The taxation of benefits in respect of insurance policies
23 May 2012
Posted by: SAIT Technical
The provisions relating to benefits in respect of insurance policies changed with effect from 1 March 2012.
Paragraph 2(k) in the Seventh Schedule to the Income Tax Act (‘the Act’) is the starting point of the new taxation provisions for employer-paid insurance policies.
Paragraph 2(k) provides that a taxable benefit shall arise if -
the employer has during any period made any payment to any insurer under an insurance policy directly or indirectly for the benefit of the employee or his or her spouse, child, dependant or nominee.
This paragraph states that the payment made by an employer to any insurer for an insurance policy that benefits the employee in any way is a fringe benefit. This new provision now makes it compulsory for an employer to raise a fringe benefit on all premiums paid as specified above, including premiums paid in terms of an income replacement policy.
The underlined words "... to any insurer ...” removes from the ambit of paragraph 2(k) any contributions that are paid to retirement funds (pension, provident and retirement annuity funds). They are taxed and administered in terms of their own special provisions.
The cash equivalent value of the fringe benefit contemplated by paragraph 2(k) above is the total value of the premiums paid by the employer during the tax year.
Paragraph 12C(2) provides that where a premium is paid in terms of a policy that covers, inter alia, the loss of income as a result of illness, injury, disability or unemployment, the amount of the premium paid by the employer is deemed to have been paid by the employee.
Employers will need to show the value of the premiums as a fringe benefit, and by virtue of the provisions of paragraph 12C(2) that same amount is deducted, so that effectively the fringe benefit has no value and no tax obligation will arise.
The taxable benefit must be indicated under the income code 3801 on the 2013 IRP5 certificates.
Section 11(w) of the Act deals with the tax treatment of policy premiums incurred on or after 1 March 2012 by the employer. However, policies of insurance solely against an accident as defined in section 1 of the Compensation for Occupational Injuries and Diseases Act, No. 130 of 1993, are not included within the ambit of section 11(w).
An ‘accident’ is defined as:
‘an accident arising out of and in the course of an employee’s employment and resulting in a personal injury, illness or the death of the employee;’
Accordingly, if a policy is solely against accidents as defined above, the provisions of section 11(w) will not apply. The provisions of section 11(a) will then have to be applied in order to determine whether the employer paying the premiums on such a policy, will qualify for a deduction.
Section 11(w) envisages two types of policies:
- a life policy with an investment element; and
- a pure risk policy.
In some cases the policy will be for the direct or indirect benefit of an employee or director, and in some cases it will not. A policy will not be for the benefit of an employee or director where the insurance pay-out is only for the employer’s benefit.
Section 11(w) is therefore split into two components:
- section 11(w)(i) dealing with risk and investment policies where the premiums paid by the employer are taxed as a fringe benefit in the hands of an employee or director;
- section 11(w)(ii) dealing only with risk policies (which have no cash value or surrender value) and the premiums are not taxed as a fringe benefit in the hands of an employee or director.
Under section 11(w)(i), an employer may deduct premiums paid by it under a policy of insurance if all of the following apply:
- The employer is the policyholder.
- The policy relates to the death, disablement or severe illness of an employee or director.
- The premiums paid by the employer are taxed as a fringe benefit in the hands of the employee in terms of paragraph 2(k) of the Seventh Schedule, read with paragraph 12C of that schedule.
In terms of section 11(w)(ii), for employer-owned policies, the deductibility of the employer-paid premiums depends on whether the policy is a ‘conforming’ or a ‘non-conforming’ policy.
A conforming key person policy is one that conforms to the criteria specified in section 11(w)(ii):
- The policy insures the employer against any loss due to death, disablement or severe illness of the employee.
- The policy is a risk policy only and has no surrender (or cash) value.
- The policy is the property of the employer at the time of paying the premiums, but can be held by a creditor of the employer as security for a debt of the employer.
Further, if the key person policy conforms with the above criteria, the employer must declare that the policy falls under section 11(w)(ii) in one of two ways depending on the age of the policy -
- if the policy was entered into after March 2012, the policy agreement must state that section 11(w)(ii) applies in respect of premiums payable under that policy; or
- if the policy was entered into before March 2012, it must be stated in an addendum to the policy agreement by no later than 31 August 2012 that section 11(w)(ii) applies in respect of premiums payable under that policy.
A non-conforming policy is one that does not conform to the above criteria, and is the ‘default’.
If it is a conforming key person policy –
- the premiums paid by the employer are deductible when paid; and
- the benefit is taxable if and when the insured risk happens.
If it is a non-conforming key person policy –
- the premiums paid by the employer are not deductible when paid; and
- the benefit is normally tax-free if and when the insured risk happens.
It is suggested that employers seek professional advice in order to ensure that the correct tax treatment is applied to benefits of this nature.
By Hanneri Ferreira (ENS)