Life insurers may gain from debt MFs being taxed at marginal rate

Experts say they may now be slightly better placed as customers looking for tax-free returns under Rs 5 lakh investment a year may now choose their guaranteed products

Removal of long-term capital gains tax (LTCG) with indexation benefits status on debt mutual funds might have evened out the playing field for long-term debt products, even as the life insurance industry has not been granted any of the relaxations it sought from the finance ministry. Experts said with this change, the insurance industry might find itself slightly better-placed as customers looking for tax-free returns under Rs 5 lakh investment per year may choose guaranteed products of life insurance companies.

 

The Finance Bill tabled in Parliament by the finance minister did not have any amendments to the tax changes proposed by the government in the Union Budget this year. “…the change in taxation for debt mutual funds (MFs) bridges the tax arbitrage and brings all debt products at par,” said CLSA in a note on Friday.

 

 

“So, life insurers, from being a superior product pre-Budget (no tax on debt savings) moved to being an inferior product post-Budget (full tax on premiums >Rs 5 lakh). Now, it is neutral as alternate debt investments are also taxed at marginal tax rate. At these valuations, we believe this is a marginal positive for life insurers,” said the brokerage firm in the note.

 

“This sort of gives everyone a level-playing field when it comes to long-term products. With indexation benefit being taken away from debt mutual funds, insurers will not be at a disadvantageous position. Now, the competitiveness of the product will decide the demand for the products,” said Mahesh Balasubramanian, MD & CEO, Kotak Life Insurance.

 

Having said that, industry insiders said the introduction of taxation on debt mutual funds and high-value participatory life insurance policies may mean bank fixed deposits will get attractive. Earlier, interest on bank deposits was taxed at individual tax rate and debt MFs enjoyed LTCG of 20 per cent with indexation and life savings products had tax free returns.

 

According to Rushabh Gandhi, deputy CEO, IndiaFirst Life Insurance, all prudent investors will work towards their own asset allocation basis risk profile and life stage. In light of recent developments, we could see a possible shift in the allocation in favour of life insurance products — both ULIPs and traditional.

 

An insurance industry insider said this move seemed to be aimed at pooling more money towards bank deposits to support the credit demand in the economy. 

 

Removing tax benefits from both life insurance products and debt mutual products doesn’t necessarily work in any industry’s favour.

 

Taxation on proceeds from life insurance policies, with premiums exceeding Rs 5 lakh per year, was introduced in the Budget. This was brought in to plug the arbitrage that high-net worth individuals (HNIs) are using to get tax-free returns on their high-value insurance policies through Section 10 (10D) of the Income Tax Act.

 

The life insurance industry had approached the government seeking some relaxations on the proposed taxation policy. They asked the premium threshold to be increased from Rs 5 lakh to Rs 10 lakh. Further, instead of taxing the proceeds from these policies under income from other sources, which could result in negative returns for policyholders (adjusted for inflation), the benefits could be taxed under LTCG with indexation benefits.

 

Although relaxations had been sought, most insurance players had started reworking strategies to combat the negative impact of this policy. To negate the impact of the government’s decision, life insurers have been looking to sell more policies with lower sum, and move into the smaller towns instead of focusing at metros. They are also looking to make unit-linked and annuity products more attractive.