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Why are ULIP returns allowed to be tax-free?

business Updated: Jun 13, 2010 22:08 IST
ULIP controversy

The ULIP controversy has been on a hold for a couple of months now, as everyone involved waits for the Supreme Court, where hearing is scheduled for July, to weigh in on the subject. It may take several widely-spaced hearings before the court comes to a decision. As things stand, this issue has gone way too long anyway: as far back as April 10, we were promised a solution within days. An issue that ought to have been resolved at the executive level, has been passed on to the judiciary simply because no one is willing to take a decision.

Indeed, there is a chance that the Supreme Court may actually refuse to deliver an opinion on the issue of whether the Securities and Exchange Board of India (SEBI) has any jurisdiction over the investment activities of insurance companies. The case itself only pertains to the combining of related cases filed in various high courts around the country, and it is possible for the court to rule on that without getting into the jurisdiction issue at this stage. All in all, this could be a long story yet.

The root of the problem is that ULIPs are primarily not an insurance product at all, but a market-linked investment product. And the SEBI Act empowers SEBI to regulate all such investment products that are offered to the public.

However, there is another aspect of ULIPs' investment characteristic that has escaped comment -- one that has nothing to do with whether SEBI's argument has merit or not. And that is the tax-free status of their returns. Like all insurance products, the returns earned by ULIPs are free of income tax. However, the returns from the investment part of these products (and some of them are close to 100 per cent investment with little insurance) is also tax-free, simply because these products come in the garb of insurance!

This is a puzzling anomaly in the way the tax authorities treat investments. There is actually no basis for treating returns from market-linked, risk bearing investments the same as any other payout by an insurance company.

In effect, returns from ULIPs are treated the same as the payout that beneficiaries get when an insured person dies!

Quite separately from the issue of whether ULIPs should be regulated as an investment, the tax authorities of the country should wake up and plug this hole, and start treating ULIP returns as the investment income that it is.