By Doné Howell, Tax Partner Grant Thornton Johannesburg
The latest in the wave of changes that affect the taxation of insurance policies that exist for the benefit of an employee, but are paid by the employer, is the recent legislation regarding the taxation of income protection policies.
Although the effective date of this legislation is 1 March 2015 (the 2016 tax year), it is important for employers to be aware of the impending changes to the PAYE system and to consider the possible review and renegotiation of your policies in the next year.
- Employer-paid premiums in respect of insurance policies for the benefit, whether directly or indirectly, of an employee or his or her spouse, child, dependant or nominee, is a taxable benefit and is reported on the IRP5 certificate against code 3801.
- However, to the extent that the premiums are in respect of a policy which (i) “… covers that person against loss of income as a result of illness, injury, disability or unemployment” and (ii) “the amounts payable in terms of the policy… constitute or will constitute income as defined” and are treated as a taxable benefit in the employee’s hands, the employee is deemed to have paid such premiums and will therefore be entitled to a tax deduction of the same amount. This deduction is reported on the IRP5 certificate against code 4018.
- Although there is an initial inclusion as a taxable benefit in the employee’s hands, the corresponding deduction in calculating the PAYE results in a nil PAYE liability.
- Taxpayers who pay premiums to such policies are also entitled to a tax deduction. The deduction is allowed in terms of section 11(a) of the Income Tax Act, No.58 of 1962 (‘the Act’) read with section 23(m)(iii) of the Act.
Reasons for change
- Although the insurance industry may have differing names for disability policies, essentially there are two types of cover; capital protection and income protection.
- Capital protection is essentially cover against a person’s loss of income earning capacity, while income protection is cover against a person’s loss of future income.
- Currently premiums paid towards capital protection are not deductible but future policy pay-outs will be tax-free. Premiums paid for income protection are tax deductible however; the income from future policy pay-outs will be taxed.
- The Legislature’s motivation to align the tax treatment in respect of these types of policies is that it believes that both types have a similar objective, which is “to protect the financial future of an individual and his or her family through insurance against an adverse personal event (death or disability).” This alignment will also ensure a similar tax treatment as applied in respect of life insurance policy premiums.
Consequences of the change
- As from 1 March 2015:
- Any premiums paid by an employer for the benefit of an employee will be treated as a taxable benefit;
- The employee will not be entitled to a tax deduction of the corresponding value;
- An individual will not qualify for a tax deduction in respect of his or her premium paid; and
- All policy pay-outs will be tax-free, irrespective of whether historical premiums qualified as tax deductions and irrespective of whether the policy pay-out is in the form of a lump sum or an annuity.
- Notwithstanding the increase in PAYE to be suffered by an employee, employers will also bear an increase to their skills development levies and unemployment insurance fund contributions costs.
- As it will no longer be necessary to provide for tax deductions when calculating the amounts in respect of future pay-outs, employees could be over-insured and employers will need to review and re-negotiate income protection policies.
- Furthermore, the employee’s net take home pay will be reduced due to the increase in PAYE and therefore the possible re-negotiation for a lower policy pay-out would have a corresponding reduction in the premiums payable.
- It will be necessary to educate employees proactively to ensure they comprehend the future tax implications of these policies.
Other employer-paid policies
- As a reminder, from 1 March 2012 (the 2013 tax year) a taxable benefit arises in respect of employer paid contributions to an insurer in respect of an insurance policy, whether directly or indirectly for the benefit of an employee, his or her spouse, child, dependent or nominee.
- The policies that will be affected by this taxable benefit provision are ‘unapproved’ policies, i.e. policies that are owned/in the name of an employer.
- Therefore, it is vital that employers ascertain whether their policies qualify as ‘approved’ or ‘unapproved’ policies. Any premiums the employer pays towards an approved policy, i.e. a policy that is part of a pension or provident fund as policyholder, does not qualify as a taxable benefit as the tax treatment is the same as employer contributions to pension or provident funds.