The Finance Bill 2021-22 has proposed to tax the gains from ULIPs (Unit Linked Insurance Policies) with a premium of more than Rs 2.5 lakh per year. The move will bring parity to ULIPs and mutual funds in terms of taxes.
From 1st February 2021, investing more than Rs 2.5 lakh as premium in ULIP will see the maturity proceeds being taxed identically to mutual funds.
However, death benefit in ULIP will continue to remain tax-free regardless of the premium amount.
This new tax rule applies to the sum of the premium of the ULIPs purchased on or after 1st February 2021.
At present, Long-Term Capital Gains (LTCG) arise out of the sale of units of equity-oriented mutual fund schemes and the gains are taxed at the rate of 10%, if the LTCG exceed Rs 1 lakh in a financial year (gains up to January 31, 2018 being grandfathered).
However, the proceeds from ULIPs of insurance companies (including early surrender / partial withdrawals), are exempted from income tax under section 10(10d) of Income Tax Act, if the sum assured in a life insurance policy is at least 10 times the annual premium and withdrawn after a lock-in of 5 years.
The above situation led to tax arbitrage in favour of ULIPs, even though ULIPs like mutual funds are also investment products that invest in equity stocks. ULIPs even have an added advantage of tax deduction under Section 80C of the Income Tax Act on the premium paid.
The capital gain tax advantage was being used by many HNIs, and their investments went to ULIPs. With the Budget proposal, there will be some tax parity between ULIPs and mutual funds.