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Indian Life Insurance Industry Fears Tax Benefit Loss

by Mary Swire,, Hong Kong

09 December 2009

The introduction of the new Direct Tax Code in India, due by April 2011, is causing concern in the life insurance industry, in which the past phase of rapid growth appears to be over, in part due to the proposed loss of tax benefits.

The aims of the reform, to simplify the tax system and remove the wide-ranging exemptions applied, would mean a disproportionate loss of tax incentives for life insurance.

The present system allows a so-called triple E (EEE) exemption: exemption as the premium is deposited; exemption as the investment accumulates; and exemption at maturity - income is deemed to be taxed as a capital gain and indexation is allowed.

The proposed reform would limit these exemptions - a so-called EET regime (the EET framework being a common feature of the new investment tax regime).

Presently on deposit of the life premium, tax exemption is granted on premiums up to 20% of the sum insured, whereas the new regime will limit the tax benefit to 5% of the sum insured; this is to apply both to the benefit on deposit of premium and for any sums paid out.

A 5% premium on the life insured is only realistic for some term assurance, life insurance without an investment element. Most present life policies involve premiums of 20% of the sum insured, admittedly to optimize the tax exempt investment aspects.

Substantial life pay-outs can easily bring the assured person into a higher tax bracket, which nullifies the benefit of reduced income tax rates which the tax code will bring; annual incomes of INR1m (USD21,400) or less are to be taxed at 10%, over INR1m (and up to INR2.5m) the tax rate will be 20%. If the life assured is someone whose income comes below the taxable threshold, the initial exemptions from tax are of no value, but the accumulated benefit can become taxable when paid out.

Industry professionals emphasize that the tax being applied as income tax as opposed to capital gains (at 10%), actually makes investment through life insurance a less attractive proposition than through mutual funds.

In a country such as India, which lacks the social security safety net of more developed countries and is also in need of vast infrastructure investment, for which the flow of long term investment from life insurance funds is vital, industry commentators argue that it makes sense to encourage more life insurance through tax incentives.

The industry will be lobbying before the new legislation is passed to increase the maximum premium limit allowable from the proposed 5% of the sum insured, and to clarify certain other matters; loans under life policies could become taxable as benefits as the legislation stands presently, and tax problems could also arise on 'Money Back' policies or policies surrendered before maturity.

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