Companies with years of assessment ending on or after 31 March this year will start to feel the impact of the decision by the government to limit the use of assessed losses carried forward.
The Income Tax Act was amended to limit companies to the higher of R1 million and 80% of the amount of its taxable income that can be set-off. A company will therefore generally pay corporate income tax (CIT) on 20% of its current-year taxable income.
Read: Limitation on set-off of assessed losses may increase companies’ cash-flow burden
Complex tax regime
The life insurance industry has been vocal about the restriction and the impact it may have on its clients, particularly on individual policyholder funds.
The industry has an extremely complex tax regime. Life insurers do not operate like “normal” companies, says PwC insurance tax partner Jos Smit.
Every insurer is required to establish five separate funds and to maintain them.
“The taxable income derived by an insurer in respect of the untaxed policyholder fund (such as pension funds), the individual policyholder fund (such as endowment policies), the company policyholder fund (policies owned by companies), the corporate fund (the life company itself), and the risk policy fund (such as funeral policies) must be determined separately as if each und had been a separate taxpayer,” the South African Revenue Service (Sars) explains in an interpretation note published in May last year.
Smit says a life insurer is basically treated like five separate companies within one company because of the different funds with its different tax dispensations.
The corporate tax rates are as follows:
- Individual policyholder fund: 30%;
- Untaxed policyholder fund: 0%;
- Company policyholder fund: 28% (reduced to 27% from 31 March);
- Corporate fund: 28% (reduce to 27%); and
- Risk policy fund: 28% (reduced to 27%).
Individual policyholder funds are typically more like a savings vehicle, but the insurer pays tax on behalf of the policyholder. The individual invests an amount with the insurer and receives the proceeds on the underlying assets of the policy when it reaches maturity, less expenses (including the tax cost).
Loss-making position
Smit says some individual policyholder funds may find themselves with assessed loss balances. Some of the operational costs, such as commissions paid to brokers on policies sold in a particular year, could exceed the investment income in the fund in that year.
In practical terms, the impact for the life insurer means that if its fund has a loss of, for example, R200 and it has a taxable income of R100, the fund can now set off only R80 against the taxable income. It will pay tax on the remaining R20.
“This is basically an additional tax-collection measure by Sars.”
Smit notes that the biggest impact on the insurer will be cash flow management because the balance of the loss can be carried forward indefinitely, but will it take longer to offset.
The change coincides with a reduction in the CIT rate from 28% to 27%. One of the reasons for restricting the offset of accumulated assessed losses against taxable income was to provide some of the fiscal space required to lower the rate.
Individual policyholders
The individual may find that proceeds from individual policyholder funds with assessed losses are negatively impacted. Lobbying by the industry was mainly focused on these funds because of the impact on individuals.
In principle, the 20% rule was aimed at companies to combat potential tax abuse (there is less incentive to overstate losses). However, because of the nature of the insurance business, the individual (in the individual policyholder fund) will be picking up the (tax) cost.
Previously, there would have been no tax cost for the fund with an assessed loss because of the ability to offset the loss in full. However, there will now be a 20% tax cost that will indirectly fall on the individual.
Smit says although the limitation may change the return on the investment policies, it is still too early to know whether it will lead to a change in investors’ decision-making processes.
“Investors in these products are generally more sophisticated and will understand the costs and tax consequences of their investments,” says Smit.
Global trend
National Treasury said in its January 2022 explanatory memorandum that the initial purpose of providing for the deductibility of assessed losses for corporate taxpayers was to smooth the tax burden for companies whose primary business is cyclical in nature and not in line with a standard tax year, and for start-up companies that are not profitable in the early years of trading.
However, there has been a “global trend” to restrict the use of assessed losses carried forward. Some countries have restricted the number of years in which a company can carry forward assessed losses, while others, such as South Africa, restrict the amount of tax losses that can be offset in a given year.
“While partial loss offsets may have a negative impact on businesses’ cash flow and investment, they can help in curtailing tax avoidance,” Treasury said.
Amanda Visser is a freelance journalist who specialises in tax and has written about trade law, competition law and regulatory issues.
Disclaimer: The information in this article does not constitute legal or financial advice.
Dear Amanda,
Please clear the following up.
Taxation in each of the different funds of ‘The Five Fund Approach’ will be determined by the type of BENEFICIARY and the type of POLICY? or By the POLICY HOLDER and TYPE of POLICY?
Regards
Hanli
0796778855
I asked Amanda for a response, which follows.
PwC insurance tax partner Jos Smit says: “The general rule is that the classification between tax funds depends on the owner of the policy (i.e. the person entitled to enforce any benefit provided for in the policy), except where the policy qualifies as a risk policy. If the policy qualifies as a risk policy, then the policy will be allocated to the risk policy fund. There are, however, various exceptions to the general rule.”
Section 29A(1) defines a “risk policy” as a policy issued by an insurer during the insurer’s year of assessment commencing on or after 1 January 2016 under which the benefits payable cannot exceed the amount of premiums receivable, except where all or substantially the whole of the policy benefits are payable due to death, disablement, illness or unemployment and excludes a contract of insurance under which annuities are being paid. Any policy relating to which an election has been made as envisaged in section 29A(13B) is also considered to be a risk policy.