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Sanjiv Shankaran

TWO proposals in the recent Budget have agitated insurance companies in India as they will have an adverse impact on future returns from insurance policies. They are the proposal to reduce tax rebate on insurance policies and the one to impose service tax on the insurance industry.

Of the two, the one on service tax is controversial. The increasing importance of the services sector in the economy has made the government look at ways to tax them and thereby improve its finances.

Over the last few years, the range of services that have been brought into the tax net have steadily increased. However, sometimes a business' inclusion to the net is accompanied by a controversy.

Last year's Budget brought leasing into the service tax net — a move that gave rise to controversy. And now, the addition of insurance has provoked a similar reaction.

Generally, the controversy arises because there is confusion over the definition of the service provided. Unless the service provided is clearly defined, how will the government's tax collection be fair?

Take the case of the proposed tax on insurance. An insurance premium is usually earmarked according to its use. For instance, a premium of Rs 100 may be earmarked into three portions.

The first would go towards meeting the insurance company's cost. Another would be earmarked to underwrite the risk of the policyholder's life.

The last would be allotted to investment, and will be returned to the investor once the policy matures.

If the premium is viewed as three distinct portions, it may not make sense to impose a tax on the entire amount. The portion of the premium earmarked for investment comes back to the policyholder with the returns. It seems no different from placing money in a bank deposit or a mutual fund.

As for the other portions of the premium income, there does not seem to be a uniform view on the service provided. Since an insurance company's primary job is underwrite risk, would the portion earmarked to underwriting risk qualify for service tax? Or would just the portion earmarked towards an insurance company's expenses be the right base for service tax?

Views seem to converge when it comes to the portion of the premium earmarked towards saving. A tax there seems unfair, and the insurance industry appears to be lobbying for the Government to go easy on the service tax

Regardless of how the Government decides to calculate service tax on insurance, the returns on policies are set to decline. The combined effect of a softening interest rate trend, reduction of tax benefits and service tax may have a telling effect over time.

Another area in urgent need of attention is pension products. The increase in the life-span of the population and disintegration of traditional social systems, such as the joint family, have combined to create a huge need for pension products.

With the organised labour force comprising a relatively small portion of the country's aggregate labour force, the importance of pension products cannot be overstated.

Far-reaching changes can be expected in pension products in the near future because an exclusive regulatory body is to be set up for it this year. Once it is in place, reforms in tax laws and other areas should be in place before long.

Once the reforms are carried out in the pension products area, the market may see the launch of a number of new products. Even with the somewhat unfavourable environment, LIC, ICICI Prudential and HDFC Standard have launched pension plans.

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