The insurance claims paid to policy holders in the event of death or disability will be subject to payment of income tax if the new Direct Taxes Code proposals are implemented.

The Code proposes that contributions by the insured are subject to the EET method of taxation of savings. This means that the sum received under a life insurance policy, including any bonus, is taxed. Only a pure life insurance policy is exempted from tax. In a pure life insurance policy, the policyholder receives money only when death occurs.

Life insurance companies are perturbed that the tax proposal could hit their business. Life insurers are taking up the issue with the government through the Life Insurance Council.

According to an insurance company official, the council is sending its suggestions to the government and the regulator.

"Even if you are in the lower tax bracket, when you get the sum assured, it will be a lumpsum amount. This would catapult you to a higher tax bracket and you will pay higher taxes,"said Kamalji Sahay, CEO, Star Union Dai-ichi Life Insurance.

Only term insurance policies would be exempted. Both ULIPs and traditional products would be taxed. The return would be taxed even in case of disability or death, said V. Srinivasan, Chief Financial Officer, Bharti AXA Life Insurance.

The Direct Taxes Code has a section, which says that maturity proceeds of an insurance policy shall be exempt only if the premium does not exceed 5 percent of the capital sum assured.