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Penalty for Evasion of Tax in Life Insurance

Penalty for Evasion of Tax in Life Insurance

Tax saving in india

Everyone feels the pinch of giving away money even when it comes to taxes. They try to scoop out ways that can help them save their earnings. However, if these tax-saving methods result in tax evasion, they may fall into a bad trap.

Tax evasion is a crime that not only makes you pay a hefty fine but can also land you in jail. And this also applies to the tax evasion in insurance. To know more about this in details, let us first understand what exactly tax evasion is in life insurance.

What Is Tax Evasion?

As per the Income Tax Act, 1961 of India, tax evasion is a criminal offence that can attract hefty penalties along with the evaded tax. In some cases, the person may also be awarded a prison sentence.

In simple words, you should know enough to not fall into the tax-evasion category by mistake. Most people involved in tax evasion to illegally collect funds and avoid the burden of taxes.

What Are The Different Ways Of Tax Evasion?

Now, typically there are two ways that people choose to save tax: tax evasion and tax avoidance. The latter refers to a situation when you find loopholes or tax-saving instruments to save yourself from taxes. This is legal and does not attract any penalty.

However, as mentioned earlier, tax evasion is when you deliberately try to hide a taxable income to avoid paying tax. Here are some of the common ways of tax evasion:

  • Not Paying the Due: It is a quite simple way of avoiding taxes is just not paying it to the government, no matter what the due date it.
  • Submitting Wrong Tax Returns: At times, individuals file taxes with wrong information to lower the tax liability.
  • False Financial Statements: In this case, a company or even an individual decide to use false financial statements or account books at the end of the financial year. They try to reduce their earnings and profit in the record to save on taxes.
  • Using Fake Records For Claims: The government provides various tax saving schemes under Income Tax Acts like Section 80C to help people get more financial progress. However, some people take advantage of this privilege and create false records to claim the tax deduction.
  • Not Disclosing the Income: This is another quite common and easy way of tax evasion is not reporting the income one receives in a financial year. When you don’t tell how much you earn, you don’t get to pay the taxes. Note that, this is where the sum assured of your insurance policy also needs to be mentioned as an income source in the ITR form.

The Link Between Your Insurance Policy and Tax:

You must have heard that insurance is one of the best tax saving plans. This is one of the reasons sale of insurance plans often go up at the end of the financial year. However, as you are trying to invest quickly do take care of the terms and conditions.

Contrary to the common notion that amount received from the insurance is tax-free, the tax status depends on specific conditions. This is determined by the ratio of premium you pay, and the sum assured you get.

Types of Payments from Life Insurance Plans

You can receive money from a life insurance policy in the following three ways:

  • Maturity Value
  • Death or Accidental Claim
  • Surrender of the Policy where paid-up value is paid out

Section 10(10D) of the IT Act defines when the money from the life insurance policy will be tax-free and when not.

Taxability of Maturity Value from Life Insurance

As per section 10(10D), different conditions apply to the policies insuring different persons. Here’s how:

Condition of Insured Policy Purchase Date Condition for Tax Exemption
Normal healthy individual Before April 1, 2012 Annual Premium should remain below 20% of the Base Sum Assured of the policy
Normal healthy individual On & After April 1, 2012 Annual Premium should remain below 10% of the Base Sum Assured of the policy
A person with permanent severe disability or suffering from a specified disease Before April 1, 2013 Annual Premium should remain below 20% of the Base Sum Assured of the policy
A person with permanent severe disability or suffering from a specified disease On & After April 1, 2013 Annual Premium should remain below 15% of the Base Sum Assured of the policy

In case you end up paying more than the defined percentage of premiums the maturity value will lose its tax-exempt status.

Pro Tip: You should take extra care with single premium policies, as the premium can easily exceed 10% of the base sum assured.

Example Case:

You start investing in a ULIP plan with Rs. 10 lakhs as the base sum assured. The annual premium of the policy is Rs. 1 lakh. However, to fulfil your 80C tax exemption limit you deposit additional Rs. 50,000 in the policy for a few years.

Thus, your total annual investment in the policy exceeds the 10% limit. If you survive the policy term and receive maturity proceeds from the plan, it will be fully taxable.

Since your maturity value from this policy is likely to exceed Rs. 100,000, you can safely assume that insurer will deduct TDS at 2% from the proceeds. Plus, you will need to declare the income in your ITR.

Taxability of Death Claim from Life Insurance

Death claim from a life insurance policy is exempt from tax without any condition. But there are two policies where the death claim is not exempt from tax:

  • Keyman insurance
  • Life insurance plan to take care of a dependent who is suffering from permanent severe disability

Keyman insurance is a life insurance policy usually bought by a corporation or business on the life or lives of key professionals in the firm. Any amount they receive due to the death of the professional is compulsorily taxable.

The premiums paid towards the life insurance policy of disabled person are deductible from your gross total income, under section 80DDA. Any death claim from this policy becomes taxable for the nominee.

Taxability of Other Claims from Life Insurance

Life insurance policies often have riders (added benefits) which help you financially in case of disability or critical illness. The accidental disability rider pays you some money when your disability is temporary, although severe, nonetheless.

Any sum received under temporary severe disability claim is taxable as per section 10(10D).

What Is The Penalty For Tax Evasion?

The amount you received at the maturity of insurance policies needs to be mentioned under ‘income’ from other sources’ when you file the ITR forms. The failure to do so results in tax evasion.

As mentioned above, if you do not disclose the income during the ITR filing, your taxes will go down. This evasion of tax attracts penalty under section 271AAC of the Act. You will be asked to pay a penalty by an assessing officer. If your reasons are justified, you may be exempt from paying the penalty. Otherwise, concealing income attracts 100% to 300% of the tax evaded as per section 271(C) of Income Tax.

There is no denial in the fact that insurance helps in saving taxes. However, take care of the 10 per cent rule if you are buying policies with a maturity value. This not only keeps you away from the risk of getting involved in tax evasion but also offers you the needed benefits of tax saving under Section 80C and 10(10D).

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