Chapter 6- South African Insurance Taxation

Question 1

List the three recent changes to taxation laws? (3)

Answer 1

• Effect of SAM on valuation of policyholder liabilities for tax purposes

• New tax fund for risk policies

• Consolidation of the rules governing retirement, pension and provident funds under proposed retirement reforms

Question 2

Describe the tax for life policies owned by individuals? (3,5)

Answer 2

• Premiums: paid from after tax income  no tax deduction allowed for life assurance premiums

• Benefits: Lump sum on death or maturity:
o Exempt from income tax in the hands of the original policyholder (or beneficiaries)
 Except second hand policies (policies which policyholder sells to another person)
o Applies to basic policy AND accumulated bonuses/ profits

• Benefits: Regular income  treated as an annuity:
o Income tax is charged on the payments made in the hands of the policyholder
o If SA is payable by instalments over a specified term (with no interest payable to policyholder)  instalments may not be taxable

Question 3

Describe the change in tax treatment of Income protection polices?

Answer 3

• Before 1 March 2015: premiums were tax deductible and benefits were subject to income tax in the hands of the policyholder

• After 1 March 2015: premiums paid from after-tax income and benefits are not taxable

Question 4

Describe the tax for life policies owned by companies (key man policies)? (2,3)

Answer 4

• Premiums: may be deducted from the employer’s taxable income if the policy meets the following requirements:
o Taxpayer (i.e. the employer) must be the policyholder
o Only benefit payable is as a result of death, disablement or severe illness of the employee
o [Premiums payable by the taxpayer] is deemed to be a [taxable fringe benefit granted to an employee] of the taxpayer in terms of the Seventh Schedule to the Income Tax Act

• Benefits: proceeds must be included in the taxable income of the company, and taxed accordingly

Question 5

Describe the retirement reforms proposed to consolidate the treatment of retirement funds? (3)

Answer 5

The tax law amendment bill 2015 made change to the contributions by members and employees to all approved funds such that they are all tax deductible (subject to limits).

It has also been proposed that the treatment of benefits be consolidated between funds with the minimum mandatory annuitisation of two thirds of the benefits at retirement irrespective of whether be a RA, pension or provident fund.

Extensive transitional rules have also been proposed to ensure that current vested rights of members are not prejudiced.

Question 6

Describe the tax treatment of contributions into a retirement fund? (4)

Answer 6

• Max deductible contribution to combination (RA + pension + provident) p.a.
= min of
o 27.5% * max(taxable income, remuneration)
o R350,000
^ limits apply to employer & employee contributions
Employer contributions tax deductible in employer’s hands, but taxed as fringe benefit in hands of employee

• Excess non-deductible contributions are carried forward and regarded as current contributions in subsequent year of assessment
o Previously disallowed deductions are available to set-off against lump sum benefit on withdrawal/ retirement

Question 7

Describe the tax treatment of the benefits of a retirement fund? (5)

Answer 7

• RA & pension
o Benefits must be taken as compulsory income (annuity)
  included in taxable income  taxed accordingly
o One third can be commuted for cash sum  tax according to the sliding scale
o If total proceeds (RA + pension) =< R247,500
  can take a lump sum
 to avoid paying very small annuities

• Provident
o Benefits usually lump sum
 May be taken as an annuity

• Lump sum benefits  taxed according to sliding scale
o Retirement and death benefits – use the same scale
• R1 050 001 (R130 500 plus 36% of excess above R1 050 000)

o Withdrawal benefits – different scale ‘

Currently, there are rules regarding the transfer of another retirement fund which is tax-free is transferred to the same or higher level fund in the following hierarchy:
• Retirement annuity fund (highest rank)
• Pension fund or Pension preservation fund
• Provident fund or provident preservation fund

Question 8

Describe the tax treatment of contributions into a benefit fund? (2)

Answer 8

The employer’s contribution to an approved benefit fund may generally be deducted from the employer’s taxable income in term section 11 (I).

The income tax Act recognises two types of benefit funds-friendly society and medical schemes registered under the medical scheme Act.

Question 9

Describe the tax treatment of voluntary annuities? (2)

Answer 9

Tax is levied on: [the amount of the annuity] less [the “capital element”]
Capital element:
Determined at the outset by the StatAct of insurance company,
remains unchanged throughout the duration of the contract
Basis for calculation is prescribed in the Income Tax Act

= ((Lump sum annuitized (i.e. cash consideration))/(Total payment expected over annuitant^' slife expectancy)) ×(annuity amount)

Question 10

Describe estate duties tax? (4,3)

Answer 10

• Estate duty act (1995)

• Tax levied on the estate of a deceased = Dutiable amount * 20%

• Dutiable amount = [total value of the estate] – [allowable deductions and abatements]
o Total value of estate includes
 Property
 All policies on the life of the deceased (including benefits payable from funds on or as a result of death)
o Abatement of R3,5m

Question 11

Describe tax-free savings rules? (6)

Answer 11

• Incentive to save
• Introduced by gov of SA
• Endowment contracts that meet certain criteria can qualify
• Investment returns are tax free
• Limits on amounts to be invested
o R33,000 p.a.
o R500,000 life time limit
• If policy reached limit – no further premiums allowed
o Even if funds are withdrawn

Question 12

Describe the tax structure of life insurance companies? (3,6)

Answer 12

• Long-term insurers pay tax on both
o profits generated by the insurer AND
o taxable income and capital generated on behalf of policyholders
 (pay tax on behalf of PHs  trustee principle)’

• A&L’s must be classified into five separate funds, each of which is treated as a separate taxpayer
o 1 for shareholders, 1 for risk policies, and 3 for different classes of policyholders
• Specific rules for life insurers relate to:
o Classification of A&L’s into 5 tax funds
o Transfers of A’s between tax funds
o Deduction of expenses
o Treatment of premiums & claims (& related reinsurance)

• New fund = RPF
o 2014 Taxation laws amendment act
o All risk policies sold after 1 jan 2016
 Option to include risk policies sold before 1 jan 2016
o Regardless of owner of the policy

Question 13

Describe the risk policy tax fund of a life insurance company? (6)

Answer 13

• Risk policy fund
o Assets have market value equal to value of liabilities (IFRS 17 basis for tax purposes although 6 year transitional period from SVM basis previously used)
o All policies sold after January 2016 which fall under the definition of risk policy will fall in this fund
o The definition of risk policy is any policy where the benefits payable cannot exceed the amount of premiums received
o Except where the all policy benefits are payable due to death, disability, illness or unemployment
o Excluding contracts where annuities are payable
o In addition insurers has the option to allocate polices sold before January 2016 to this fund

Question 14

Describe the untaxed policy tax fund of a life insurance company? (4)

Answer 14

o Assets have a market value equal to the value of liabilities (IFRS 17 basis for tax purposes although 6 year transitional period from SVM basis previously used)

o Any policy that is not included as part of a risk policy fund and is owned by a pension, provident, retirement annuity funds or benefit fund

o Any policy not in the risk policy fund whose owner is tax exempt

o Any annuity contract in respect where annuities are being paid

Question 15

Describe the IPF, CPF and CF tax fund of a life insurance company?

Answer 15

• The individual policyholder fund (IPF)
o Assets have a market value equal to the value of liabilities
o These are polices that are not included in the risk policy fund or UPF where the policyholder is not a company

• Company policyholder fund (CPF)
o Assets have a market value equal to the value of liabilities
o These are polices that are not included in the risk policy fund or UPF where the policyholder is a company

• Corporate fund/shareholder fund
o These are represented by assets held by the insurer other than those mentioned in the above funds

(IFRS 17 basis for tax purposes minimum of zero although 6 year transitional period from SVM basis previously used)

Question 16

Describe how transfers between various funds impact the taxable income of the fund? (4)

Answer 16

• At the end of each financial year,
o any excess/shortfall of the [MV of A’s] over the [value of liabilities] in each fund
o will be transferred to/from the corporate fund

• Transfers to the CF will be included in the taxable income of the CF

• Transfers from the CF cannot be deducted from the taxable income of the CF
o Then, not included in the taxable income of the policyholder or risk policy funds

• BUT, if transfer from CF and then transfer back to CF  not included in taxable income of CF

Question 17

Describe the expense deductions from the taxable income of policyholder funds?

Answer 17

i. Expenses directly attributable to the income of that fund (not subject to Y – deducted from I)

ii. Expenses allocated to the fund
(e.g. selling and admin)
(but excluding any expenses directly attributable to amounts which do not constitute income),
multiplied by the [expense relief ratio] of Y = (X + U) / Z

a. X = taxable income of the fund
i. (before applying expense deductions)
ii. (includes taxable portion of realised capital gains)

b. Z = all income
= sum of X,
i. dividends,
ii. foreign dividend not included in taxable income,
iii. capital gains not included in the taxable income, and
iv. URCG = unrealised cap gain = diff between MV of asset at end of year vs beginning, subject to min of 0

c. U = UCG multiplied by 0.4 for IPF and 0.8 for UPF (i.e. the capital gains inclusion rate!)

 only obtain tax relief on expenses that relates to the proportion of total income that is TAXABLE

iii. 30% of: [any amount transferred by the policyholder fund to the corporate fund] multiplied by the [expense relief ratio],
a. capped at [income – other deductions]

Question 18

Describe Excess E (unreleived expenses) on policyholder funds? (2)

Answer 18

• [Deductible expenses of the policyholder fund] > [taxable income of the fund]
o  fund in “excess E” position
o  fund will not pay tax and generates a tax shield

• Excess E amount is carried forward to the next year and offset against that year’s taxable income

Question 19

Describe the implications of capital gains tax on the policyholder funds? (6)

Answer 19

• Capital gains arising will be subject to CGT as part of the taxable income of the fund
• CGT can arise from:
o Sale of any investment
o Deemed disposal of A’s from policyholder funds to/from the corporate fund
o The actual transfer of A’s between funds which are required when there is a change in ownership of the policy or change in the status of the owner of the policy

• Realised gain = [Sales proceeds] – [Base cost]
o Base cost =
 actual expenditure incurred in acquiring asset
 OR if asset acquired before 1 Oct 2001  base cost = either:
• MV on 1 Oct 2001
• 20% of sales proceeds OR
• [total gain] * [period from 1 Oct 2001 to sale date] / [ total period owned]

• Capital losses are deducted from other capital gains in the relevant fund
o Any net capital losses are carried forward to the next year

• Net capital gain is multiplied by the relevant CGT inclusion rate and added to the fund’s taxable income
o 40% IPF
o 80% CPF

• CGT inclusion rates increased as part of the Tax Laws Amendment Bill, 2016

Question 20

Describe the impact of the increase in the inclusion rate on the capital gains in taxable income? (6)

Answer 20

• Effective date 1 March 2012 & 1 March 2016
• Before 2012, 25% & 50%  after 2012, 33.3% % 66.6&  after 2016 40% & 80%

• At 2012, if incl rate change, have to pay higher tax on UCG that accrued before 2012
o  inequitable treatment over generations of PHs

•  [Deemed disposal and re-acquisition rule] introduced
o aimed to prevent misallocation of additional CGT among policyholders
o Only PH funds! No impact on CF!
o relates to all ph fund A’s – certain A classes excluded (interest bearing A’s. interest rate agreements, reinsurance A’s)
o At 1 March 2012, Account for all CGT on all unrealised gains & losses arising before 2012
o New higher inclusion rates then only apply for disposals from 2012 onwards

• BUT insurers had to account for all unrealised CGT gains and losses on the 1 March 2012 effective date
o (ie, at 1 March 2012  CGT on all URCG; after 1 March 2012  use higher inclusion rates)
o  significant crystallisation of CGT that appreciated over many years  potential liquidity strain
o  National Treasury allowed the CGT from ‘deemed disposal’ to be spread over four years
Spreading of capital gains  extra tax complications in calculations

• Inclusion rates increased again at 1 March 2016
o Another ‘deemed disposal’ as at 29 Feb 2016
o Spread over 3 years

Question 21

Describe the impact of dividends tax and securities transfer tax on policyholders funds?

Answer 21

• Dividends tax is levied on the beneficial owner of the dividend (mostly shareholders)
o but the company declaring the dividend has a withholding obligation
 except where the dividend is paid to a regulatory intermediary (i.e. the life insurer)
• Company to company dividend are exempt from dividends tax i.e. not applicable to CPF
• Withholding tax rate: 20%

Securities transfer tax (STT) •	Payable on the transfer of a security                        •	0.25% of MV of the security transferred