The taxation of Unit Linked Insurance Policies (ULIPs) has undergone several changes over the years. The latest amendments aim to bring clarity in how redemption income from ULIPs is treated under the Income Tax Act. The proposed changes ensure that high-value ULIPs are taxed appropriately while still maintaining exemptions for smaller policies.
Existing Tax Exemption Under Section 10(10D)
Clause (10D) of Section 10 of the Income Tax Act provides that any sum received under a life insurance policy, including any bonus, is exempt from income tax, provided that the annual premium does not exceed 10% of the actual capital sum assured.
Amendment Introduced in Finance Act, 2021
- To restrict tax exemption to genuine life insurance cases, the Finance Act, 2021 introduced a limit on ULIPs.
- If the aggregate annual premium exceeds ₹2,50,000 for policies issued on or after 01.02.2021, the exemption under Section 10(10D) will not apply.
Tax Treatment of ULIP Income: Current Issues & Need for Clarity
- Capital Asset Status of ULIPs: A ULIP is considered a capital asset only if Section 10(10D) exemption does not apply due to exceeding the premium threshold.
- Classification of Taxable Income:
- For ULIPs exceeding the ₹2.5 lakh premium limit, redemption income is taxed as capital gains.
- For other life insurance policies (excluding ULIPs), the sum received is taxed under Income from Other Sources.
- Non-Exempt ULIP Proceeds: Any amount received under ULIPs that do not qualify for Section 10(10D) exemption is currently subject to ambiguity in tax treatment.
Key Problem Areas
- Inconsistencies between tax treatment of ULIPs vs. other life insurance policies.
- Lack of clarity on applicable tax provisions for redemption of non-exempt ULIPs.
- Equity-oriented tax benefits were not explicitly applicable to ULIPs.
Proposed Amendments for Clarity
To remove ambiguities, the following changes are proposed from April 1, 2026 (AY 2026-27 onwards):
(I) ULIPs Exceeding ₹2.5 Lakh Premium to be Considered Capital Assets
- Clause (14) of Section 2: Any ULIP where Section 10(10D) exemption does not apply shall be classified as a capital asset.
(II) Capital Gains Taxation for Non-Exempt ULIP Redemptions
- Sub-section (1B) of Section 45: Profit and gains arising from redemption of ULIPs where Section 10(10D) exemption is not available shall be taxed under capital gains.
(III) ULIPs to be Considered as Equity-Oriented Funds
- Clause (a) of Explanation to Section 112A: ULIPs where Section 10(10D) exemption does not apply will now be included in the definition of equity-oriented funds.
Implication of This Change:
- Short-term & long-term capital gains (LTCG) taxation will apply to ULIP redemptions.
- ULIP investors will benefit from preferential tax treatment under Section 112A if the policy meets the criteria of an equity-oriented fund.
Effective Date of Implementation
- These amendments will be effective from April 1, 2026.
- They will apply to Assessment Year 2026-27 and subsequent years.
Summary of Changes in Tax Treatment of ULIP Income
| Policy Type | Premium Amount | Tax Treatment Before Amendment | Tax Treatment After Amendment (From AY 2026-27) |
|---|---|---|---|
| ULIPs issued before 01.02.2021 | Any | Exempt under Section 10(10D) | No Change (Still Exempt) |
| ULIPs issued on or after 01.02.2021 | ≤ ₹2.5 Lakh per year | Exempt under Section 10(10D) | No Change (Still Exempt) |
| ULIPs issued on or after 01.02.2021 | > ₹2.5 Lakh per year | Taxed as Capital Gains (Unclear provisions) | Classified as Capital Asset, Taxed under Capital Gains |
| Other Life Insurance Policies | Any | Taxed under Income from Other Sources if Section 10(10D) does not apply | No Change |
Impact of These Amendments
For Policyholders & Investors:
✅ Greater Clarity: ULIPs with high premiums (above ₹2.5 lakh) will now have a clear tax treatment under capital gains. ✅ Equity Tax Benefits: Investors may benefit from LTCG tax rates under Section 112A if ULIPs meet equity-oriented fund conditions. ✅ Easier Tax Planning: Policyholders can now assess the long-term tax implications of investing in ULIPs.
For the Government:
🔹 Prevents Tax Avoidance: Ensures that high-value insurance products are not misused for tax exemptions. 🔹 Standardized Taxation: Aligns ULIP taxation with mutual funds and equity investments. 🔹 Encourages Genuine Insurance Buyers: Ensures Section 10(10D) exemption benefits are preserved for small, genuine insurance policyholders.
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