The taxation of risk policies – throw away existing principles

By way of background, the business of an insurer has to date been divided into four separate funds for tax purposes, being –

• the individual policyholder fund relating to policies owned by individuals;
• the company policyholder fund relating to policies owned by corporates;
• the untaxed policyholder fund relating to policies owned by untaxed entities and annuity contracts; and
• the corporate fund which reflected the remaining assets of the insurer.

To date both risk polices as well as investment policies were categorised within the relevant policyholder funds concerned. However, the proposals will have the effect that risk policies will have to be accounted for by an insurer in the corporate fund and no longer in any of the policyholder funds. In other words, it will only be risk policies that are accounted for in the policyholder funds concerned.

The proposals are to the effect that any policy issued by an insurer during any year of assessment commencing on or after 1 January 2016 in respect of a risk policy must be accounted for in the corporate fund. A risk policy is defined as a policy in terms of which any benefits payable under the policy is dependent on any future event, the happening of which is uncertain, or in terms of which any amount payable under the policy is only payable by reason of death. It includes any reinsurance policy in respect of these issues. Importantly, however, to the extent that the policy contains both investment and risk elements, the policy will be deemed to be a risk policy even if only a small portion of the policy benefits may be attributed to risk and/or investment. This categorisation may well give rise to manipulation as it would be relatively easy to decide in which fund a policy must be accounted for. To the extent that a decision is taken to reflect the policy in the corporate fund, one can merely attach a small element of risk to the policy. In cases where it is more advisable to account for the policy in the policyholder fund, one can split the policy so that only investment risk is accounted for in one policy and the risk element in another policy.

It is noteworthy that no reference is made to existing losses that may have been derived in a policyholder fund and how that is to be dealt with going forward. The only reference is that the insurer must place assets having a market value equal to the liabilities in respect of the relevant policies in the fund concerned.

Once the policy is reflected in the corporate fund, however, a number of new principles are introduced. Firstly, the corporate fund is only entitled to claim a deduction equal to the amount of the insurance liabilities as reduced by reinsurance assets in respect of the risk policies as determined in accordance with accounting principles. The amount of insurance liabilities reduced by reinsurance assets relating to risk policies that have been claimed in a preceding year of assessment must be added back. The problem, however, is that the corporate fund now contains a mix of both risk business as well as the surplus assets of the insurer.

In order to overcome this difficulty, premiums will now be included in the income of the corporate fund on the basis that claims actually incurred will be allowed as a deduction. This is similar to the treatment of the short-term insurance industry. However, the proposal goes much further in the sense that –

• dividends going forward will become taxable;
• reinsurance claims received will become taxable, whereas reinsurance premiums paid are deductible;
• capital gains will now be subject to normal tax at the rate of 28% and not the normal corporate rate.

There are a number of fundamental changes in the normal taxation principles that apply to corporate taxpayers. The fact that dividends will become taxable and capital gains are subject to normal tax at the rate of 28% is far-reaching. This should be seen against the background that insurers are to be taxed on an annual basis in respect of unrealised capital gains. It is appreciated that not all of the dividends and capital gains will be taxed, but only a percentage thereof, calculated with reference to the premiums received compared to the total value of assets in the corporate fund. Even on this basis, however, it seems inconsistent with existing tax principles and the previous amendments that have been made to the taxation of the long-term insurance industry. If anything, one should rather consider the use of a fifth fund in which the risk policies must be reflected. This will have a much more equitable effect than throwing these polices into a corporate fund where a number of inconsistencies will arise.

• DLA Cliffe Dekker Hofmeyr
• Emil Brincker
• South Africa