Service tax will be applied even on the premium instalments of existing policies. This is contrary to the expectations of life insurers that they would not have to revisit old contracts. The government has also indicated that the levy on new services that have been brought under the tax net will be applied as soon as the Union Budget is passed and will not have to be separately notified, as in the past.
The impact of service tax on the risk premium on life insurance will be felt by holders of over 14 crore policies issued by LIC. The policyholders will now have to budget for a higher premium on their existing cover. The increase could range from 10.2% on term insurance plans to a 0.7-2% increase on policies with savings.
The proposal is a logistical nightmare for LIC, the biggest player. Besides having to revisit each of the 14 crore contracts to work out the break-up of risk premium, the corporation has to contend with issuing new instructions on lakhs of salary-saving scheme policies. This week, the top management of LIC met with the finance ministry to explain the issues they face. However, the corporation has already asked its actuarial department to work on the feasibility of splitting contributions made by policyholders into risk premium and savings contribution.
Private insurance companies, which are better off with fewer policies and a more advanced information technology system, have their own set of problems.
Some of them have accepted prepaid cheques for instalments of future premium, while others have asked customers to provide standing instructions to their banks for electronic clearing. One advantage for private insurers is that most of their volumes have come from unit-linked insurance plans, where the mortality charges are separately identified.
The Budget had announced that the new levy would be imposed only on the risk premium component of payments to insurance companies. According to senior government officials, the service tax will have to be paid even on premiums that come up for renewal when the Finance Bill becomes a law.
The decision to reintroduce service tax on the risk component of life insurance was announced by finance minister P Chidambaram. According to rough estimates made by the government, the risk component works out to about 10% of the total premium paid by the policyholder. The tax on the proposed 13 new services will come into force on the date of enactment of the Finance Bill. The bill is enacted after the official amendments are passed by the Parliament and presidential assent is granted.
The proposed service tax on the risk cover of life insurance does not figure under the list of new services, since former finance minister Yashwant Sinha had already introduced the tax. The levy will, however, come into force as soon as the Finance Bill becomes a law.
The government expects to mop up Rs 14,150 crore from service tax in the current fiscal. Of this, Rs 1,278 crore would come from insurance and Rs 1,764 crore from other services (as the government has expanded the scope of existing services in the Budget).
The target for insurance is quite low, considering that last year non-life insurance companies alone, generated a risk premium of Rs 16,000 crore. Sources said that a conservative estimate has been taken on revenue realisation from risk premium on life insurance. This is partly because of the decision to grant credit of service tax and excise duty across sectors.
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