Ulips, equity MFs to lose tax cover in new-look Code

Unit-linked insurance plans (Ulips), equity-oriented mutual fund schemes and a number of other popular savings and investment instruments will lose their tax immunity, and with it, their attractiveness when the Direct Taxes Code (DTC) comes into operation.

The Central Board of Direct Taxes (CBDT) plans to reduce the number of instruments that qualify for tax deductions to only about half a dozen, its chairman SSN Moorty said, as the government overhauls the direct tax regime to try and make it simpler, boost revenues and encourage long-term savings. The Rs 3-lakh tax deduction limit proposed in the draft DTC will also be lowered.

Revised proposals for a new Direct Taxes Code to replace the nearly 50-year-old Income-Tax Act were unveiled on Tuesday. The government has said it hopes to operationalise the code by April 2011.

Ulips, which are hybrid products incorporating investment and insurance cover as traits, are particularly popular. In the 2009-10 fiscal, such products accounted for more than four-fifths of the total insurance premium of around Rs 2.60 lakh crore that was collected. They are controversial too: capital market regulator Sebi and insurance regulator Irda are involved in a tug-of-war over who has the right to regulate Ulip products.

“Ulips will be out of the exempt, exempt, exempt (EEE) tax regime,” said a senior finance ministry official, referring to the different stages at which financial instruments may be taxed.

At present, individuals who invest in Ulips do not pay tax at any stage—at the time of investment or contribution, during the tenure of investment, or at maturity. It qualifies for tax deduction along with a host of other savings schemes, including bank deposits, equity-oriented mutual funds, national savings certificate deposits and principal repayment on home loans. Taxpayers can claim a deduction of up to Rs 1 lakh a year on these instruments.

“Tax benefits are a key driver for insurance penetration and dilution of any benefits will have an impact on penetration,” said GV Nageswara Rao, MD and CEO, IDBI Fortis Life insurance.

The revised proposals make it clear that only six schemes—public provident fund (PPF), the pension scheme administered by the Pension Fund Development Regulatory Authority, general provident fund, recognised provident funds and pure life insurance and annuity schemes—will be tax-free. Tax will not be levied at any stage on these schemes.

The new pension scheme will also be covered by the EEE method of taxation and withdrawals will not be taxed at maturity.

However, investments made before the DTC comes into force will continue to be eligible for the EEE method of tax treatment for the full duration of the financial instrument. This means an investor who buys a Ulip before the DTC comes into force will not be taxed at any stage during the full tenure.

Ulips could be taxed at the time of maturity, but the government has not clarified yet the tax treatment of the products.

“The existing tax treatment of Ulips is beneficial as it helps in the flow of funds to the infrastructure sector, besides contributing significantly to the capital market”, said R Kannan, member-actuary, Irda.

The original code had proposed the concept of savings intermediaries that would invest the amounts deposited with them in Ulips, equity-linked mutual fund schemes, debt-oriented mutual fund schemes or other financial products depending on investors’ choice. Withdrawals would be taxed, but not a rollover.

CBDT has dropped the proposal to tax savings instruments at maturity in the absence of a social security system.

The aim now is to encourage taxpayers to invest in long-term savings schemes. PPF, for instance, has a 15-year tenure, although partial withdrawals are allowed after the sixth year. The revised discussion paper has said the rules for contribution and withdrawal will be harmonised and made uniform so that savings are made by the taxpayer for the long term.

Source: http://economictimes.indiatimes.com/personal-finance/mutual-funds/mf-news/Ulips-equity-MFs-to-lose-tax-cover-in-new-look-Code/articleshow/6056607.cms