Taxation of Insurance Contributions
07 March 2012
Posted by: TaxFind ™
Taxation of Insurance Contributions
The Taxation Laws Amendment Bill, 2011 (the ‘Bill’) contains significant amendments with regards to taxation of long-term insurance policies. The majority of the amendments address the taxation of employee benefit plans (generally group-life policies), key person policies, and the taxation of policy proceeds.
Many companies have pension or provident funds that include group-life cover. Generally the contributions towards the group-life cover are carried by the employer. Where contributions were made to group-life or other long-term insurance policy that was not part of an approved pension or provident fund, the contributions to such policy should be treated as a fringe benefit and taxed in the hands of the employee. Currently employers do not subject the contributions to the insurance funds, where so made in terms of an approved fund, to fringe benefit tax. The Bill introduced amendment to paragraph 2(k) and addition of a new paragraph 12C of the Seventh Schedule to the Income Tax Act.
Paragraph 2(k) applies where the employer has during any period directly or indirectly made any payment to any insurer directly or indirectly for the benefit or on behalf of the employee or his or her spouse, child, dependant or nominee, and such premiums paid by an employer in respect of insurance policies will constitute a taxable fringe benefit in the hands of the employee. In turn, paragraph 12C provides that the cash equivalent of the taxable fringe benefit, which is subject to employees’ tax and disclosure in the employees’ IRP5 certificate, is calculated as follows:
Where any contribution or payment was made by the employer the amount of such contribution or payment will be the cash equivalent; or Where any contribution or payment was made by the employer, but the employer is not able to determine the appropriate portion to attribute to the relevant employee, the amount of the contribution or payment in relation to an employee will be deemed to be an amount equal to the total contribution or payment by the employer during the relevant period for the benefit of all employees divided by the number of employees in respect of whom the contribution or payment is made; or In the event that the above apportionment method does not reasonably represent a fair apportionment of the contribution or payment, the Commissioner may direct that the apportionment be made in such other manner as to him or her appears fair and reasonable.
The above amendments with regards to taxation of fringe benefits with regards to contributions made by employers to long-term insurance funds are intended to commence on 1 March 2012.
The Bill also introduced amendments to section 11(w) of the Income Tax Act, intended to commence 1 March 2012, with regards to key person long-term insurance policies. These amendments follow a revision of the distinction between conforming and non-conforming policies that provide cover against the loss of key individuals. The amendment now defines a conforming policy, for purpose of deduction, to have the following characteristics:
The business must be insured against the loss of a key person by reason of death, disability, or severe illness; The policy must be solely a risk policy that has no cash or surrender value (policies with a cash or surrender value are associated with investment policies); The taxpayer must be the sole owner of the policy, and "… any premium paid shall not be disallowed as a deduction by reason of the policy being held by a creditor of the taxpayer as security for a debt of the taxpayer"; and No transaction, operation, or scheme may exist that compels the taxpayer that owns the policy to turn over the policy proceeds, or the equivalent thereof, to the key person or their beneficiaries.
Where any contribution or payment was made by the employer the amount of such contribution or payment will be the cash equivalent.
In addition to the above qualification criteria for a conforming policy, the Bill introduces an addition to section 11(w) requirements for deduction in respect of any policy entered into on or after 1 March 2012, the policy agreement states that this paragraph applies in respect of premiums payable under that policy; or before 1 March 2012, it is states in an addendum to the policy agreement by no later than 31 August 2012 that this paragraph applies in respect of premiums payable under that policy"
The Bill introduces the following amendments to paragraph (m) of the ‘gross income’ definition of the Income Tax Act. Firstly, the Bill effectively includes all amounts directly or indirectly received or accrued from any long-term insurer into the ‘gross income’ of the recipient (a catch-all net). Then specific exemptions and deductions will apply. The general intention is that the policy proceeds should be tax-free were such policy was funded with post-tax contributions, where as the policy proceeds should be taxed were such policy was funded with pre-tax contributions.
Firstly, the Bill effectively includes all amounts directly or indirectly received or accrued from any long-term insurer into the ‘gross income’ of the recipient (a catch-all net). Then specific exemptions and deductions will apply. The general intention is that the policy proceeds should be tax-free were such policy was funded with post-tax contributions, where as the policy proceeds should be taxed were such policy was funded with pre-tax contributions.
An exemption has been provided where the proceeds of a long-term insurance policy are received by or accrued to a person other than the policy holder. Effectively, the insurance proceeds received by an employee (a non-policyholder beneficiary) will be exempt where all the policy premiums did not "rank for" a deduction by the policyholder, or where the premiums were claimed as a deduction and the contributions was taxed as a fringe benefit in the hands of that employee. However, if the employee in turn deducted the taxable premiums in his/her tax return, the proceeds of the policy will be taxable in the hands of the employee.
An apportionment methodology has been introduced for "tainted" contributions (such as where the employer claimed a deduction without the corresponding fringe benefit recognition, or where the beneficiary claimed a deduction for the fringe benefit contributions), so that the exemption will only apply with regards to "non-tainted" contributions.
The Bill provides a further exemption in terms of the new section 10(1) (gG) in respect of insurance proceeds received by a policyholder to the extent that the contributions were not deductible.
The amendment to paragraph (m) of the definition of ‘gross income’ and new section 10(1)(gG) is intended to commence on 1 March 2012.
Section 23(m) that limits the deductions available against employment income/remuneration has be extended to now also include contributions or payment made by the employer (the fringe benefit value) as a deduction in terms of section 23(m)(iii).
Source: SAIPA Tax Committee (Tax Professional)