Section 194DA clarification needed

Applicability of various provisions of Income Tax Act 1961 to Insurance policies:

Also a debate over newly inserted section 194DA

A brief Description

With a view to inculcate a habit of thrift, GOI, has through Income Tax Act 1961 and various Finance Acts offered tax soaps to investors. Sections 80C,80C(1),80C(2)(i),(ii),(xii) and section 88(2), 88(2)(i)(ii) and 88(xiiia), 80CCC (1), 80CCD and 80 CCE of the Income Tax contain the various provisions, instruments and limitations (caps) etc. for such tax saving investments. Also relevant are the provisions contained in sections 10(10D), 10(23AAB) and 194DA.The scope of this article is limited to the tax treatment (including recently introduced TDS) of investments made in Insurance policies (both Life and Pension) only. We have kept out Key-Man Insurance and exclusive Health/disability as there are no issues involved with regard to their interpretation.

Definition of life insurance under Sec. 2(17), which incidentally includes definition of contract of insurance for human life, the relevant extract being reproduced below:

"Life insurance business means the business of effecting contracts of insurance upon human life, including any contract whereby the payment of money assured on death (except death by accident only) or the happening of any contingency dependent on human life, and any contract which is subject to payment of premiums for a term dependent on human life and shall be deemed to include: (a) ......, (b) the granting of annuities upon human life, and (c) ......".

Sec. 4 of the Insurance Act also contemplates annuity policy as life insurance policy, as long as life risk is also covered.

This definition will be used while interpreting the term Actual Capital Sum Assured and any sums payable under a life insurance policy referred to in this article.

Provisions u/s 80C of Income Tax Act 1961 as amended by Finance Act 2014

(1) In computing the total income of an assessee being an individual there shall be deducted, in accordance with and subject to the provisions of this section, the whole of the amount paid or deposited in the previous year being the aggregate of the sums referred to in subsection (2), as does not exceed one lakh fifty thousand rupees.

(2) The sums referred to in sub-section (1) (as above) shall be any sums paid or deposited in the previous year by the assessee—

(i) to effect or to keep in force an insurance on the life of the individual, the wife or husband and any child of such individual subject to so much of any premium or other payment made on an insurance policy, other than a contract for a deferred annuity, as is not in excess of ten per cent of the actual capital sum assured.

Explanation.—in calculating any such actual capital sum assured, no account shall be taken—

(a)  of the value of any premiums agreed to be returned, or

(b) of any benefit by way of bonus or otherwise over and above the sum actually assured, which is to be or may be received under the policy by any person.

(ii) to effect or to keep in force a contract for a deferred annuity, not being an annuity plan referred to in clause (xii), on the life of the individual, the wife or husband and any child of such individual.

Provided that such contract does not contain a provision for the exercise by the insured of an option to receive a cash payment in lieu of the payment of the annuity…

(iii)………….. (xi)…….. (Not mentioned here as they represent investments made in instruments other than insurance policy)

(xii) to effect or to keep in force a contract for such annuity plan of the Life Insurance Corporation or any other insurer as the Central Government may, by notification75 in the Official Gazette, specify. (Like LIC’s New Jeevan Dhara, New Jeevan Akshay etc. but now stand closed.)

(xiii)……..…………… (xxiv) (Not mentioned as they represent investments made in instruments other than insurance policy)

Thus three categories of Life/pension policies as per 80C (2) (i), (ii) and (xii) above qualify for deduction under section 80 C.

(5) Where, in any previous year, an assessee—

(i) terminates his contract of insurance referred to in clause (i) of subsection (2), by notice to that effect or where the contract ceases to be in force by reason of failure to pay any premium, by not reviving contract of insurance,—

(a) in case of any single premium policy, within two years after the date of commencement of insurance; or (b) in any other case, before premiums have been paid for two years; then,—

(a)  no deduction shall be allowed to the assessee under sub-section (1) with reference to any of the sums, referred to in clauses (i), (x), (xi) and (xviii) of sub-section (2), paid in such previous year; and

(b)  the aggregate amount of the deductions of income so allowed in respect of the previous year or years preceding such previous year, shall be deemed to be the income of the assessee of such previous year and shall be liable to tax in the assessment year relevant to such previous year.

Conclusions and Remarks on Section 80C

1. The section refers to both life insurance policies and annuity (both deferred and immediate) policies. Various life insurance policies covered here either belong to EEE or ETE ( where incomes accruing on such policies, refer 10.3 of circular no 7/2003 dated 05.09.2003, are taxed in the year of receipt only and return of premium/invested amount kept out of tax).

2. The section while referring to ratio between Actual Capital Sum Assured and Premium paid/payable viz. 5:1 or 10:1, mentions, other than a contract for deferred annuity. Hence restriction of 5 times or 10 times of premium is applicable only on life insurance policies or in other words on policies covered by sub-section 2(i) above and not deferred annuity plans as per Sub-section 2(ii) and 2(xii) above. However, if any annuity plan having an element of life cover, as per the definition given above by Insurance act 1938, then such a plan has to be treated as life insurance contract and dealt with accordingly i.e. 10 or 5 times SA and applicability of section 10(10D). So Annuity plans with life cover have to satisfy the conditions of premium being restricted to 20% or 10% of Actual Capital SA. But this aspect under an annuity/pension plan is never insisted upon while considering deduction allowable u/s 80C under chapter VI of Income Tax Act 1961.

3. It may be recalled that the restriction of premium allowable upto 10% of SA was also there on Life insurance policies till 31.03.1992. At that time the Endowment policies with terms 5-10 years came in this purview. Some of them also matured after insertion of Section 10(10D) w.e.f. 1992 but the sum including bonus were treated at par with other policies and got exempted by virtue of section 10(10D).

4. As per 80C (2) (xii) only individuals in their own name can invest in New Jeevan Dhara/Akshay etc.

5. If a plan is notified for the purpose of 80C (2) (xii) or 88(2) (xiiia) then the same will not be allowed a deduction u/s 80C(2)(ii) or 88(2)(ii).

Deduction in respect of contribution to certain pension funds 80CCC.

(1) Where an assessee being an individual has in the previous year paid or deposited any amount out of his income chargeable to tax to effect or keep in force a contract for any annuity plan of Life Insurance Corporation of India [or any other insurer] for receiving pension from the fund referred to in clause (23AAB) of section 10, he shall, in accordance with, and subject to, the provisions of this section, be allowed a deduction in the computation of his total income, of the whole of the amount paid or deposited (excluding interest or bonus accrued or credited to the assessee’s account, if any) as does not exceed the amount of [one lakh] rupees in the previous year.

(2) Where any amount standing to the credit of the assessee in a fund, referred to above in respect of which a deduction has been allowed under subsection (1), together with the interest or bonus accrued or credited to the assessee’s account, if any, is received by the assessee or his nominee—

(a) on account of the surrender of the annuity plan whether in whole or in part, in any previous year, or

(b) as pension received from the annuity plan, an amount equal to the whole of the amount referred to in clause (a) or clause (b) shall be deemed to be the income of the assessee or his nominee, as the case may be, in that previous year in which such withdrawal is made or, as the case may be, pension is received, and shall accordingly be chargeable to tax as income of that previous year.

Conclusions and Remarks on Section 80CCC

1. This section pertains to pension funds referred to under section 10(23AAB). In other words this section deals with only deferred pension plans. This section covers investments made under EET regime following the fiscal principle of allowing fiscal incentives on what one contributes to the pool and disincentivize what one takes out of the pool, i.e. on lines of old NSS scheme under section 80CCA.

2. Any contribution made to these funds is eligible u/s 80CCC (1), now upto 1 lac, but not an exclusive limit any longer. Earlier it had an exclusive limit of Rs.10000 upto 31.03.2005.LIC’s Jeevan Suraksha (with or without Life Cover qualified under this section). Later LICs Future Plus (as per product brochure), Jeevan Nidhi and Market plus, Market Plus-I (not as per product brochure but by practice) were eligible in this section. No distinction was ever made between with Life Cover and without Life Cover plans. Hence qualifying the premium only upto 20% (01.04.2003 onwards) never came in picture.

3. Withdrawal either as Surrender Value before vesting or annuity after vesting are taxable on full amount under this section 80CCC(2) itself in the hands of the recipient. Hence these plans need not be referred to section 10(10D) as matter relating to taxability or otherwise for sum including bonus payable under such policies have been dealt with here clearly and exclusively.(one may recollect that the very purpose of insertion of Section 10(10D) was to resolve this issue of policy payments under life insurance policies and tax treatment of such proceeds only.

4. Since TDS under section 194DA is applicable on those life insurance policies which are mentioned in 10(10D) (c and d), and do not fulfill the restriction of 20% or 10% as the case may be, the said section10 (10D) is not applicable to deferred pension plans covered under 80CCC for the purpose of creation of a pension fund whose income is exempted under section 10(23AAB).

5. A deduction of 2% or 20%, as per newly introduced section 194DA, is not warranted on payment of surrender value or annuity payments made under these policies irrespective of the fact whether they are with or without life cover. On these proceeds recipient will continue to be liable to pay taxes.

6. Commuted Value payable in Deferred Annuity plans as per section 80CCC (1) for funds referred to under section 10(23AAB) has been made exempted u/s 10(10A) (iii) of the Income Tax Act 1961. So while paying commuted value under Jeevan Suraksha-I or Jeevan Nidhi and may be under Future plus, Market plus and Market plus-I (irrespective of the fact whether such policies contain life cover element or not) deduction as per 194DA is not warranted.

80CCE. The aggregate amount of deductions under section 80C, section 80CCC and section 80CCD (NPS) shall not, in any case, exceed one lakh fifty thousand rupees.]

10 [(23AAB) any income of a fund, by whatever name called, set up by the Life Insurance Corporation of India on or after the 1st day of August, 1996 71[or any other insurer] under a pension scheme,—

(i) to which contribution is made by any person for the purpose of receiving pension from such fund;

(ii) which is approved by the Controller of Insurance 72[or the Insurance Regulatory and Development Authority established under sub-section (1) of section 3 of the Insurance Regulatory and Development Authority Act, 1999 (41 of 1999), as the case may  be].

10[(10D)

Purpose;

The purpose of inserting section 10(10D) was to help the investors, who were entitled to get tax free proceeds under life insurance policies, as was happening as per  tradition, in their smooth assessments. So it was done with retrospective effect i.e. 01.04.1962. Further when this section was proposed to be inserted some reservations were there whether to include sums allocated by way of Bonus or not within the purview of this section for exempting the amount of Bonus. CBDT clarified its intention of accommodating policy holders further for valid reasons vide circular number 621, DATED 19-12-1991 and thus bonus was also exempted under this section.                                                           

(Circular 621 reproduced)

FINANCE (NO. 2) ACT, 1991

Exemption from income-tax of bonus paid on Life Insurance policy

14. Payments received under an insurance policy are not treated as income and hence not taxable. However, in a recent judicial pronouncement, a distinction has been made between the sum assured under an insurance policy and further sums allocated by way of bonus under life policies with profits. The sum representing bonus has been held to be chargeable to income-tax in the year in which the bonus was declared by the Life Insurance Corporation.

14.1 Since such bonus has always been considered as payment under an insurance policy, section 10 of the Income-tax Act has been amended to exempt from income-tax the bonus declared or paid under a life insurance policy by the Life Insurance Corporation of India.

14.2 This amendment takes effect retrospectively from 1st April, 1962.

[Section 5]

The said purpose continues to be there barring certain exceptions where the government thinks the provisions or concessions as per this section have been either misused or favoured Life insurance investments vis-à-vis other similar investments

(Exact wordings of section 10(10D) reproduced below to facilitate better understanding of what has been discussed)

Any sum received under a life insurance policy, including the sum allocated by way of bonus on such policy, other than—

(a) any sum received under sub-section (3) of section 80DD or sub-section (3) of section 80DDA*; or ( beyond the scope of this article)

(b) any sum received under a Keyman insurance policy; (beyond the scope of this article) or

(c) any sum received under an insurance policy issued on or after the 1st day of April, 2003 [but on or before the 31st day of March, 2012] in respect of which the premium payable for any of the years during the term of the policy exceeds twenty per cent of the actual capital sum assured [; or]

[(d) any sum received under an insurance policy issued on or after the 1st day of April, 2012 in respect of which the premium payable for any of the years during the term of  the policy exceeds ten per cent of the actual capital sum assured:]

Provided that the provisions of [sub-clauses (c) and (d)] shall not apply to any sum received on the death of a person:

Provided further that for the purpose of calculating the actual capital sum assured under [sub-clause (c)], effect shall be given to the [Explanation to sub-section (3) of section 80C or the Explanation to sub-section (2A) of section 88, as the case may be] :

Analysis, Conclusion and Summary

In other words, the exemption for insurance policies issued on or after 1st April, 2012 would only be available for policies where the premium payable for any of the years during the term of the policy does not exceed 10% of the actual capital sum assured.

This said change is intended in order to ensure that the life insurance products are not designed to circumvent the prescribed limits by varying the capital sum assured from year to year. Accordingly, it is also proposed to provide that the capital sum assured would be the minimum of the sum assured in any of the years of the policy.

As sums under Life insurance includes sums also received under an Annuity plan having life cover but for only those annuity plans which are either as per 80C (2) (ii) or 80C (2)(xii) and not as per section 80CCA or 80CCC under reference to 10(23AAB) because taxability aspects for such plans is very much clear for both withdrawal/surrender and annuity and therefore section 10(10D) need not be made applicable here.

If we read the contents of section 10(10D) along with what is contained in CIRCULAR NO. 7/2003, DATED 5-9-2003 (reproduced below), it would read like ……any sum received under a life insurance policy (not including the premium paid by the assessee) including sums allocated by way of bonus…………..

Insertion of new section 194DA  Payment in respect of life insurance policy

After section 194D of the Income-tax Act, the following section shall be inserted with effect from the 1st day of October, 2014, namely:––

“194DA. Any person responsible for paying to a resident any sum under a life insurance policy, including the sum allocated by way of bonus on such policy, other than the amount not includible in the total income under clause (10D) of section 10, shall, at the time of payment thereof, deduct income-tax thereon at the rate of two per cent.:

Provided that no deduction under this section shall be made where the amount of such payment or, as the case may be, the aggregate amount of such payments to the payee during the financial year is less than one hundred thousand rupees.”

Conclusions and Remarks on Section 194DA

1. It has been made very much clear that provisions of section 194DA are applicable on those life insurance (and not on deferred pension plans) policy payments where such said payments are not exempted under section 10(10D).

2. The words used under section 194DA, any sum under a life insurance policy, including the sum allocated by way of bonus on such policy, may imply or subject to interpretation that entire policy proceeds which represents amount invested ( premium paid under the policy either periodically or lump-sum) and accretion by way of Bonus or otherwise both get included in  the entire policy proceeds and whole amount is to be considered for TDS purpose. Whereas as per CBDT CIRCULAR NO. 7/2003, DATED 5-9-2003 (enclosed at the end), the tax is to be levied on income accruing on such policies (not including the premium paid by the assessee).

3. If 2% or 20%, as the case may be, is deducted from total amount and the same is also reported as income of policy holder by the insurer to tax authorities, it will lead to a lot of litigation. Logically also only income earned/accruing on insurance policies should form a subject matter of TDS u/s 194DA. Even as per provisions contained under relevant sections for TDS, Tax at source is always collected on income and not on return of capital (original investment out of already taxed income) on lines with other tax saving instruments like Bank FD and NSC.

Enclosure:  FINANCE ACT, 2003                            

CIRCULAR NO. 7/2003, DATED 5-9-2003

Amendments at a glance

Sections/Schedules                         Particulars

10. Restriction of tax benefits in respect of certain insurance policies having premium of more than twenty per cent of the actual capital sum assured

10.1 Under the existing provisions contained in clause (10D) of section 10, any sum received under a life insurance policy including the sum allocated by way of bonus on such policy, (other than any sum received under a policy for the medical treatment, training and rehabilitation of a handicapped dependent under section 80DDA or any sum received under a Keyman insurance policy), is tax-exempt.

10.2 Under the existing provisions of section 88, a deduction from the income-tax payable is allowed to an individual or a Hindu undivided family (HUF), in respect of any sums paid or deposited in PPF, GPF, NSC, insurance premia, etc. The deduction is allowed at specified percentage of such sums.

10.3 The insurance policies with high premium and minimum risk covers are similar to deposits or bonds. With a view to ensure that such insurance policies are treated at par with other investment schemes, amendments have been made in section 88 and clause (10D) of section 10. The existing clause (10D) of section 10 has been substituted so as to provide that the exemption available under the said clause shall not be allowed on any sum received under an insurance policy issued on or after the 1st day of April, 2003, in respect of which the premium payable in any of the years during the term of the policy, exceeds twenty per cent of the actual capital sum assured. In view of this, the income accruing on such policies (not including the premium paid by the assessee) shall become taxable. However, any sum received under such policy on the death of a person shall continue to remain exempt. The new provision also provides that the amounts received under sub-section (3) of section 80DD, shall not be exempt under this clause.

10.4 For the same reasons, a new sub-section (2A) has been inserted in section 88 which provides that the deduction in respect of the sums paid or deposited as premium under an insurance policy shall be available only on so much of any premium or other payment made on an insurance policy other than a contract for a deferred annuity as is not in excess of twenty per cent of the actual sum assured.

10.5 It has also been clarified in both the sections that the value of any premiums agreed to be returned or any benefit by way of bonus or otherwise, over and above the sum actually assured, which may be received under the policy by any person, shall not be taken into account for the purpose of calculating the actual capital sum assured.

10.6 These amendments will take effect from 1st April, 2004 and will, accordingly, apply in relation to the assessment year 2004-05 and subsequent years.