TAX Flashcards
Why is transfers out of a retirement annuity taxed but transfers to a retirement annuity (from provident fund, pension fund & co. and between them) not taxed?
This can be seen as a transfer to a less restrictive retirement vehicle (RA is most restrictive). This is discouraged, because the less restrictive the vehicle
- the more likely you are to have access to your funds
- higher risk of funds leaving the retirement system
- want to promote lifetime income which stricter vehicles help with.
Why can the prudential supervision reporting basis not be used as the tax basis?
- it recognises the majority
of profits on the commencement of the policy - rather than gradually over the lifetime of the policy (IFRS)
- this would result in the payment of tax before the insurer has received the cash associated with the policy.
How might Capital Gains Tax arise?
- when any investment sold (like shares or property)
- transfer to corporate fund when there are excess assets at year end (treated as a “deemed disposal” as MV, even though nothing sold)
- policy changes which require fund changes (policy ownership/status changes
e.g.
- PH moved from healthy to disabled so annuity starts
- policy moves from IPF to UPF
- assets must physically transfer between funds -> CGT triggered
Why can’t you apply normal income tax rules to insurers?
Story: the timing of insurers vs. other businesses is just so slow, they really don’t grow because they don’t eat enough purity and take enough risks.
- timing mismatch: for insurer’s receive premium now and only pay claim in 20 years -> massive profit in year 1 and losses thereafter which isn’t a true reflection of profitability.
- investment growth: PH pays R200 premium but R1000 paid on death, should insurer or PH pay tax on R800 growth? The R800 isn’t just insurance but also investment growth.
- pure risk isn’t taxed: for 1 year term assurance, if 5 PH contribute R1k in premiums, the R5k pool used to pay claims for anyone who dies. If you don’t die you get nothing out, so no value created for PH so cannot tax them. However, the insurer can be taxed on all unused risk premium as it can be considered profit.
What is the single greatest weakness of four funds tax basis?
Because insurer’s pay tax on behalf of PH, the tax rate charged is consistent across all PH no matter their marginal tax rate. If the PH had to pay this tax, this obviously would not be the case. The tax rate chose should be in line with the group of PH. This makes is beneficial for the wealthy, as they’re paying less tax on this basis than they would if they were charged marginal tax.
How do we split the balance sheet into different tax funds?
- Risk fund (RF)
- all risk policies post-2016 - Untaxed (UPF)
- retirement annuities and annuities
- all institutions which are tax exempt e.g. government institutions, NGOs, Unit trusts etc. - Corporate Fund (CF)
- risk policies or endowments bought by corporates
- different tax rate to individual fund - Individual Fund (IPF)
- risk policies (pre-2016) and endowments - Company Fund (CPF)
- tax on shareholder profits
Why was the Risk Fund created in 2016?
- for pure risk policies, PHs as a group make a net loss equal to the expense and profit margins
- so there’s no investment gain/value accumulated by PH to tax.
- the premiums less claims and expenses represent the insurer’s profit, which is taxed at the corporate level
- risk policies tend to generate lots of expenses (especially commission) but don’t require lots of assets to back them (i.e. not much taxable income) -> causing excess E position
- when risk policies were still in the IPF, insurer’s weren’t charging their PH tax, due to the excess E position risk policies put the fund in
What falls into taxable income?
Interest income
Rental income
Taxable foreign dividends
Included portion of capital gains (40% for IPF, 80% for CPF)
- only portion of capital gains because :
– some of the gain might be due to inflation
– don’t want investors to be reluctant to sell due to tax consequences
– avoid double taxation
What are direct vs. indirect expenses?
Direct Expenses are directly attributable to generating taxable income + are fully deductible e.g. costs directly associated with fixed-interest investments
Indirect Expenses cannot be directly linked to generating specific income e.g. commissions, administration expenses, general operating costs. Only a portion is deductible, determined by the expense relief ratio.
Liberty uses a cost per policy in order to determine the level of indirect expenses in each fund (IPF vs. CPF)
What is the expense relief ratio?
- It is a ratio used to determine the deductible portion of indirect expenses
- it prevents deducting expenses relating to non-taxable income e.g. local dividends
- ERR = taxable investment return/ total investment return
How is tax calculated?
tax = tax rate * (taxable income - direct expenses - indirect expenses * expense relief ratio - transfer deductions)
tax rate is 28% for CPF and 30% for IPF
What is a transfer deduction?
- refers to the tax treatment of profits transferred from a IPF/CPF to the CF.
- when a life insurer makes profits on PH business, these profits are transferred to the CF and need special tax treatment to avoid inappropriate taxation.
- deduction reduces I - E tax in order to avoid double taxation
- transfer deduction = 30%expense relief ratio(PH profit in the IPF/CPF)
- very crude allowance for double taxation
- if you are in excess E this will be 0 but if in excess I can reduce tax to zero.
What is deferred tax liabilities?
- DTL represents the tax you need to pay in the future
- Arises when the prudential supervision reporting liabilities are lower than IFRS liabilities
- As a result, profits are released earlier on the prudential basis compared to IFRS
- These “released profits” haven’t been taxed yet (since tax follows IFRS)
- A DTL is set up to account for the future tax that will be paid when these profits are eventually recognised in IFRS
- This DTL will sit on the prudential balance sheet
What is the deferred tax assets?
- DTA represents the tax benefits you’ll receive in the future
- This arises when the prudential supervision reporting liabilities are higher than the IFRS liabilities
- This causes Basic Own Funds to be lower than IFRS equity
- As a result, prudential supervision is realising expenses earlier than IFRS
- DTA is set up to ensure that there is a tax benefit i.e. less tax is paid when these expenses are realised in IFRS
- The DTA will sit on the prudential balance sheet.
