Income Tax - Taxation of Insurance Policies doc INSURANCE POLICIES

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1 INCOME TAX INSURANCE POLICIES BACKGROUND Effective from January 2011, a number of significant changes to the Income Tax Act were made which resulted in some unintended consequences. These changes were intended to raise a fringe benefit when the employer paid the premiums on behalf of an employee to an unapproved group scheme for Group Life Assurance, Lump-Sum Disability, Income Protection and Funeral Cover. However, the legal wording was not explicit enough, and some tax advisors and employers interpreted the new requirements to mean that the premiums paid by an employer to a group scheme did not result in a fringe benefit to the employee. This caused the Law to change again to accommodate these intended tax consequences. 2 APPLICABLE SECTIONS FROM THE INCOME TAX ACT 2.1 PARAGRAPH 2(K) OF THE SEVENTH SCHEDULE TO THE INCOME TAX ACT 2. For the purposes of this Schedule and of paragraph (i) of the definition of gross income in section 1 of this Act, a taxable benefit shall be deemed to have been granted by an employer to his employee in respect of the employee s employment with the employer, if as a benefit or advantage of or by virtue of such employment or as a reward for services rendered or to be rendered by the employee to the employer (k) 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. 2.2 PARAGRAPH 12C OF THE SEVENTH SCHEDULE TO THE INCOME TAX ACT 12C. (1) The cash equivalent of the value of a taxable benefit deemed to have been granted as contemplated in paragraph 2 (k) is the amount of any expenditure incurred by an employer during a year of assessment in respect of any premiums payable under a policy of insurance directly or indirectly for the benefit of an employee or his or her spouse, child, dependant or nominee. (2) Where any premium is paid in terms of a policy of insurance contemplated in section 23 (m) (iii), the amount of any premium paid by the employer of that employee must, to the extent that the amount has been deemed to be a taxable benefit in terms of paragraph 2 (k), be deemed to have been paid by that employee. (3) Where an appropriate portion of any expenditure contemplated in subparagraph (1) cannot be attributed to the employee for whose benefit the premium is paid, the amount of that expenditure in Page 1 of 5

2 relation to that employee is deemed, for the purposes of subparagraph (1), to be an amount equal to the total expenditure incurred by the employer during that year of assessment for the benefit of all employees divided by the number of employees in respect of whom the expenditure is incurred. 2.3 SECTION 11(W) OF THE INCOME TAX ACT 11. General deductions allowed in determination of taxable income. For the purpose of determining the taxable income derived by any person from carrying on any trade, there shall be allowed as deductions from the income of such person so derived (w) expenditure incurred by a taxpayer in respect of any premiums payable under a policy of insurance (other than a policy of insurance solely against an accident as defined in section 1 of the Compensation for Occupational Injuries and Diseases Act, 1993 (Act No. 130 of 1993)) of which the taxpayer is the policyholder, where (i)(aa) the policy relates to the death, disablement or severe illness of an employee or director of the taxpayer; and (bb) (ii)(aa) (bb) (cc) the amount of expenditure incurred by the taxpayer in respect of the premiums payable under the policy is deemed to be a taxable benefit granted to an employee or director of the taxpayer in terms of paragraph 2 (k) of the Seventh Schedule; or the taxpayer is insured against any loss by reason of the death, disablement or severe illness of an employee or director of the taxpayer; the policy is a risk policy with no cash value or surrender value; the policy is not the property of any person other than the taxpayer at the time of the payment of the premium: Provided that 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 (dd) in respect of any policy entered into (A) on or after 1 March 2012, the policy agreement states that this paragraph applies in respect of premiums payable under that policy; or (B) before 1 March 2012, it is stated 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; 3 TAXATION OF LONG TERM INSURANCE POLICIES EFFECTIVE FROM 1 MARCH EMPLOYEE TAXABLE COMPANY CONTRIBUTION Paragraph 2(k) was added to the Seventh Schedule of the Income Tax Act and is applicable from 1 March It basically states that if the employer contributes to a policy that either directly or indirectly will benefit the employee, his dependants or any nominated person of that employee, then the employer contribution should be taxed in the hands of the employee on the payroll as a fringe benefit. Page 2 of 5

3 If the policy is in the name of the employer, the company contribution should be taxed against code If the policy is in the name of the employee then the company contribution should be taxed against code 3808 (release from debt) TAX DEDUCTIBLE DEDUCTION If the policy is an income protection policy, the new requirements go one step further. An income replacement policy is a policy that covers the employee against loss of income as a result of illness, injury, disability or unemployment. The company contribution to an income replacement policy which is taxed as a fringe benefit according to paragraph 2(k) of the 7 th Schedule is deemed to be a premium paid by the employee and a deduction in terms of section 11(a) and paragraph 2(4)(cA) of the 4 th Schedule is allowed, meaning the total contribution is a tax deductible deduction. This leaves the employee in a tax neutral position as far as premiums are concerned. This is on condition that the income protection benefit (if and when paid out) must be included in the employee s income (in terms of section 23(m)(iii)), and will be taxed in the event of the insured risk arising in the future. Note that this deduction is not allowed for other policy types - only for income protection policies as defined. 3.2 EMPLOYER Section 11(w)(i) states that for employer-owned group scheme policies, the employer will be allowed to claim the premium that is taxed as a finge benefit according to Paragraph 2(k) of the 7 th Schedule as a deduction. Note that this is a deduction of the Income of the company and not a payroll deduction. 4 CONCLUSION 4.1 THE COMPANY CONTRIBUTION The Act is very clear that the contribution by the employer to insurance policies should be taxed as discussed above. This is only applicable to products supplied by an insurer and therefore not apply to 1. Retirement Funds (pension fund, provident fund and retirement annuity fund). 2. Fees and benefits paid in terms of the Compensation for Occupational Injuries and Diseases Act 3. Fees and contributions paid in terms of the Unemployment Insurance Act. 4. Severance benefits paid by the employer. The special taxation requirements are unchanged for all of the above types of policies. Group Life, Disability Lump Sum, and Funeral Cover policies can be included as part of the retirement fund, and if these rules are approved by SARS (approved fund), are taxed and administered according to the tax requirements for the type of fund. Unapproved funds are funds that are not approved. It would include funds that provide a product outside the ambit of an approved pension or provident fund. These typically include Group Life, Disability Lump Sum, Funeral Cover and Income Protection (including Permanent Health Insurance) schemes. Page 3 of 5

4 4.2 THE DEDUCTION If it is an Income Replacement Policy the tax deductible portion will be the employee contribution plus the fringe benefit value and should be reported against code SUMMARY Insurance Policy CC Taxable:3801 or 3808 Income Replacement Policy CC Taxable:3801 or 3808 Tax Deductible = Employee Contribution + Deemed Employee Contribution (Fringe Benefit) Approved Funds Taxed according to the type of fund. The unapproved portions which form part of the approved fund should be taxed as a fringe benefit on code 3801 or Example: You have an approved provident fund. A component of the provident fund is an unapproved group life scheme the group life portion should be taxed as this is unapproved. Unapproved Funds Company contribution should be taxed as a fringe benefit. Page 4 of 5

5 6 REFERENCES Taxation Law Amendment Act No. 24 of January 2012 Income Tax Act No. 58 of 1962 Page 5 of 5