Challenges in the taxation of insurance companies
Income taxation of companies in Nigeria is imposed by the Companies Income Tax Act 2007 (as amended). Section 16 of this Act provides guidelines for the taxation of life and non-life insurance companies in Nigeria. Unfortunately, the current tax regime in Nigeria appears to be unduly unfair to insurance companies when compared with other companies in the financial service sector (such as banks). A review of the fiscal policies guiding the insurance sector is necessary to fasttrack the development of the sector, as this will bring equity so that insurance companies can compete adequately within Nigeria and eventually with insurance companies in other emerging markets. The issues with the current tax legislation is analysed below.
- Restriction on carry forward of tax losses Section 16(7) of CITA places a limit of four years on insurance companies to carry forward their tax losses.
Through amendments made in 2007, other companies (including banks) can carry forward their tax losses indefinitely until they can be utilised against taxable profits. However insurance companies can carry forward their tax losses for four tax years (i.e. years of assessment). There is no obvious reason for the restriction of carry forward of tax losses for insurance companies since historically, insurance companies have not been the most profitable in the financial services industry. Therefore, the country will not be losing any significant tax revenue from removing this restriction compared to the social and economic benefits to be derived if the insurance companies are encouraged to thrive.
The risk-taking nature of insurance business as well as the stage of development of the insurance sector warrants insurance companies to be able to take the tax benefit from their losses indefinitely similar to the allowance granted to other companies.
- Cap on deductions for unexpired risks
The unexpired risk reserve is required to cover the claims and expenses that are expected to emerge from an unexpired period of cover. As long as the period of insurance cover has not expired, companies are required by the Insurance Act to anticipate and make a reserve for possible claims against premiums received. Section 16(8) (a) of CITA stipulates a cap on deductions for reserves, claims and outgoings for general insurance business. It limits the amount of deduction for unexpired risks to 25% of total premium for marine cargo and 45% of other classes of general insurance business. This is inconsistent with Section 20(1) (a) of the Insurance Act which prescribes time apportionment as a basis for determination of the provision of unexpired risks. Also, IFRS 4 paragraph 15 requires an insurer to assess at the end of each reporting period whether its recognised insurance liabilities are adequate, using current estimates of future cash flows under its insurance contracts. The Solvency II framework which represents best practice in the global insurance sector recommends that technical provisions be determined as a discounted best estimate augmented by a risk margin.
While insurance companies are restricted under Section 16(8) of the CITA to take a deduction, banks and other financial institutions are allowed in practice to deduct similar liabilities imposed under their regulations as specific provisions. The insurance sector should work with the Federal Inland Revenue Service (FIRS) to remove this restriction from the law so that insurance companies can compete more favourably in the global market.
- Minimum taxable profit
Section 16(8) (b) limits the deduction allowed for an general insurance company such that after the deductions are made and capital allowances claimed, there will be an amount of “not less than 15% of taxable profit for tax purposes”. This phrase means nothing and has been redundant since its introduction in 2007. It has been rightly ignored by insurance companies in respect of their general business. It should therefore be deleted due to the confusion it could create. Section 16(9)(b) suggests that after all limited deductions have been granted to life insurance companies, the company must have 20% of its gross income available as taxable profit. This is a type of minimum tax provision different from the general minimum tax provision in Section 33(1) of the CITA which is computed roughly as 0.5% of the higher of a gross profits, net assets and paid-up capital plus 0.125% of turnover above N500,000. This effectively means that life insurance companies are almost always subject to a higher basis of minimum tax compared to other companies, including banks and financial institutions. The restriction on minimum taxable profit for life insurance companies creates a competitive disadvantage and therefore should be removed through a legislative change.
- Earned investment income for life insurance business for tax purposes
Under Section 16(5)(b) of the CITA, the income of a life insurance company which are subjected to tax include the whole income and other incomes. This raises an ambiguity on whether income earned from investment of life policy holders’ funds and annuities are taxable, even though these funds include undistributed amounts that would only be distributed upon maturity of the policy. Due to the nature of life insurance business, it is logical for investment income from such policy holder funds and annuities to be taxed only to the extent that they are distributed during the year. The provisions of Section 16(5) will therefore need to be amended to reflect this deferral and to remove the ambiguity.
- Payment of value added tax (VAT) on commissions paid Another challenge faced by insurance companies in Nigeria is the practice of the FIRS requiring insurance companies to account for VAT on commissions paid to brokers and agents. Based on the VAT Act, all companies are only required to charge and pay VAT on their output or supplies, except in a few instances such as oil and gas companies that account for VAT on their input or purchases. In this regard, an insurance company is required to charge and remit VAT on their commissions earned and have no legal requirement to account for VAT on commissions paid. Any insurance company that goes the extra mile of deducting VAT on commissions paid is simply doing the FIRS a favour. However, there should be no exposure for the company if it accounts for VAT on only its commissions earned. It would appear that a requirement for insurance companies to account for the VAT on behalf of its brokers and agents only exist because the insurance companies are easier targets for revenue collection than broker/ agents who may not be properly registered for taxes. However, there must be a legislative mechanism for the FIRS to impose this additional obligation on the insurance companies. A way forward will be for the key stakeholders in the insurance sector to have discussions with the tax authority, agree on a position based on the realities of the current business model and propose the required legislative change.
We are strong believers in the growth prospects of the insurance sector in Nigeria. Its enormous potential however requires growth focused economic and fiscal policies to be unleashed. The government and regulatory bodies should also be engaged by industry stakeholders to consider tax incentives which will deepen the market for performing insurance companies e.g. companies that pay a minimum percentage of claims submitted for processing while concerted effort is made to educate the public on the immense benefits of insurance in this age.