ULIPs, Draft DTC And Proposed Changes

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With the regulatory row settled in favour of Insurance Regulatory and Development Authority (IRDA), it would soon be business as usual for Unit Linked Insurance Plans (ULIPs). ULIPs are a type of investment where the characteristics of insurance and mutual funds are combined. Accordingly, a part of the premium is utilized towards the insurance cover as well as the administrative charges and the rest is invested as per the option selected by the investor.

Before IRDA-SEBI spat grabbed centre stage, ULIPs were contributing to around two-third of the business of all the insurance companies. However, ULIPs have also been facing criticism due to very low component of insurance as well as for rampant mis-selling. In fact, IRDA-SEBI spat also highlighted some of the regulatory issues about the need for better transparency and protection of investors’ interests. To settle some of these issues, the Law Ministry passed an ordinance recently, thereby defining ULIPs as an insurance product and hence authorizing IRDA to regulate them. Having won the mandate to regulate ULIPs, IRDA has announced a few measures such as minimum risk cover of 10 times of annual premium as well as minimum 4.5 per cent yield to be offered on maturity by all those ULIPs that offer pension and annuity schemes.

However, issues like misselling and suitability of these products for investors with different risk profiles and time horizon would still require continuous attention from all the stakeholders such as the regulators, insurance companies, agents and investors themselves. While the new look ULIPs could bring cheers to investors, the draft Direct Tax Code (DTC) proposes to take away tax immunity that these products enjoy at present. Even equity and equity-oriented mutual funds too are set to lose the exempt-exempt-exempt (EEE) status. In fact, the revised draft of the DTC announced a few weeks ago offers a mixed bag to investors.

On the positive side, the government has restored the EEE status for Government Provident Fund (GPF), Recognised Provident Fund (RPF), Public Provident Fund (PPF) and pure life insurance products as well as annuity schemes. Besides, the New Pension Scheme (NPS) has also been granted the EEE status. On the negative side, the draft DTC has proposed a change in the tax regime from EEE to exempt-exempt-taxed (EET) for ULIPs as well as for equity and equity-oriented funds. [PAGE BREAK]

Considering that these investment options have a major role to play in the long-term wealth-building process of millions of investors in the country, the proposed changes could have a significant impact on their ability to build the required corpus to meet their investment objectives.

Thankfully, the provisions relating to capital gains on equity and equity-related funds have been amended.  While the original provision eliminating distinction between short-term and long-term investment assets depending on the basis of length of holding of the asset remains, capital gains arising from the sale of an investment asset held for more than one year shall now be computed after allowing a deduction at a specified percentage of capital gains without indexation. The adjusted capital gains will be included in the income of the taxpayer and then taxed at the applicable rate.

The discussion paper gives three illustrative examples using rates of 50, 60 and 70 per cent, while clearly stating that the specific rate of deduction for computing-adjusted capital gains will be finalised in the context of overall tax rates.

If one considers 50 per cent as the deduction, for an investor in the highest tax bracket, the effective rate of tax on capital gains would work out to be 15 per cent. Similarly, for investors in the tax bracket of 20 and 10 per cent, the effective tax rate on capital gains would work out to be 10 and 5 per cent respectively. Though the revised provisions bring some relief to investors, the taxes on capital gains would cause a dent on their long-term wealth-building process.  However, considering the potential of equities to do well over the longer term, one may still get better post-tax returns as compared to traditional instruments. Hence, investors need to keep faith in equities for their long-term investment goals and continue with their investment process.