NEW DELHI: Budget 2021 has restricted avenues for tax-free returns for middle-class taxpayers. From April 1, returns on investment of more than Rs 2.5 lakh in two of the most popular instruments — provident fund and unit linked insurance plan (ULIP) — will be taxed. This, say industry sources, will bring ULIPs on a par with mutual funds, doing away with the edge they have had since 2018 when long term capital gains was introduced.
So far, returns on investment of any amount in voluntary provident fund (VPF), along with EPF and ULIP, are tax-free on maturity.
With this amendment, return on investment up to Rs 2.5 lakh in PF will remain tax-free while the return on the portion exceeding that amount will be treated as income in the investor’s hand. This portion will be taxed at the rate at which the investor’s income is taxed, said Sonu Iyer of Ernst and Young.
In case of ULIP, if the investment in a year exceeds Rs 2.5 lakh, the investor will not get the benefit of tax exemption at all. The entire income will be taxed at the rate of 10% plus surcharge, treating the ULIP as an equity-oriented investment plan, said Jay Mehta (Partner) PWC India.
The Memorandum Explaining Provisions of Finance Bill, 2021, says there are instances of some employees contributing huge amounts to PF, and the entire interest accrued being exempt from tax under clause 11 and clause 12 of Section 10 of the Income Tax Act. “This exemption without any threshold benefits only those who can contribute a large amount to these funds as their share,” said the memorandum.
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From April 1, 2021, the Memorandum stipulates, income on the contribution made by a person exceeding Rs 2.5 lakh would not be tax-free. “However, the rate at which it would be taxed has not been specified,” Iyer said. If it is treated as interest income, it would be taxed at a marginal tax rate in the hand of recipient, he pointed out.
In the case of ULIP, any sum received after January 31, 2021, which entails premium payments exceeding Rs 2.5 lakh in any financial year during the policy term, would be taxable in the year of receipt as capital gains, said Mehta. Such sums’ taxability would be on a par with those received on the transfer of equity-oriented mutual funds.
The limit of Rs 2.5 lakh would be applied across ULIPs held by the same policyholder. However, sums received upon death will continue to be exempt.
To enjoy the tax-free benefits of ULIP, investors have to buy a policy where the annual premium is not more than 10% of the sum-assured. Though the term of ULIP is 10 years, one can get the pre-maturity tax-free amount after five years of the policy being enforced.
The new provisions in both schemes apply from February 1, 2021. ULIPs issued up to January 31, 2021 would remain unaffected, Mehta said.
“ULIPs were on a par with mutual funds before long-term capital gains were introduced in 2018. Returns on ULIPs were superior to mutual funds after the seventh year because of the nature of charges in insurance. After the tax was reintroduced, insurance schemes generated better returns after six years. Now, it is back to seven years,” said an insurance industry official.
The amendment seeks to close the loophole used by insurance companies to structure schemes for high net-worth individuals to avoid tax by reporting investment gains as proceeds from a maturing insurance policy, industry sources said. “This tends to reduce the competitive advantage that ULIPs enjoyed as compared to other short-term investment vehicles,” said Tarun Chugh, MD & CEO of Bajaj Allianz Life.
