Earlier (February 2002) it was announced in the budget that life insurance premium would attract a service tax of 5%. This was a subject of some confusion and heated debates until it was clarified by the finance minister recently.

The finance minister elaborated that the service tax would be levied only on the premium allocated for covering risk and not on the remaining premium. In other words, polices which do not have a risk cover, like pension plans or the single premium bonds, will not attract any service charge. Moreover, the service tax will be applicable on all policies, fresh ones as well as those in force.

Even in case of endowment or money back policies, the service tax would be levied proportionately on the premium allotted for the risk cover which accounts for less than 10% of total premium. The balance premium amount in case of endowment accounts for the saving element and is beyond the purview of the service tax net. However, in case of term insurance (pure risk cover) the service tax would be levied on the total premium.

For example, if an insurance seeker – Raj were to take an endowment policy for which the premium payable is Rs 2,000 and assuming that the life cover charges account for 10% of the total premium, the service tax would be levied on Rs 200. The service tax payable by Raj would be 5% of Rs 200, which is Rs 10. However, if this had been a term insurance policy the 5% service tax would be on Rs 2000 amounting to Rs 100.

The service tax now applicable only on the risk portion should not demotivate anyone from going for life insurance as it would be negligible in most cases. However, in case of endowment or money back policies where the sum assured is on the higher side the policy holder’s liability could go up by a few hundreds or thousands each year thereby influencing his decision to buy life insurance.

In short, all policyholders having a life cover would be hit by the service tax. But those with a pure risk cover (term insurance) or with a large sum assured (in endowment) would be affected more than others.

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