Introduction The Budget 2025 has introduced a crucial clarification regarding the taxation of Unit-Linked Insurance Policies (ULIPs). Under the new rule, ULIPs where the annual premium exceeds Rs 2.5 lakh and do not qualify for tax exemption under Section 10(10D) of the Income-tax Act will be treated as equity-oriented mutual funds (MFs). This amendment, effective from April 1, 2025, impacts high-net-worth individuals (HNIs) who invest in ULIPs as a wealth-building instrument.

How Will This Change Affect ULIP Taxation?

With this amendment, ULIPs failing to meet Section 10(10D) criteria will be considered capital assets. Consequently, profits earned on redemption or maturity will be taxed under capital gains rather than being entirely tax-exempt. The tax implications are as follows:

• Long-term capital gains (LTCG) exceeding Rs 1.25 lakh per year will attract a 12.5% tax rate.

• Short-term capital gains (STCG) (holding period less than 12 months) will be taxed at 20%.

This taxation aligns ULIPs more closely with equity mutual funds, rationalizing the tax structure across investment categories.

Understanding Section 10(10D)

Section 10(10D) provides a tax exemption for sums received under a life insurance policy, including bonuses, subject to certain conditions:

1. The annual premium must not exceed 10% of the sum assured.

2. For ULIPs issued after February 1, 2021, the tax exemption does not apply if the aggregate annual premium surpasses Rs 2.5 lakh.

3. For endowment policies issued after April 1, 2023, the exemption is withdrawn for policies with aggregate premiums exceeding Rs 5 lakh.

Why Was This Clarification Needed?

Previously, there was ambiguity regarding whether gains from non-exempt ULIPs should be taxed as capital gains or income from other sources. The Budget 2025 eliminates this confusion by classifying such ULIPs as equity-oriented funds, ensuring uniformity in tax treatment.

Mayank Mohanka, founder-director of TaxAaram.com, notes, "While tax experts largely treated ULIPs as capital assets, some viewed them under 'income from other sources.' This clarity benefits policyholders as the concessional 12.5% LTCG rate applies, instead of being taxed at slab rates."

Impact on ULIP Holders Investing in Debt or Balanced Funds

A crucial aspect of the amendment is that ULIPs will only be considered equity-oriented funds if at least 65% of the investment is allocated to equity assets. If a policyholder predominantly invests in debt or balanced funds, their ULIP proceeds may not receive the equity tax treatment, potentially subjecting them to higher tax rates.

Are Death Claim Proceeds Taxed?

No, the taxability amendment does not affect death claim proceeds. The amount received by nominees upon the policyholder’s demise remains completely tax-free, ensuring financial security for beneficiaries.

The Budget 2025 has introduced much-needed clarity in ULIP taxation, aligning them with equity mutual funds where applicable. High-value ULIP investors should evaluate their portfolios and understand the tax implications. While the new tax regime introduces some changes, the concessional LTCG rate of 12.5% remains a silver lining compared to potential taxation under slab rates.