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The Finance Act 2023 has ended the ‘tax-holiday’ glory of the maturity proceeds of high-ended life insurance policies/endowment plans, requiring payment of annual premium in excess of Rs 5 lacs. The section 10(10D) of the Income Tax Act has been amended to provide that the maturity proceeds received under a life insurance policy, (other than ULIPs), issued on or after 1.4.2023, shall not be exempt, if the premium payable in any year, during the term of such policy, exceeds Rs 5 lakhs.

The amended section also stipulates that if the policy holder holds and pays premium in respect of multiple life insurance policies, issued on or after 1.4.2023, the exemption from income tax in respect of the maturity proceeds shall be available only in respect of such policies where the aggregate annual premium does not exceed Rs 5 lakh, during the term of any of such policies.

If the policyholder holds multiple life insurance policies, issued on or after 01-04-2023, and the premium payable for each of such policies during any year does not exceed Rs. 5 lakhs, but the aggregate of premium payable for all such policies exceeds Rs. 5 lakhs in a year, the exemption under section 10(10D) shall be allowed only in respect of those policies whose premium falls within the aggregate limit of Rs. 5 lakhs.

It is pertinent to mention here that the clubbing or aggregating of annual premium for the purpose of determining the threshold annual premium limit of Rs 5 lakhs in respect of multiple life insurance policies, is to be done only for those life insurance policies which have been issued on or after 1.4.2023. Further the maturity proceeds of such life insurance policies, have been made taxable under the head income from other sources under a new section 56(2)(xiii).

Amidst such taxing times for the high-ended life insurance policies, the CBDT has brought in some respite by way of its Circular No. 15 of 2023 dated 16.8.2023. This Circular contains guidelines to remove difficulty in practical implementation of the amended provisions of section 10(10D), concerning the taxability of maturity proceeds of life insurance policies, issued on or after 1.4.2023. The Circular also contains practical examples for better understanding and clarity of the stakeholders, in this respect.  

Among other things, the key take-away and main highlight of this Circular is the clarification in respect of the taxability of the maturity proceeds of life insurance policies, in cases where the policy holder holds multiple life insurance policies issued on or after 1.4.2023, and the policy tenure or part of the tenure of such policies coincides with each other. The Circular clarifies that in such cases, the policy holder shall have the option to choose the policies which can be claimed as exempt and which can be offered for taxation.

The Circular clarifies that in order to optimise the utilisation of the aggregate exemption threshold limit of premium of Rs 5 lakhs, in respect of multiple life insurance policies, issued on or after 1.4.2023, the policy holder should first exhaust this threshold annual premium limit of Rs 5 lakhs, in respect of those policies which are having the higher maturity proceeds in value, so that the life insurance policies having comparatively lower value of maturity proceeds are subject to income tax.

It is pertinent to mention here that in majority of the cases, the absolute value of the maturity proceeds will be the deciding factor in making the choice of the insurance policies for claiming exemption u/s 10(10D), as compared to the net yield basis. The Net Yield of the life insurance policy is equivalent to Maturity Proceeds of the policy – (Annual Premium * Policy Tenure).

The Net Yield basis may not be practical as the premium paid in respect of the policy is allowed as deduction from the taxable amount of maturity proceeds only if the policyholder has not claimed deduction in respect of such premium in any earlier years under any other sections like section 80C. In all likely-hood, the policyholder would have already claimed deduction in respect of the premium paid on life insurance policy u/s 80C of the Act, and as such it will be the gross maturity proceeds amount, which will be taxable and not the net yield amount after claiming deduction of premium paid. However, if the policyholder is opting for the new personal tax regime, then the net yield basis may be considered for making this choice.

Although it is a welcome development that the CBDT Circular has clarified that in case of multiple life insurance policies issued on or after 1.4.2023, the policyholder will have the option to choose those policies for claiming exemption u/s 10(10D), which are having comparatively higher maturity value and the annual premium of which falls within the aggregated threshold annual premium limit of Rs 5 lacs, but the said clarification has one inherent downside also. The downside is the mandatory requirement of clubbing of premiums paid or payable in respect of all life insurance policies, the premium payment tenure of which coincides with each other even for a fraction of a month only, for the purpose of determination of the aggregate threshold annual premium limit of Rs 5 lakhs.  

Consider a case where a policyholder has bought one life insurance policy/endowment plan on 1.4.2023, with sum assured of Rs 40 lakhs with an annual premium of Rs. 4 lacs and with a policy term of five years, maturing on 31.3.2028. Now suppose in order to ensure continuity of his insurance coverage he purchases another life insurance policy, at the fag end of the maturity of his first insurance policy on 1.1.2028, with another insurer, with the same sum assured of Rs 40 lakhs, with an annual premium of Rs 3 lakhs, and with a maturity tenure of 10 years. Though the second life insurance policy has been practically purchased just to continue the insurance coverage of the first almost maturing life insurance policy, but still for the purpose of calculation of the aggregate annual premium of Rs 5 lakhs for claiming exemption u/s 10(10D), the annual premium in respect of both these life insurance policies will be clubbed together, by virtue of the seventh proviso to section 10(10D).   

Therefore, all multiple life insurance policies issued on or after 1.4.2023, shall be clubbed into one eligible batch period, which starts from the first premium payment year of the first policy and ends with the last premium payment year of the last policy. The exemption should be claimed up to the threshold limit of Rs. 5 lakhs during the eligible batch period of all such policies. If any new policy has been taken during this eligible batch period of the existing policies, the annual premium of such policy shall also become part of the threshold limit.

If the new life insurance policy is taken after the expiry of the premium payment term of all life insurance policies, contained in the first eligible batch period, then the annual premium paid in respect of such new policy will be considered afresh and will not get clubbed with the annual premiums of earlier policies.

Consider this example: Mr. X, is holding the undermentioned life insurance policies.

The aggregate annual premium of the above four life insurance policies A, B, C and D is Rs 6,50,000/-, which is in excess of the threshold annual premium limit of Rs. 5,00,000/-, and so Mr. X is required to make an intelligent decision in order to optimise his tax outflow. This can be done if Mr. X offers the maturity proceeds of Rs. 12,00,000 in respect of Policy A to tax and not claim exemption u/s 10(10D). This will enable him to make use of his threshold annual premium limit of Rs 5 lakhs for claiming exemption in respect of the higher value maturity proceeds of Rs. 18,00,000/- of Policy C, with annual premium of Rs. 1,50,000/- and the maturity proceeds of Rs. 34,00,000/- of Policy D, with annual premium of Rs. 3,00,000/-. He will have to offer the maturity proceeds of Rs. 12,00,000/- in respect of Policy B to income-tax u/s 56(2)(xiii) of the Income Tax Act.

Thus, by offering the comparatively lower value maturity proceeds of Rs. 24 lacs in respect of Policy A and B, to tax and choosing the higher value maturity proceeds of Rs. 52 lacs in respect of Policy C and D, for claiming exemption u/s 10(10D), Mr. X can optimise his tax outflow.

The Circular also clarifies that the GST component is to be excluded in calculating the threshold limit of Rs 5 lakhs of annual premium. The term life insurance policies, wherein the maturity proceeds are given only in the event of the death of the policy holder to the nominee, are also excluded from taxability, and also the premium paid in respect of such term life insurance policies is not be considered for the purpose of aggregating annual premium of Rs 5 lakhs.      

This Article has also been published in Taxmann with the Citation [2023] 153 taxmann.com 455 (Article).