Clause 393 Tax to be deducted at source.

Income Tax Bill, 2025

Introduction

Clause 393(1)[Table: S.No. 8(i)] of the Income Tax Bill, 2025 and Section 194DA of the Income-tax Act, 1961 both deal with the mechanism for deduction of tax at source (TDS) on payments made under life insurance policies. These provisions are critical in the context of ensuring tax compliance and plugging revenue leakages in respect of insurance maturity proceeds that are not exempt from tax. The evolution of these provisions reflects the legislative intent to bring greater transparency and efficiency in tax collection, especially in the financial services sector. The focus of this commentary is a detailed analysis of Clause 393(1)[Table: S.No. 8(i)] as proposed in the Income Tax Bill, 2025, followed by a comparative and critical analysis with the existing Section 194DA of the Income-tax Act, 1961. The analysis will cover the legislative background, objectives, key features, interpretative issues, practical implications, and suggest possible areas for reform or judicial clarification.

Objective and Purpose

The primary purpose behind both Clause 393(1)[Table: S.No. 8(i)] and Section 194DA is to ensure that tax is collected at source on insurance proceeds that are not exempt under the governing tax laws. Historically, life insurance proceeds were largely exempt from tax Section 10(10D) of the Income-tax Act, 1961. However, with the proliferation of high-premium insurance-cum-investment products, the government observed a potential misuse of the exemption, leading to tax avoidance. To address this, Section 194DA was introduced in 2014, mandating TDS on non-exempt insurance payouts. The Income Tax Bill, 2025, in its effort to consolidate and rationalize the provisions of the Income-tax Act, 1961, carries forward this legislative intent in Clause 393(1)[Table: S.No. 8(i)], with certain modifications to reflect contemporary policy priorities and streamline TDS administration.

Policy Considerations:

- Preventing tax evasion through insurance products that are not genuine risk covers.

- Ensuring early tax collection on non-exempt payouts, reducing the risk of non-reporting.

- Simplifying compliance for payers (insurance companies) and payees (policyholders).

- Aligning TDS rates and thresholds with the nature and quantum of insurance payouts.

Detailed Analysis of Clause 393(1)[Table: S.No. 8(i)] of the Income Tax Bill, 2025

A. Text of the Provision:

Any sum under a life insurance policy, including the sum allocated as bonus on such policy, other than the amount not includible in the total income under Schedule II (Table: Sl. No. 2). Payer: Any person. Rate: 2% on income comprised in such sum. Threshold limit: Rs. 1,00,000

B. Key Features:

• Scope: Applies to any person responsible for paying to a resident any sum under a life insurance policy, including bonuses, except amounts not includible in total income under the relevant exemption schedule.
• Exemption Reference: The carve-out for exempted amounts refers to Schedule II (Table: Sl. No. 2) of the Bill, which is analogous to Section 10(10D) of the Income-tax Act, 1961.
• Threshold: No deduction is required where the aggregate payout to a payee in a tax year is less than Rs. 1,00,000.
• Rate: TDS is to be deducted at 2% of the "income comprised in such sum" (i.e., the taxable portion, not the gross payout).
• Timing: Deduction is to be made at the time of credit or payment, whichever is earlier.
• Declaration for No Deduction: Clause 393(6) provides for the possibility of furnishing a declaration for no deduction if the estimated total income is below the taxable threshold, subject to procedural compliance.

C. Interpretation of Key Terms:

• "Any person": The obligation to deduct tax is cast on any payer, typically insurance companies, but could also include any person making such payment.
• "Sum under a life insurance policy": Includes maturity proceeds, surrender value, or any sum received under the policy, along with bonuses.
• "Income comprised in such sum": Only the taxable portion (i.e., proceeds received minus total premiums paid, where exemption does not apply) is subject to TDS, not the entire payout.
• Exempted Amounts: The reference to Schedule II ensures that genuine insurance payouts (e.g., on death, or policies satisfying prescribed conditions) remain outside the TDS net.

D. Ambiguities and Issues in Interpretation:

• Calculation of "income comprised": The provision does not directly specify the computation mechanism, but by analogy to Section 194DA and the explanatory circulars issued under the 1961 Act, it is understood that "income" means the payout minus total premium paid (if not exempt).
• Aggregation of Payments: The threshold of Rs. 1,00,000 applies to the aggregate of payouts in a tax year, but the mechanism for aggregation (e.g., across multiple policies or payers) is not explicitly detailed.
• Interaction with Declaration for No Deduction: The provision allows for a declaration (sub-section 6) for no deduction, but only where the aggregate income is below the basic exemption limit. Practical implementation may require further clarification, especially for senior citizens.

4. Practical Implications

A. For Insurance Companies (Payers):

• Obligation to deduct TDS at 2% on taxable portion of non-exempt payouts exceeding Rs. 1,00,000 per payee per year.
• Need to compute "income comprised" correctly, i.e., payout minus total premium paid (excluding premiums for riders not eligible for deduction).
• Maintain records of aggregate payouts per payee to apply the threshold correctly.
• Obligation to process declarations for non-deduction (where applicable) and file requisite returns with tax authorities.
• Compliance burden in cases of joint holders, assignment of policies, or multiple policies held by the same individual.

B. For Policyholders (Payees):

• Greater clarity on taxability of insurance proceeds; only the non-exempt portion is subject to TDS.
• Ability to furnish declarations for non-deduction if total income is below the taxable threshold.
• Need to claim credit for TDS deducted while filing their income tax returns, especially where the actual tax liability is lower.
• Potential cash flow impact if TDS is deducted but the individual is otherwise not liable to tax (e.g., senior citizens with low income).

C. For Tax Administration:

• Improved tracking of taxable insurance payouts and better enforcement of tax laws.
• Reduction in tax evasion through high-premium, non-genuine insurance products.
• Administrative challenges in reconciling TDS credits, especially in the case of multiple policies or payers.

Comparative Analysis with Section 194DA of the Income-tax Act, 1961

Evolution and Amendments

Section 194DA was introduced in the Finance (No. 2) Act, 2014, and has undergone several amendments, especially in the TDS rate:

• Initially, the rate was 2% on the gross amount paid.
• It was later clarified that TDS should be on the "income comprised" in the payout (i.e., after deducting premiums paid).
• The rate was changed to 1% (2016), then to 5% (2019), and most recently, reduced to 2% (effective 01-10-2024).

Key Differences and Similarities

1. Rate of Deduction: - Both the 2025 Bill and the current 1961 Act (as amended w.e.f. 01-10-2024) prescribe a TDS rate of 2% on the income component of the payout.

2. Threshold Limit: - Both provisions prescribe a threshold of Rs. 1,00,000 in aggregate per year, below which no TDS is required.

3. Scope and Exemptions:

- Both exclude amounts exempt under the respective exemption provisions (Schedule II in the Bill; Section 10(10D) of the Income-tax Act, 1961).

- Both cover all sums under a life insurance policy, including bonuses.

4. Basis of Deduction:

- The deduction is only on the "income comprised" in the payout, not the gross amount.

- The computation of "income comprised" is not explicitly detailed in either provision, but administrative circulars and FAQs clarify that it means the payout minus total premiums paid.

5. Timing of Deduction:

- Section 194DA: Deduction at the time of payment.

- Clause 393(1): Deduction at the earlier of credit or payment, aligning with the general TDS framework.

6. Declaration for No Deduction:

- Clause 393(1) explicitly provides for a declaration for non-deduction (sub-section 6), subject to conditions.

- Section 194DA does not specifically provide for such a declaration, but general provisions (Forms 15G/15H) are applicable.

Policy Rationale for Modifications

- The reduction in TDS rate to 2% (from 5%) in both the new Bill and the amended 1961 Act reflects concerns that a higher TDS rate on the income component may result in excessive deduction, especially for individuals in lower tax brackets.

- The explicit reference to the "income comprised" ensures that the tax is not deducted on the entire payout, which could include a substantial return of capital (premiums paid).

Potential Issues and Areas for Clarification

- Computation of "Income": There remains a need for detailed rules or guidance on computing the taxable portion, especially in cases of partial withdrawals, multiple premium structures, and policies with riders.

- Aggregation Across Policies: Whether the threshold applies per policy or per payee per year is not always clear. Administrative instructions generally require aggregation at the payee level, but explicit statutory language would be beneficial.

- Interaction with Other TDS Provisions: The Bill is more explicit in cross-referencing other TDS provisions and providing for precedence, which is an improvement over the existing structure.

Comparative Table: Key Elements

Conclusion

Clause 393(1)[Table: S.No. 8(i)] of the Income Tax Bill, 2025, largely carries forward the policy framework and operational mechanics of Section 194DA of the Income-tax Act, 1961, with certain refinements to align with the broader rationalization and modernization of the tax code. The provision strikes a balance between the need for efficient tax collection and the imperative to avoid excessive or unwarranted deduction, especially for genuine insurance payouts. The explicit provision for declarations for non-deduction, the alignment of TDS rates, and the clarification of scope and exemptions are positive developments. However, further clarity is needed on the computation of the "income comprised," aggregation rules, and procedural aspects for declarations. The provision's impact is likely to be significant for insurance companies, policyholders, and tax administrators, and its effectiveness will depend on robust implementation and continuous administrative guidance.

Full Text:

Clause 393 Tax to be deducted at source.