17 February 2017 Global Tax Alert South African Tax Authority clarifies corporate tax classification of risk policies and once-off election for long-term insurers EY Global Tax Alert Library Access both online and pdf versions of all EY Global Tax Alerts. Copy into your web browser: www.ey.com/taxalerts Executive summary During January 2017, the South African Revenue Service (SARS) issued a draft interpretation note setting out practical guidance and clarifying the classification of risk policies and the so-called once-off election afforded to insurers for certain policies issued prior to years of assessment commencing on or after 1 January 2017. Taxpayer comments must be submitted to SARS by 31 March 2017. Detailed discussion Background Long-term insurance legislation has undergone significant changes during the past 18 months. Prior to 1 January 2016, long-term insurers were required to record their business in one of four funds: (i) three policyholder funds (individual policyholder fund, company policyholder fund and untaxed policyholder fund); or (ii) the shareholder fund (corporate fund). The allocation of written policies to one of the three policyholder funds was generally dependent on the identity of the policyholder. Under this four funds model, there was no distinction between the type of insurance business actually being written, i.e., investment business, or risk business. This led SARS, through
2 Global Tax Alert consultation with the insurance industry and its regulators, to introduce a fifth fund, the risk policy fund (RPF). This new fund applies to any policy written in years of assessment commencing on or after 1 January 2016, which meet the definition of a risk policy as set out in section 29A of the Income Tax Act. 1 In addition, SARS allowed long-term insurers a so-called once-off election. This election affords long-term insurers the opportunity to move (tax-neutrally) all policies or one or more classes of policies 2 issued before the inception date, which would have qualified as a risk policy had these policies been issued after the inception date. This election is binding for the duration of those policies and cannot be reversed. Draft Interpretation Note During January 2017, SARS issued a draft interpretation note (Draft IN) clarifying certain corporate tax aspects of the classification of risk policies and the once-off election. The Draft IN sets out a two-step approach in determining whether a policy will constitute a risk policy. The first requirement is to determine whether the benefits payable under the policy exceed the premiums receivable in terms of that policy. The second requirement is where the benefits do exceed the premiums receivable, but all or substantially the whole of the benefits payable in terms of that policy are due to death, disablement, illness, or unemployment. These policies will constitute risk policies. Paying annuities are specifically excluded from the definition of a risk policy. The classification of a policy should be done on day one, i.e., when it is issued (or amended significantly). Substantially the whole The risk policy definition includes policies for which all or substantially the whole of the policy benefits are payable due to death, disablement, illness, or unemployment. SARS clarifies in the Draft IN that its interpretation of the term substantially the whole will be 90% or more. This percentage appears to be based on a past SARS Binding General Ruling, adapted for the insurance industry. This is particularly important in light of certain risk products currently issued by insurers, which contain a cashback or no-claim bonus element. Based on the Draft IN, such benefits should not constitute more than 10% of the total benefits payable under that policy in order to ensure that it will meet the risk policy definition. Amendments to policies Significant amendments to an insurance policy may result in a new policy arising. SARS seeks to clarify in the Draft IN as to what will merely constitute an amendment (i.e., no new policy), and what will constitute a new policy. Practical examples given of amendments which will not give rise to a new policy include automatic increments, voluntary increments, the buy-back of benefits and the right to amend cover in certain scenarios. Examples given of amendments that may lead to a new policy arising include options to convert a risk policy to a non-risk policy, and significant changes or extensions to the cover which are newly determined. A key determinant is whether the amendment (in substance) constitutes a new policy, or merely a change to existing policy benefits. Once-off election The Drat IN sets out three steps in the process of determining qualifying policies for purposes of the once-off election : Identify the relevant policies or classes of policies important factors to consider here in determining whether the policies within an identified class have substantially similar contractual rights and obligations include product design features, premium patterns and benefit structures. Classes can be divided into sub-classes for these purposes. Determine whether the individual policies or the policies included in a class constitute risk policies more than 50% of the policies within a class should constitute risk policies. Determine whether the class of policies as a whole will meet the risk policy definition the total policy benefits within a class must relate at least 90% to risk events.
Global Tax Alert 3 The once-off election must be disclosed in the insurer s IT14L tax return relating to the first year of assessment commencing on or after 1 January 2016, in the form and manner which SARS will prescribe. Reinsurance arrangements Reinsurers are to determine whether a reinsurance policy will constitute a risk policy independently of the related insurer s classification of the reinsured policy. Where the reinsurance policy does not constitute a risk policy, the reinsurer must consider the identity of the original insured party in order to determine the policyholder fund to which that reinsurance policy will be allocated. Per the Draft IN, adding policies to an existing reinsurance treaty by a reinsurer will not constitute the issuing of a new policy. A reinsurer s once-off election will be made independently and without regard to the underlying insurer s election regarding the reinsured policies. Taxpayers have until 31 March 2017 to submit comments to SARS with regard to the Draft IN. Endnotes 1. No. 58 of 1962. 2. That share substantially similar rights and obligations.
4 Global Tax Alert For additional information with respect to this Alert, please contact the following: Ernst & Young Advisory Services (Pty) Ltd., Cape Town Russell Smith, Tax Partner Global Compliance & Reporting +27 21 443 0448 russell.smith@za.ey.com Greg Boy, Tax Manager Business Tax Services +27 21 443 0463 greg.boy@za.ey.com Ernst & Young Advisory Services (Pty) Ltd., Africa ITS Leader, Johannesburg Justin Liebenberg +27 11 772 3907 justin.liebenberg@za.ey.com Ernst & Young LLP (United Kingdom), Pan African Tax Desk, London Leon Steenkamp +44 20 7951 1976 lsteenkamp@uk.ey.com Byron Thomas +44 20 7951 4144 bthomas4@uk.ey.com Gonçalo Dorotea Cevada +44 20 7951 2162 gcevada@uk.ey.com Ernst & Young LLP, Pan African Tax Desk, New York Silke Mattern +1 212 360 9707 silke.mattern@ey.com Dele A. Olaogun +1 212 773 2546 dele.olaogun@ey.com Jacob Shipalane +1 212 773 2587 jacob.shipalane1@ey.com
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