In this article we examine the treatment of money received from an insurance policy under the income tax act.
Insurance was originally marketed as an instrument through which people can put some of their income aside to financially secure themselves from uncertainties and for emergencies. Most governments in the world actively encourage citizens to insure themselves by offering tax benefits such as allowing the annual premium on an insurance policy as a deduction against taxation income and tax relief for the proceeds received on maturity. And because of these benefits, insurance is no longer just a matter of prudence in terms of mitigating risks and uncertainties anymore.
It has also become a prudent instrument for investment of surplus funds due to the fixed rate of interest and the tax benefits attached to it. The income tax authorities have taken this changing utility of insurance policies into consideration over time and introduced certain provisions into the income tax act to ensure that any policies taken solely with the outlook of earning returns on investment are duly taxed, at the same time making sure that the genuine cases are spared from the burden of taxation. Let us take a look at how the provisions of the income tax act separates the two classes.
Deduction Of Insurance Premium Against Taxable Income
A deduction against taxable income is usually meant to be an expenditure incurred directly in the process of generating income. The provision to allow Insurance premium as a deduction is one of those rare instances where a personal expense has been included in the list of expenses that can be deducted against taxable income.
Usually the taxpayer is expected to incur their personal expenses from their disposable income, which is income remaining after payment of income tax. But this exception was made as a part of the government’s social welfare initiative in order to encourage people to insure themselves in order to secure their dependents financially given that most households in India have only one earning member in the family.
But in 2003, certain provisions were brought in to ensure that people don’t take undue advantage of this deduction. So how does one identify which insurance premium is genuine and which one is not?
While there is no sure way to identify this, one can make certain fair presumptions to make sure that can help identify a genuine policy from a policy that is just an investment. The presumption made in this case was that any policy which mature within five years of paying the first premium will be considered as an investment oriented policy and any interest or bonus earned on that policy will be added to the incomes from the other heads to arrive at the total taxable income for the purpose of calculating the income tax liability.
So simply said, any insurance policy with an annual premium exceeding 20% of the amount that has been insured will be considered as investment oriented policies and will not be allowed as a deduction from Income tax. This was further modified in 2012 when it was decided that not five years but ten years should be the term for maturity of a policy in order for it to qualify for income benefits. So since 2012, any policy with a premium greater than 10% will be disallowed as a deduction against taxable income.
However, those who have taken insurance policies without anticipating the implementation of such policies cannot be penalised for taking advantage of the system. So any policy taken prior to 2003, will continue to enjoy the tax benefits that were available at the time of purchasing the policy. Furthermore, any person who took the policy after 2003 but before 2012 can enjoy tax benefits after just five years of purchasing the policy.
Now these deductions are available for a premium on policies taken in the name of the person earning the income only. Premium on insurance policies taken in the name of dependents is not allowed as a deduction. But in 2013 an exception was made to this rule and another provision was introduced specifying that any premium paid for an insurance policy taken in the name of a dependent with disabilities and certain diseases can be claimed as a deduction as long as the premium on insurance does not exceed 15% of the insured amount.
For the purpose of this provision, a dependent has been defined as a spouse, child, parents or siblings of the taxpayer. And disabilities and deductions will be as per the definitions under section 80U and 80DDB. Under section 80DDB, a disabled person has to be disabled by at least 40% to qualify for tax benefits. And disease under section 80U is any disease that has cancerous malignancy.
Tax and TDS on Proceeds from Insurance
Money received on maturity of insurance, or for medical expenditure, or upon the death of the policyholder is exempt from tax. Even money received on maturity of a policy is exempt, as long as the premium is less than 10%, 15% or 20% of the insured value, as applicable, or the policy date is older than the year 2003. However, if it does not meet these criteria, then income tax is applicable on the income earned on the policy as well as any bonus given out on the policy and the insurer must deduct TDS from the proceeds before paying to the beneficiary and make TDS deposit online.
As of 2014, the insurer is required to deduct 1% of the income earned on the policy as TDS and make the TDS payment online. Income earned is calculated by deducting the total amount of premiums made from the actual money received on maturity.
It may be very difficult for a layman to understand the rules and provisions that need to be followed while deducting TDS and making the payment online. They may not seem like common sense because the tax department makes the provisions and rules based on data that is not accessible to the common man.
So when it comes to matters of TDS: https://incometaxindia.gov.in/Pages/Deposit_TDS_TCS.aspx and taxation it is always better to consult with a tax expert who has been trained in understanding the nuances of taxation and its structure. If you want to get in touch with a tax expert, contact Vakilsearch today, and we will connect you to the right professional to help guide you and structure your tax to keep your liability at a minimum.