LIAFI COIMBATORE DIVISION: December 2014

1st December 2014
Taxability of Life Insurance Benefits – An Actuarial View
1) The Finance Act 2014, has introduced Section 194 (DA) in the Income tax
Act, 1961, requiring deduction of tax at source at the prescribed rate from any
sum paid including bonus to a resident of India under a life insurance policy,
provided such policy payment is not eligible for exemption under Section
10(10 D) of the Income tax ACT, 1961 and also if the gross payment under
all such policies during the financial year is Rs. 1 lakh and more.
Tax Deduction at Source (TDS)
2) As per Sec.37 of the LIC Act, 1956, “The sums assured by all policies issued
by the Corporation, including any bonuses declared in respect thereof and,
subject to provisions contained in Sec.14, the amounts assured by all policies
issued by any insurer the liabilities under which have vested in the Corporation
under this Act, and all bonuses declared in respect thereof, whether before or
after the appointed day, shall be guaranteed as to payment in cash by the
Central Government.
3) A significant aspect of the above guarantee is “payment in cash”. This means
that, except for any outstanding premium or loan under the policy, no other
amount can be deducted from the amount payable under the policy. That is, no
amount can be deducted from the amount payable, in respect of any tax due. In
particular, no TDS deduction can be made from the amount payable under the
policy. However, this position could have been valid when the LIC had a
monopoly over life insurance business. In an open competitive environment,
there cannot be one rule for the LIC and another for the private players in respect

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of Tax Deduction at Source (TDS) and so, what is applicable to the private
players can be taken as applicable also to the LIC.
Section 10 (10D) of Income Tax Act, 1961
4) Exemption under Sec.10 (10D) is Not Available in respect of Policies issued
on or after 1.4.2003, where premium payable for any of the years during the
policy term exceeds 20% of actual capital sum assured. This situation can arise
only in the case of policies where the premium paying term is 6 years or less
(including single premium) or where the premiums payable during one part of
the term is higher than the premiums payable during the other part.
Capital Sum Assured
5) The capital sum assured is defined as the minimum sum assured payable on
death during the policy term. The sum assured under a Term Rider is to be
added to the sum assured payable on death. In my view, the sum assured under
Accident Benefit Rider can also be similarly added since, as per circular No.
953, dated 14th November 2014 of the Central Office (of the LIC of India), “if a
policy is accepted with any rider and, under such rider if any death benefit is
payable, then sum assured of such rider benefit should be clubbed with basic
sum assured for deciding capital sum assured”. As Death Benefit is payable
under Accident Benefit rider, the sum assured under this rider can also be added
to the Capital Sum Assured. However, as per the circular, the rider benefit
should be clubbed with basic sum assured. I think that, it should be with “sum
assured payable on death.
6) As per Central Office circular Ref: CO/CRM/ 953 /23 dated November 14, 2014,
“Under the linked or non-linked plans where no risk cover or death sum assured
is available, such policies are exempted under section 10 (10D) of the income
tax Act, 1961. As such, there is no need to deduct any tax from policy payment

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payable under such policies. This is applicable for all type of plans and all type
of premium modes”. It is not clear however, whether annuity/pension plans with
provision for return of corpus on the death of the annuitant, will be treated as
plans where death sum assured is available.
7) What could have been the reason behind this decision? For a long time, the
rate of bonus declared by the LIC of India under a Plan had been independent of
the policy term. Consequently, the rate of bonus under a 5-year policy was the
same as that under a 20-year policy. Till the opening of the insurance sector and
constitution of the Insurance Regulatory & Development Authority (IRDA), the
Finance Ministry and the top management of the LIC were keen to have a
uniform bonus rate for all terms. Their reasoning was, when no differentiation is
made between small and high sum assured policies in the declaration of bonus
rate, why should distinction be made on the basis of policy term? As long as the
proportion of short term policies was insignificant, this anomaly was not taken
seriously. While the benefits under a life insurance policy (not annuities) were
tax free, the interest income on Fixed Deposits kept with banks was taxable. This
resulted in the rate of return under a short term life insurance policy becoming
higher than the corresponding return under a bank deposit of the same term and
many began using the short term life insurance policy as a convenient vehicle for
tax avoidance (not tax evasion). This situation could have been easily rectified
by directing the life insurance companies that, the rate of bonus declared should
be commensurate with the bonus earning capacity under the policy. But, the
method adopted by the Government for rectifying this position, through the
introduction of Sec. 194(A) in the Finance Act, is a remedy worse than the
disease.

8) With the introduction of this section in respect of policies issued on or after
1.4.2003, any sum paid including bonus (i.e. sum assured + bonus) is taxable if

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the premium payable for any of the years during the policy term were higher

than 20% of the actual capital sum assured. What will be the impact of this new

provision?

a. Under a life insurance policy, a person pays premiums for a pre-determined

number of years and, on survival upto the end of the term or earlier death,

receives the sum assured plus vested bonuses, if any. The premiums paid are

the amounts invested. As per Sec. 194(A), under certain conditions, the sum

assured and bonus will both be taxed. Generally, when an amount is

invested, only the dividend/interest income on the amount invested will be

taxed.

With the introduction of Sec. 194(A), India would become the only

country where the amount invested as well as the income from

investment will both be taxed. One can only wonder whether the

Ministry of Finance is keen on achieving this unique distinction.

b. This new section will also result in an anomaly. Consider the annual

premium (ignoring mode and high sum assured rebates) under the six year

endowment plan for age at entry 35. It is, Rs.180.10 and is less than 20% of

the sum assured. So, maturity proceeds are not taxable. The premium for age

at entry 65 is Rs.203.75, higher than 20% of the sum assured. So, when the

age at entry is 65, the maturity proceeds (both sum assured and bonus) are

taxable. This is an arbitrary discrimination against older persons, and is

bad in law.

c. Under the non-par endowment plan, the annual premium is less than 20% of

the sum assured for all terms 5 years and above and all ages at entry. Under

the 5 year, participating endowment plan, the premium is higher than 20% of

the sum assured for all ages at entry. The premium under the par plan is

higher due to loading for bonus. So, when the policy matures, 20% of the

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annual premium is to be compared with (sum assured + bonus) and not just
sum assured. Comparing the premium with 20% of the sum assured instead
of 20% of (sum assured + bonus), and declaring that the maturity proceeds
are taxable, will tantamount to discrimination against par policies and may
not stand legal scrutiny.
d. If the premiums paid under a policy had enjoyed some tax concession, there
can be meaning in recovering the concession given, at the time of payment of
maturity claim. (For example, tax concessions given under National Savings
Scheme). When no concessions are given in respect of premiums paid,
arbitrarily taxing the maturity proceeds cannot be justified.
e. Next comes the question, Can Bonus be taxed?
♦ As per Sec.49 of the Insurance Act, 1938, bonus can be declared only out
of the valuation surplus, As per the LIC act, 1956, not less than 95% of
the valuation surplus has to be allocated to or reserved for participating
policies and only the balance surplus can be allocated to or reserved for
shareholders.
♦ As per Sec.115B of the Income Tax Act, 1961, the tax payable by a life
insurance company is 14.1265% of the valuation surplus. (Basic tax is
12.5% of the valuation surplus, surcharge 10% and education cess 3%.
And, 12.5% x 1.10 x 1.03 = 14.1625%)
♦ That is, from the gross surplus emerging in the valuation, 14.1625% will
go towards Tax. From the balance surplus, not less than 95% will be
allocated to policyholders and the balance to shareholders as dividend. (In
the case of private sector life insurance companies, the shareholders get a
higher proportion of the balance surplus). Since the allocations to
policyholders and shareholders are made out of surplus that has already
suffered tax, these are not again taxable. So, taxing fully the bonus

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payable on maturity of a policy will tantamount to taxing the same
amount twice. It may be noted that,
The shareholders’ share of surplus, transferred to the shareholders’
fund, is not being taxed.
In the case of mutual funds, since dividend distribution tax is levied on
that part of the profit to be distributed as dividend to unit holders, the
dividend paid is not taxed in the hands of unit holders.
In the case of banks, since tax is levied only on profit emerging after
payment of interest on deposits, the interest income on deposits is
taxable in the hands of depositors.

9) If all the five points listed above are taken into account, it can be seen that the
newly introduced Sec. 194 (A) under the Finance Act, 1961, will result in,
• Discrimination against policies with higher ages at entry
• Discrimination against participating (with-profit) policies,
• Taxing of not only income from investment but also the amount invested and,
• Taxing of bonus paid out of valuation surplus, which has already suffered
tax,
and so, may not be legally tenable.
Bias against Single Premium policies
10) For reasons that are not clear, Section 194 (A) of Income Tax Act, 1961,
appears to reflect some bias against Single Premium policies. Compare this with
the position in the United Kingdom. During the eighties and Nineties, Single
Premium Life Insurance Bonds were very popular in that country, because of tax
concessions available. Such bonds can prove to be very useful in mopping up
any excess liquidity in the system and utilising the same for infra-structure
development. Instead of encouraging life insurance companies to increase the
sale of Single Premium policies, with a minimum term of 10 years, the

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Government appears to be trying its best, for some inexplicable and illogical
reasons, to discourage the marketing of these products.
Taxability of annuity instalments
11) In the case of life annuities, with no provision for Return of Corpus on the
death of the annuitant, only the interest portion of the annuity instalments
received during a year will be taxed. But, when the provision for “Return of
Corpus on the death of the annuitant” is present, the entire annuity instalment is
being taxed at present. This is not correct, as explained in the following sections.
12) Let us start with the simple example of Equated instalments for repayment of
a loan. To simplify the working, Equated Yearly Instalment (EYI), instead of the
usual Equated Monthly Instalment (EMI) has been taken.
13) A person takes a loan of Rs.1,000 and agrees to repay the same in 5 equal
yearly instalments of Rs.263.80. If the rate of interest is 10% prepare the
schedule of interest and loan repayments.
♦ Interest payable at the end of first year = 10% of 1,000 = Rs.100
♦ Yearly repayment instalment = Rs.263.80
♦ After payment of Rs.100 towards interest, the balance amount of Rs.163.80
will be taken as loan repayment.
♦ So, outstanding loan at the beginning of 2nd year = 1,000 – 163.80 =
Rs.836.20
♦ Interest due at the end of 2nd year = 10% of 836.20 = Rs.83.62
Proceeding in this way, the repayment schedule will be as shown below.

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Loan Amount Rs.1,000 and Rate of Interest 10%
Equated Yearly Instalment Rs.263.80
Year Amount of loan
at Beginning of
year
Interest due
at the end of
year
Amount of
Loan
Repayment
Amount of loan at
the end of year
1 Rs.1,000.00 Rs.100.00 Rs.163.80 Rs.836.20
2 Rs. 836.20 Rs.83,62 Rs.180.18 Rs.656.03
3 Rs. 656.03 Rs.65.60 Rs.198.20 Rs.457.83
4 Rs. 457.83 Rs.45.78 Rs.218.02 Rs.239.81
5 Rs. 239.81 Rs.23.98 Rs.239.82 NIL
♦ The difference of Re.0.01 at the end of fifth year is due to approximation to
two decimal places. The sum of Interest due at the end of the year and
Amount of Loan Repayment during the year will always be equal to the
Equated Yearly Instalment, i.e. Rs.263.80. It may also be noted that, as the
duration increases, the interest portion of the Equated Yearly Instalment
decreases and Amount of Loan repaid, increases.
♦ If the interest rate charged by the Bank were 11%, the equated yearly
instalment will be, Rs.270.57. That is, as the rate of interest increases, the
equated instalment will also increase and vice versa.
♦ If the period over which the loan is to be repaid were six years and the rate of
interest 11%, the equated instalment will be Rs.236.38. So, as the period
over which the loan is to be repaid increases, the equated instalment will
decrease and vice versa.

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Extension of this concept to Life Annuity
14) In the above example, a person takes a loan from a Bank and repays the
same in Equated Yearly Instalments. When a person purchases a life annuity
from a life insurance company, he will be paying a single premium as the
amount of consideration for the annuity payments he will be receiving
throughout his life time. This can also be viewed as the life insurance company
taking a loan from the policyholder and repaying the loan by equated instalments
over the life time of the policyholder. In this case however, the period over
which the loan is to be repaid does not have a predetermined value, as in the case
of bank loans, and depends on the life time of the policyholder.
15) The amount of annuity instalment to be paid to the policyholder would
depend on three factors,
♦ Age at entry of the policyholder,
♦ The rate of interest assumed and,
♦ The mortality table used.
On the basis of the mortality table, an estimate of the Expected Future Life Time
of policyholder (annuitant), in terms of Number of Years, can be determined.
Taking this as the period over which the loan is to be repaid, the amount of
annuity instalment can be calculated. (The exact method used is different and
what is given here is an equivalent approach). Each instalment of annuity can be
divided into two parts, viz.
♦ The interest on the loan taken from the policyholder and,
♦ The amount paid towards repayment of the loan.
The policyholder has to pay tax only on the interest portion of each of the
annuity instalment received. As seen earlier, as the duration increases, the
interest part will decrease and the return of capital part will increase and so, the
amount of tax payable by the policyholder will also decrease continuously and
become negligible.

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16) The amount of annuity instalment depends on the Expected Balance Life
Time of the policyholder, which in turn depends on the age at entry of the
policyholder and the mortality table used. At the end of this period, the loan (i.e.
single premium) taken by the company from the policyholder would have been
repaid fully. If the policyholder survives for a longer period, the life insurance
company has to continue to pay the annuity instalment and hence will suffer a
loss. If the policyholder dies before the end of Expected Balance Life Time, no
further annuity instalments will be payable, even though the single premium
taken by the company would not have been fully repaid, and the policyholder’s
estate will suffer a loss.
17) When the immediate and deferred annuity plans, Jeevan Akshaya and
Jeevan Dhara, were introduced by the LIC of India in the second half of eighties,
the uncertainty caused by the longevity of the annuitant was neutralised by
providing for the “Return of Corpus on the death of the annuitant”. Consider
again the example of bank loan. If the borrower opts for paying only interest at
the end of each year then, at the end of the term, he has to repay the loan amount.
In this case, the amount paid at the end of each year will have only one part, viz.
interest, and the “repayment of capital” part will be zero. In the same way, in the
case of annuities with provision for Return of Corpus, the Revenue Authorities
treated each annuity instalment as interest on the single premium paid and the
Corpus being returned on the death of the annuitant as the repayment of loan (i.e.
single premium). This approach is not strictly correct.
18) The annuity instalment received under an Immediate Annuity plan, with
provision for Return of Corpus, has to be viewed as a combination of two plans,
a life annuity plan and a whole life plan.
♦ Under the life annuity plan, Annuity Payments will be made throughout the
life time of the annuitant and will cease on the death of the annuitant and

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♦ Under the (single premium) whole life plan, Death claim will be settled on
the death of the policyholder.
It can be shown that the formula for determination of the single premium
actually consists of two parts. One in respect of life annuity and the other in
respect of whole life plan. The single premium collected too is the sum of the
two single premiums, one in respect of the life annuity and the other in respect of
the whole life policy.
19) As seen under Sec.15, each instalment of annuity under the life annuity
policy can be divided into two parts, viz.
♦ The interest on the single premium, equivalent to loan taken from the
policyholder and,
♦ The amount paid towards repayment of the loan.
The policyholder has to pay tax only on the interest portion of each of the
annuity instalment received. As seen earlier, as the duration increases, the
interest part will decrease and the return of capital part will increase and so, the
amount of tax payable by the policyholder will also decrease continuously and
become negligible. This has not been recognised by the revenue authorities
since the two single premiums have not been shown explicitly in the policy
document and the term “Return of Corpus” has been used.
20) What is the advantage of combining a life annuity and a whole life policy?
As seen earlier in Sec.16, if the annuitant survives for a longer period than the
Expected Balance Life Time, the life insurance company will start losing. On the
contrary, if the life assured under the whole life policy survives for a longer
time, the life insurance company will start gaining. On the other hand, if the
annuitant dies before the Expected Balance Life time, the annuity payments will
cease but, the annuitant’s successors will immediately get the sum assured under
the whole life policy. That is, the two parts of the same policy act as hedge

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against each other and so, neither the life insurance company nor the
policyholder will lose.
21) One may wonder as to why the term “Return of Corpus” has been used. It is
just a marketing strategy and will have greater appeal to those who want to, but
hesitate to purchase a life annuity. The concept of annuity is well established in
the U.K and other Western Countries, but has still not caught up in India. The
Government too has not given any worthwhile tax concession to make it popular.
Compared to the tax concessions given in the U.K in respect of premiums paid
under a deferred pension policy, the concessions given in India are insignificant
and are just peanuts. The flip-flop policy adopted by successive Finance
Ministers has not also helped.
22) Shri.Pranab Mukherjee was the first to recognise the importance of annuity
and introduced some tax concessions in this regard. The Jeevan
Dhara (deferred pension) and Jeevan Akshaya (immediate pension) plans of the
LIC of India were direct outcomes of this concession. His successor,
Dr.Manmohan Singh, not only withdrew the concession, but also encouraged
those who had taken the pension policies to surrender them and directed the LIC
to give liberal surrender values. A few years later, Shri.Chidambaram
reintroduced some concessions. But later (in the Finance Bill of March 2012),
imposed Service Tax on the premiums paid under pension policies, indirectly
discouraging one from purchasing these policies.
23) With the introduction of this service tax, India has again acquired the
dubious distinction of being the only country that taxes premiums paid
under a pension plan and discouraging people from saving for their post
retirement days.

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An appeal to the LIC Agents
24) I am only an actuary and not a qualified tax consultant. As such, I do not
have the authority to give any advice in this matter. The Agents’ Association can
approach a Competent Tax Consultant and discuss the issues raised in Sections 8
and 9 of this article. If the Consultant agrees with the views expressed, get a
representation prepared by him/her, in respect of both Sec.194 (DA) and
Taxation of annuity instalments and submit the same to the Ministry of Finance,
the Central Board of direct Taxes (CBDT) and the IRDA. This is to be followed
by a delegation of agents meeting the officials of the Ministry, CBDT and the
IRDA. The problems can be solved only through persistent lobbying. The
Corporation has got many limitations and so, cannot do such lobbying
effectively.
25) In the meantime, the LIC can arrange to issue two policies, one in respect of
Immediate Life Annuity and one in respect of Single Premium Whole Life,
whenever a proposer chooses the “Return of Corpus” option. In the I.T system, it
is quite simple to show that the two policies are interconnected. This would
enable the annuitants to pay tax only on the interest portion of the annuity
instalments.

1st December 2014 (R.RAMAKRISHNAN)
(Actuary)

Wednesday, 31 December 2014

WISH YOU AND \YOUR FAMILY MEMBERS "A HAPPY NEW YEAR 2015"

Tuesday, 30 December 2014

LETTER ADDRESSED TO FINANCE MINISTER BY OUR LIAFI SECRETARY GENERAL

Thursday, 25 December 2014

EXIT INTERVIEW OF POLICYHOLDER AT THE TIME OF SURRENDER THE POLICY

Monday, 22 December 2014

SETTLEMENT OPTIONS

Saturday, 20 December 2014

Pending Issues of Policyholders and Agents

Wednesday, 10 December 2014

INCOME TAX DEDUCTION UNDER 194 DA

DEDUCTION OF INCOME TAX AT SOURCE REGARDING.

Taxability of Life Insurance Benefits – An Actuarial View

Friday, 5 December 2014

NEW PLAN - PLAN NO.830 - LIC WILL LAUNCH SHORTLY.

Thursday, 4 December 2014

LETTER ADDRESSED TO LIC, E.D. MARKETING ABOUT EMPOWERED AGENTS BY SECRETARY GENERAL,LIAFI

LETTER ADDRESSED TO E.D. MARKETING,LIC BY OUR SECRETARY GENERAL LIAFI

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