Good evening Bart
As you know, National Treasury released for public comment a draft of the 2011 Taxation Laws Amendment Bills that gives effect to most of the 2011 Budget review tax proposals, as well as the additional urgent matters. The draft legislation and explanatory memorandum can be found on the websites of National Treasury (
www.treasury.gov.za) and SARS (
www.sars.gov.za). The draft 2011 Taxation Laws Amendment Bills (TLAB) are published for public comment before formal introduction in Parliament. The Standing Committee of Finance (SCOF) convenes informal hearings on these draft bills and considers public comments received. Subject to confirmation from the SCOF, the date for the briefing is planned for 15 June 2011, and the dates for the public hearings are set for 21 and 22 June 2011. The National Treasury and SARS consider all the comments received, and thereafter submit a response document to the SCOF in August. The draft Bills are then revised and formally introduced in Parliament by the Minister of Finance (expected to be in early September).
The three most important proposed amendments that we feel will affect products offered by Altrisk, are set out under paragraphs 2.3 “Long-Term Insurance: Contributions as a Fringe Benefit”, 2.4 “Long-Term Insurance: Key Person Plan Elections” and 2.5 “Long-Term Insurance: Taxation of Proceeds”, of the Explanatory Memorandum on the Draft Taxation Laws Amendment Bill, 2011 Draft, dated 2nd June 2011.
At the risk of over-simplifying these matters, we thought it good to forward you a short summary of these three important amendments, whilst inviting readers to refer to the abovementioned websites for more detailed discussions on these and other tax related proposals.
“Contributions as a Fringe Benefit”
Up until now, employers could provide for employee death or permanent disability cover largely through either “approved plans” (i.e. group long-term insurance with pension or provident funds being the policyholder) or through “unapproved plans”.
An “unapproved” group life or disability policy is taken out by employers for the benefit of these employees (or their dependants) and can qualify as a pure risk or investment policy, or a combination of both. Each of these policies makes payment upon the happening of a “life” or “disability” event.
“Unapproved plan” premiums, on the other hand, are paid by employers because the employer is the policyholder. However, the parties to whom the proceeds are paid, may vary. The policy can be structured so that the proceeds can be paid directly to the employees (or their beneficiaries) or to the employer. If the proceeds are paid to the employer, a side arrangement usually exists so that the employer is obligated to turn over the insurance proceeds (or their equivalent) to the employees (or their beneficiaries).
On proposal is that:
In view of the above, explicit fringe benefit rules will be added for employer-provided long-term insurance. More specifically, employer premiums or similar payments made to group long-term insurance will be treated as a fringe benefit if the insurance is for the direct or indirect benefit of employees (or their dependants/nominees). Fringe benefit inclusions for these benefits will equal employer premium contributions (i.e. will be deemed to be the value of the taxable fringe benefit).
Special rules for disability:
Employer-provided disability policies will largely follow the same paradigm as unapproved group plans that protect against death. However, a long-held distinction exists between two forms of disability plans – income capacity versus income protection. Income capacity plans operate just like life plans (deductible employer premiums matched by employee fringe benefit inclusions). On the other hand, in the case of an income protection policy, the individual is incurring an expense related to the production of income with the premium being deductible by the individual (and with the payment of proceeds resulting in gross income – see drafter note on policy payouts below under “Taxation of Proceeds”).
While premiums paid by individuals for disability income protection plans are deductible if paid by those individuals for their own coverage, recent revisions to the rules for employer-provided insurance have raised questions about the impact of those rules in respect of employer-provided income protection plans. In particular, these plans seem to give rise to employer-premium deductions and employee fringe benefit inclusions. However, employees seemed to have lost the option of the deducting the premiums paid on their behalf. This option will be restored.
“Long-Term Insurance: Key Person Plan Elections”
Up until the 2010 proposals of the Tax Amendment Bill, the tax impact of key person plans depended on whether the plan was conforming or non-conforming. Employers with conforming plans (i.e. those meeting certain statutory requirements) could (and still can, until the TLAB, 2011, becomes of force) deduct the premiums in respect of those plans; whereas, no deduction was allowed for non-conforming plans. Insurance pay-outs from conforming plans gave rise to tax, whilst pay-outs from non-conforming plans were generally viewed as tax-free.
In 2010, the distinction between conforming and non-conforming key person insurance policies that provide cover against the loss of key persons was fundamentally revised. Under the revised rules (taking effect from 1 January 2011), a conforming plan contains four criteria:
1. The business must be insured against the loss of a key person by reason of death, disability or severe illness;
2. The policy must solely be a risk policy (without any cash or surrender value associated with investment policies);
3. The taxpayer must be the sole owner of the policy (setting aside the holding of technical title by creditors as collateral security); and
4. No transaction, operation or scheme may exist for the business to turn over policy proceeds (or their equivalent) to those key persons (or their beneficiaries).
On proposal are two scenario’s:
1. Plans entered into from 1 January 2012
In view of the above, taxpayers seeking an upfront deduction for key person policy plans will now have to opt into the regime (conforming treatment). Inaction will mean that the policy will remain non-conforming (despite satisfying the other objective requirements). Non-conforming treatment means that the policy will give rise to an exempt payment of proceeds at the expense of a non-deductible contribution. It is assumed that most employers will opt for inaction to obtain non-conforming treatment.
Taxpayers seeking to opt into the regime must express a choice in the policy agreement by stating that section 11(w)(ii) is intended to apply to that policy agreement. This choice is to be expressed by making this statement in the policy agreement so that the choice is clearly visible for all parties involved (including SARS). The once-off choice cannot be changed once made.
2. Pre-existing plans
Taxpayers with pre-existing key person plans have slightly different objectives. Their goal is mainly to preserve their prior position. Therefore, if a taxpayer has a policy entered into before 1 January 2012 that satisfies the post-effective date objective criteria for conforming plans, the taxpayer may similarly opt into the regime as above (even though the intention was not initially expressed at the beginning). In this scenario, the taxpayer expresses this choice by adding an addendum to the policy agreement. This addendum will state that section 11(w)(ii) is intended to apply to that policy agreement. Again, the once-off choice expressed cannot be changed once made. In addition, this choice must be expressed by 30 June 2012. Taxpayers with pre-existing key person plans without the addendum will be viewed as having non-conforming plans.
“Long-Term Insurance: Taxation of Proceeds”
There are typically two major forms of long-term insurance:
- A facility to provide risk cover (life, disability, accident, and dread disease); and/or
- An investment function (investment access into a portfolio of assets).
Therefore, a long-term policy can be either risk-based or investment- based (or a combination of both).
There are various forms in which insurance can be acquired, which range from the individual acquiring his/her own insurance, to employers acquiring insurance on behalf of their employees.
Basic common law appears to view lump sum proceeds as capital in nature, and therefore falling outside of the ordinary revenue.
From a CGT point of view, an explicit set of rules exist for long-term insurance proceeds, whereby original owners and beneficiaries are often free from CGT, whilst secondary holders being subject to CGT.
On proposal are:
Rules to cover the tax treatment of the proceeds of long-term policies.
As a general matter, proceeds received or accrued from insurers will initially be treated as ordinary revenue (subject to significant exemptions).
Application of these rules will essentially fall into the following paradigm:
- If premiums were funded with post-tax contributions, policy proceeds will be tax-free; or
- If the premiums were funded with pre-tax contributions, policy proceeds will be taxable.
The CGT will act as a residual regime and will mainly impact 2nd hand owners of long-term policies.
It is proposed that all amounts directly or indirectly received or accrued from an insurer in terms of a long-term insurance policy (risk and/or investment) will initially be included as gross income. This inclusion will typically cover proceeds payable upon the contingency of death, disability, etc…
As a side matter, this regime does not apply if the proceeds of a policy stem from group life plans associated with pension or provident fund membership. These plans are excluded because proceeds in these circumstances are taxed under the retirement tax regime (i.e. pursuant to the lump sum formula).
Proposed exemptions from gross income
Gross income falls under one of two overall exemptions – an exemption for policyholders receiving proceeds and an alternative exemption for non-policyholder beneficiaries receiving proceeds. As stated above, application of these exemptions depends on whether the policies are funded with post-tax or pre-tax contributions.
If the policyholder receives the insurance proceeds, these proceeds will be tax-exempt unless one or more premiums were deductible by the policyholder. If one or more premiums were deductible, a tax exemption may still exist, but the exemption is limited solely to the amount of the non-deductible premiums contributed.
If a beneficiary other than the policyholder receives the proceeds (either from the insurer or the policyholder), the distinction between taxable and tax-free proceeds is based on the same concepts but is slightly more complex.
Have a look at some examples:
• An individual policyholder cannot claim a deduction in respect of premiums paid on a life insurance policy. Therefore, the proceeds from these life policies will be tax-exempt.
• In the case of an individual income protection policy, the premiums paid by the individual are typically deductible. Therefore, the proceeds will be taxable.
• An employer will receive a deduction for premiums contributed in respect of an unapproved group life policy. However, the employee will be deemed to receive matching fringe benefit income in respect of the premiums. Therefore, the proceeds will be tax-exempt.
• In the case of an employer group income protection policy, the employer deducts the premiums and the employee initially has matching fringe benefit income. However, the employee will obtain a simultaneous deduction for the premiums (thereby neutralising the tax as a fringe benefit). As a result, the policy proceeds will be taxable when paid to the employee.
• The impact of policy proceeds in respect of keyperson plans is largely open-ended. The employer decides upfront whether the premiums will rank for a deduction in the case of a key person policy (refer to the drafter note on Employer Long-Term Insurance Coverage to Protect against the Loss of Key Persons). The proceeds will be taxable if the employer chooses in favour of a deduction or exempt if the employer chooses otherwise.
CGT
As under current legislation, second-hand long-term insurance policies will remain subject to capital gains tax. The intention is to continue to discourage the trade in 2nd hand policies (that is, policies purchased from or ceded to another person by the original beneficial owner).
It is now proposed that all risk policies be additionally excluded from the application of capital gains tax (including second-hand policies). The nature of a risk policy prohibits these policies from being regularly traded as a ‘second-hand’ policy because these policies do not have inherent tradable value.
I trust that the above will be of some help in understanding what the proposals are and how one should go about trying to understand the rationale thereof.
There surely will be many questions and I urge readers to also have a look at the various documents available on the websites of National Treasury and SARS as mentioned above. Where possible, please attend the public hearings on the 21st and 22nd of June, should you have serious concerns regarding any of these proposals.
Kind regards
IAN BRINK
Managing Director:
Crest Trust Services (Pty) Ltd
Tel. +27 12-643 1049
Cell +27 82 494 0097
Fax +27 86 6155 854
Skype: discotdv6
GPS site: S 25 51 48.8 E 28 11 75.4
e-mail:
ian@cresttrust.co.zaLicensed Financial Service Provider
www.cresttrust.co.za
