One aims of the Finance Act was to simplify the taxation of the insurance sector to facilitate its growth, here experts at EY (Ernst & Young) take a look at some of the most important changes and how they may impact the sector. Modestus Anaesoronye brings the report.
The insurance sector plays a very crucial role in the economy of any nation, and this has been exemplified on a global scale owing to the Covid-19 pandemic, which has brought into focus the critical role of the industry in the healthcare sector.
According to the AXCO 2017 Market Ranking, Nigeria’s insurance market ranked 72nd in the world, based on the industry gross premium income. In 2018, the insurance market in Nigeria grew at about 14.46 percent, recording a gross premium income of about N426 billion as against the N372 billion recorded in 2017. The non-life sector accounted for about 57.58 percent of the gross premium income, while the life sector in its steady upward trajectory, accounted for 42.42 percent of the gross premium income for the period.
Nigeria’s insurance sector remains attractive mainly due to its untapped potential, as the current insurance penetration rate is estimated to be 0.5 – 1 percent of about 200 million (i.e. the current population of Nigeria).
The Federal Government of Nigeria has over the years used policy interventions to try and increase the rate of insured customers, but execution of these policies has proven to be challenging and implementation of such policies has not been successful. From the standpoint of companies participating in Nigeria’s insurance market, while there are several factors that have contributed to the sector’s non-optimal performance, there has been a longing for reforms in terms of the tax and regulatory regime as it affects the sector.
Taxation of Insurance Businesses
Prior to the enactment of the 2019 Finance Act (“the Finance Act”), the extant tax framework as applicable to the insurance industry can be said to have been discriminatory and non-neutral. This made the insurance industry relatively uncompetitive compared to other operators in the financial services sector and their counterparts in other jurisdictions.
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The erstwhile Section 16 of the Companies Income Tax Act (CITA) provides for the taxation of insurance companies in Nigeria. In line with the CITA, insurance companies are required to file separate tax returns for the different classes of insurance business being undertaken by the company i.e. non-life (general) insurance, life insurance and reinsurance, and separate books of accounts are required to be kept for these different classes.
Given that one of the aims of the Finance Act was to simplify the taxation of the insurance sector to facilitate its growth, we will take a look at some of the most important changes and how they may impact the sector.
Deductibility of Unexpired Risks, Claims, Outgoings and Underwriting Expenses
Based on the Insurance Act, insurance companies are required to make provisions for unearned premium, unexpired risks, outstanding claims and claims incurred but not reported, prior to determining their net profits for a reporting period. For income tax purposes, there were certain restrictions surrounding the deductibility of unexpired risks, claims, outgoings and underwriting expenses despite being wholly, reasonably, exclusively and necessarily (WREN) incurred for companies’ operations.
With the advent of the Finance Act, insurance companies’ deduction of expenses is no longer restricted to 25 percent of companies’ total premiums. Specifically, non-life insurance businesses can now deduct total estimated outstanding claims and outgoings from premium income. However, the Finance Act’s additional provision to tax unutilized deducted amounts as part of the profits of the company for the following year necessitates the need for insurance companies to proactively plan in an efficient manner in this regard.
In relation to reserves for unexpired risks, the Finance Act’s allowance of companies to now deduct such claims on a time apportionment basis aligns the tax practice applicable to insurance businesses with the insurance act and the relevant standard guiding accounting for insurance. This alignment of tax and accounting should simplify insurance business taxation as the treatment of such claims in the financial statements of insurance companies should be the basis of taxation for same, thereby setting aside the requirement to have a different practice for tax purposes.
These revised provisions create a business case for the recognition of deductible expenses, creating opportunities for insurance businesses to make business decisions with no bottleneck of expense restrictions. This should also reduce the taxable income of insurance companies, ultimately leading to relatively higher profits for distribution to shareholders or future investments into the business for expansion.
Carrying Forward of Tax Losses
Based on the Finance Act, insurance companies can now carry forward tax losses indefinitely, thereby aligning this tax treatment with what is obtainable for companies in other sectors and creating uniformity across board. This therefore is in line with one of the objectives of the Finance Act, which is to bring about fiscal equity.
Minimum Tax Regime
Insurance companies now have their minimum tax payable pegged at 0.5 percent of gross premium for non-life business, and 0.5 percent of gross income for life business, which is consistent with other entities in the financial sector?
Therefore, this also fairly aligns the taxation of the insurance sector with that of the other sectors. The change could foster economic growth in the country and create possible expansion for companies to expand their risk absorption base rather than ceding possible business overseas.
Tax-exemption for Income from Policyholders’ Funds
Insurance companies involved in life business invest in different asset classes such as treasury bills, government bonds, securities etc., will now have some income tax relief specifically as it relates to income derived from investment of policyholders’ funds. In this regard, the Finance Act’s clarification that investment income to be taxed should only be the income attributable to investment from shareholders’ funds should mean that life insurance companies would have less tax payable, given that a huge portion of investment income was derived from policyholders’ funds.
Although income from the aforementioned investment avenues are currently tax-exempt (regardless of the source of funds i.e. shareholder or policyholder), the incentive in this regard would be pronounced where insurance companies involved in life business make investments outside those currently tax-exempt avenues, using policyholders’ funds for such investment.
Thus, this specific exemption of investment income from policyholders’ funds presents an opportunity for life businesses to further explore the diversification of their investments to realize higher profits which should be tax-free. However, care must be taken to adequately accumulate all the costs incurred in generating the exempt income since these costs will also not be tax deductible.
Conclusion
The transformation brought to Nigeria’s insurance sector is by no means a small feat, as the tax system can be said to be on par with what is obtainable in other sectors of the economy.
Following these amendments to the tax framework of Nigeria’s insurance sector, there has been a notable increase in the level of investment in the sector, partly attributable to the National Insurance Commission (NAICOM)’s recapitalization project, which increases the minimum capital requirement for the different classes of insurance businesses in the country.
Overall, Nigeria’s insurance sector is projected to experience a sizable growth in the medium to long term, notwithstanding the disruption caused by the Covid-19 pandemic. Life insurance business is projected to grow by 4.8 percent in 2020, while general insurance business is expected to grow by 2.9 percent.
While the tax framework has been amended and is somewhat attractive (considering where the sector was coming from) such that investment in the sector should increase, achieving the projected growth in the sector will require increased penetration of Nigeria’s population and businesses by insurance companies. It is expected that insurance companies would seek to do more in this regard, as they look to derive maximum benefits from the tax transformation of the sector.
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