Treatment of ULIPs (Unit-Linked Insurance Plans) as Capital Gains – Direct and Indirect Taxes with Tax Ready Reckoner

Here’s a detailed summary of the treatment of ULIPs (Unit-Linked Insurance Plans) as capital gains under the Finance Bill 2025, including key changes, tax rates, and applicability:

Table of Contents

1. Key Changes in ULIP Taxation (Effective April 1, 2026)

Capital Asset Classification: ULIPs with annual premiums exceeding ₹2.5 lakhwill now be classified as capital assets under Section 2(14) of the Income Tax Act, 1961 .
Taxation as Capital Gains: Redemption proceeds from non-exempt ULIPs (premiums > ₹2.5 lakh) will be taxed under capital gains(Section 45(1B)) instead of “Income from Other Sources” .
Equity-Oriented Fund Status: Non-exempt ULIPs are included in the definition of equity-oriented fundsunder Section 112A, aligning their tax treatment with equity mutual funds .

2. Tax Rates for ULIP Redemption

HOLDING PERIOD	TAX RATE	TAX TYPE
<12 months	20%	Short-Term Capital Gains (STCG)
≥12 months	12.5%	Long-Term Capital Gains (LTCG)

Note:

For ULIPs issued before February 1, 2021, the ₹2.5 lakh premium rule does not apply (maturity remains tax-free) .
Death benefitsremain tax-exempt under Section 10(10D), irrespective of premium amount .

3. Conditions for Tax Exemption

ULIP maturity proceeds are tax-free under Section 10(10D) only if:

Premium Limit: Annual premium ≤ ₹2.5 lakh (for policies issued after February 1, 2021) .
Sum Assured Ratio: Premium must be ≤10% of the sum assured (for policies issued after April 1, 2012) .
Multiple ULIPs: Aggregate premiums across all ULIPs must not exceed ₹2.5 lakh/year .

Example: If you hold 3 ULIPs with annual premiums of ₹1 lakh, ₹1 lakh, and ₹60,000, all remain tax-exempt. If one policy has a ₹3 lakh premium, its maturity proceeds will be taxable .

4. Rationale for the Change

Preventing Tax Avoidance: High-net-worth individuals were using ULIPs to invest large sums in equities tax-free. The new rules ensure parity with direct equity investments .
Clarity: Earlier, non-exempt ULIPs faced ambiguity in tax treatment (e.g., whether taxed as “Other Income” or capital gains). The 2025 amendment resolves this .

5. Impact on Investors

Higher Premium Policies: Investors paying >₹2.5 lakh/year will now pay 5% LTCG tax(vs. earlier slab rates up to 30%) .
Planning Tip: Split investments across multiple ULIPs to stay under the ₹2.5 lakh/year threshold for tax-free maturity .

6. Comparison with Pre-2025 Rules

ASPECT	PRE-2025	POST-2025 (FINANCE BILL 2025)
Tax Treatment	Taxed as “Other Income” (slab rates)	Taxed as capital gains (12.5% LTCG)
Premium Threshold	₹2.5 lakh/year (exemption limit)	Same, but clarity on capital gains tax
Holding Period	Not defined	12+ months for LTCG benefits