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Future benefit

More FDI and no taxes on maturity proceeds are the big things expected from the FM this year, writes Stuart Purdy, Managing Director, Aviva India.

india Updated: Feb 22, 2006 15:00 IST

What is the insurance industry looking forward to in Budget 2006-07? Will the archaic insurance laws go through a major over haul? What about foreign equity participation? These are the questions one wants answers to.

Will foreign equity investment go up? The growth of the Indian insurance sector is critical as a key social security measure. Fresh FDI is required to fuel this and ensure that customers get access to worldclass products that foreign partners bring into India. Increase in FDI will give the insurance industry the necessary capital infusion required for development. Political parties should view the FDI limit in an overall perspective to encourage growth of the insurance industry. In this sector, the proposal is to raise FDI to only 49 per cent, so the majority control still remains with the Indian partners.

Will there be tax incentives for long-term savings? The FM had announced a committee that would make recommendations on the ‘Exempt-Exempt-Taxable’ (EET). As a result, the maturity proceeds would become taxable. Taxing life insurance proceeds will adversely impact life insurance business. It will discourage investors who have made their decisions based on the assumption that the returns will be tax-free. It is important to note that the surplus of the life insurance fund is taxable at 12.5 per cent. Therefore, to avoid any double taxation impact, the earnings should remain tax free in the hands of the policyholder.

Most saving instruments such as mutual funds, bank deposits are designed to garner short-term savings with attendant benefits. Life insurance and pensions are the only segments of financial services that address the needs of individuals in the long-term. Successive governments have applied different forms of tax-incentives to promote savings but there has been no significant support in tax policy to actively encourage long-term savings.

In the last Budget, the deduction for life insurance premiums (under Section 80 C) was revised to Rs 1 lakh. This was a positive move. We see a need to further increase the amount of deduction to Rs 3 lakh. Of this, Rs 2 lakh should be invested in products like pension plans to encourage long-term savings and Rs 1 lakh should be invested in other insurance and investment products. The relevance of insurance as a social security measure should not be undermined especially when the governments have constraints in offering public funding for the citizens’ medical and old-age needs. Further, the current amount of deduction of Rs 10,000 (in Section 80 CCC(1)) for pension policies is inadequate and needs to be raised to a level of Rs 1 lakh. Thereafter, it could be marked to the annual inflation rate. The current exempt status should continue.

There already exists a restriction in the Income Tax Act prescribing that maturity proceeds would be taxable if the annual premium were to exceed 20 per cent of the sum assured. Thus, insurance policies that are selected with the intent of short-term investment is already taxable. We recommend that the limit of 20 per cent on the premium of life insurance policy should be removed from Section 10(10D) and Section 80C. If this is not feasible gains under such a policy should be taxed at a lower rate under long-term capital gains tax.

In Asia-Pacific, Australia, the US and Britain, maturity proceeds are exempt from tax. In India, if maturity proceeds are taxed, it will kill the nascent insurance industry and will lead to diversion of funds into short-term avenues. This will, therefore, defeat the purpose of privatisation of the insurance industry to provide alternative and innovative social security options to the public. It is, therefore, important for the government to recognise the importance of long-term savings and encourage the same by ensuring that the taxation policy on long-term savings is ‘EEE’.

Will we do away with the fringe benefit tax? The FBT has a negative impact on the growth of group insurance business — a benefit that employers provide employees. In view of a lack of social security mechanism, contribution towards superan nuation fund by employers should be encouraged and hence FBT should be removed. Will there be incentives to invest in pensions and annuities? There should not be a cap on the number of Pension Fund Managers so that the market finds its own equilibrium. Restrictions on numbers may lead to some deserving candidates being left out.

Currently, Section 80 CCC (2) provides that pension received from annuity plans is ‘income’. No distinction is made between the interest and capital components of annuity. When a person receives annuity under pension plan, it consists of capital and interest. Currently, the receipts of the entire annuity are fully taxable whereas the income is only the interest component. Provisions of Section 80CCC should be amended to provide that only the interest portion is taxed and not the capital.

The Indian insurance industry is poised take pensions, savings and insurance products into the homes of many more consumers. If the government creates the right opportunity for growth, individual players will change the face of the life insurance industry by making it a source for India’s infrastructure development in the country.

India has an insurable population of approximately 300 million of which only 150 million are insured. The life insurance policy has become a powerful social security tool. Keeping in mind the vital role it can play in mobilising long-term savings and providing policyholders security, the government needs to make some changes in the current tax structure.

(The writer is Managing Director, Aviva India)