Dhirendra Kumar makes a useful point:
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 negligible insurance) is also tax-free simply because these products come in the garb of insurance.
This is a puzzling anomaly in the way the Indian tax authorities treat investments. There is actually no basis for treating returns from market-linked, risk bearing investments the same as any other payout from 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 should wake up and plug this hole and start treating ULIP returns as the investment income that they are.
While I don’t particularly like ULIPs, anyone would agree it’s unfair to have offered them a tax saving return of all gains, regardless of what they invested in. Buy a mutual fund that invests in debt – you pay 10-20% capital gains tax on exit; but an insurance fund that invests in debt gets you money without tax. (That’s before the DTC; after the DTC in its current form, most current ULIP proceeds will be taxed)
Note also I’m very much in favour of both reintroducing long term capital gains taxes in the equity and mutual fund markets, and in removing 80C exemptions for both insurance and mutual fund investments; both are options proposed in the DTC.
It does two things – first, it levels the field for equity markets versus other forms of risk investments (like investing in a friend’s company). Second, it increases tax revenues for the government which does not have easy options like spectrum auctions every year. Our stock markets might grow 15-20% every year, which is about 10 lakh crores; and if the government can see 5% of it, it’s equivalent to half the broadband/3G spectrum auction proceeds.
While I’m not in favour of the government making truckloads of money, they better make money where we can afford to pay them, otherwise they will do things much worse.