources."

5. Impact on Tax Liability: If the sum received under a life insurance policy during a previous year exceeds the aggregate premium paid during the policy term and is not claimed as a deduction elsewhere, the excess amount will be chargeable to income tax under "Income from other sources."

Before the amendment, individuals enjoyed an income tax exemption under Clause (10D), Section 10 of the Income-Tax Act, 1961. Any sum received under a life insurance policy, including the sum allocated by way of bonus on such a policy, did not attract tax in most cases.

Definition Clarifications:

The circular introduces certain definitions to facilitate clarity:

Eligible Life Insurance Policy: Refers to any life insurance policy (except unit-linked insurance policies) issued on or after April 1, 2023.

Consideration: Denotes the sum received under an eligible life insurance policy, including any bonus amount.

Current Previous Year: Refers to the previous year in which the consideration is received and its taxability is being examined.

Implications:

"This is a proactive step by CBDT to clarify confusion on computing Rs 5 lakh exemption limit, especially when the policy was taken and some premiums paid before and some are paid after 31st March 2023. This will certainly go a long way in providing certainty while purchasing life insurance policies," said Punit Shah, Partner, Dhruva Advisors

"CBDT has provided detailed example of how exemption shall be calculated in several scenarios to help taxpayers arrive at taxation accurately. This will mostly apply to high net worth individuals who have multiple insurance policies or have one policy where premium exceeds Rs 5 lakh," said Archit Gupta, Founder and CEO, Clear

"The CBDT's circular provides comprehensive guidelines on the taxation of sums received under life insurance policies issued on or after April 1, 2023. These guidelines include premium limits, aggregation of premiums, tax treatment of unclaimed sums, and definitions to ensure proper implementation of the amendments. It's important for policyholders to understand these changes and their implications for their tax liability," said Ankit Rajgarhia, Principal Associate, Karanjawala & Company, Advocates 

AKM Global Tax Partner Amit Maheshwari said the provision was introduced to nullify tax advantage given to investments disguised as insurance policies. Since this provision would impact many individuals, especially the rich, CBDT has issued guidelines to remove difficulties, which is a welcome move.