Life insurance policies
The holders and beneficiaries of life insurance policies enjoy various tax advantages, which are detailed below.
In terms of current practice of SARS, the proceeds of a life insurance policy are normally treated as being a non-taxable capital receipt. They will also be free of CGT if certain criteria apply.
Capital Gains Tax exemption
Any capital gain or loss in respect of a disposal of a long term policy issued by a life insurance company is exempt from CGT if it resulted in a receipt or accrual:
- To the original beneficial owner(s) of the policy;
- To the spouse, nominee, dependant or deceased estate of the original beneficial owner(s) of the policy;
- To the spouse of the original beneficial owner(s) of the policy in consequence of a divorce order;
- In respect of a company owned policy as contemplated in Section 11(w) of the Income Tax Act;
- In respect of buy and sell policies provided that no premium was paid by the taxpayer while the other person was the beneficial owner of the policy; or
- In respect of policies taken out as a consequence of a person’s membership of a pension, pension preservation, provident, provident preservation or retirement annuity fund.
Lump sum benefits from pension, pension preservation, provident, provident preservation or retirement annuity funds are also exempt from CGT.
Deductibility of premiums
Expenditure incurred in respect of premiums payable under a long-term insurance policy, of which the taxpayer is the policyholder, are deductible in terms of Section 11(w) when:
- the premium paid by the employer (the taxpayer seeking the deduction) is included in the taxable income of the employee or director of the taxpayer; or
- when all the following requirements have been met:
- the policy insures the employer taxpayer 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 or surrender value prior to the maturity date or the death of the employee or director whose life is insured under the policy;
- the policy is not owned by anyone other than the employer taxpayer at the time that the premium is paid (except in instances where the policy is held by a creditor of the taxpayer); and
- no transaction, operation or scheme exists where any amount payable under the policy (or in lieu of or equivalent to such amount) is ceded to the employee or director (or connected persons), the estate of the employee or director or to any person who is or was wholly or partly dependant on the employee or director for his or her maintenance.
The above is the result of substantial changes to Section 11(w) which are effective as from 1 March 2011 and will affect many employer owned policies such as ‘key person’, deferred compensation, as well as many unapproved (free standing) group life policies and also unfortunately group disability income policies.
Of particular concern is the effect on employer owned group disability income policies. Many aspects of the new law are still unclear and the Association for Savings and Investments (ASISA) is currently engaging with National Treasury and SARS to obtain clarity on the full impact of the changes. Under unapproved (free standing) group life policies, where the employer is the policyholder, that employer may claim a tax deduction in terms of section 11(w) of the Income Tax Act in respect of premiums paid, only if fringe benefit tax is applied to the employees on these premiums. This has in fact always been the position. The benefit paid out on death to the beneficiaries will be paid out tax-free. If fringe benefit tax is not applied to the employees, then the employer will not enjoy a tax deduction.
The change for employer owned group disability income policies is that employers must now apply fringe benefit tax on their employees in respect of the premiums paid by the employer, as from 1 March 2011. At present, the employer pays the group disability premiums in full and claims a tax deduction as an expense. But in terms of the latest amendments, the employer will only qualify for a tax deduction if the premiums are taxed as a fringe benefit in the hands of the employees.
ASISA has made representations to National Treasury that they should amend the law so as to allow a tax deduction via payroll for employees in terms of section 11(a) of the Income Tax Act, for the fringe benefit tax levied. This would align the tax treatment of the deductibility of premiums by employees with the tax deductibility of premiums that apply to individual disability income policies. Indications are that National Treasury is amenable to changing the law to allow this. These deductions may then be processed in bulk by employers on their payroll systems so that there is no financial impact on employees.
If National Treasury grants this concession, there could be a backdated reversal of this part of the legislation and employees will remain tax neutral. In the unlikely event that National Treasury does not approve this concession, then employers may have to consider an employee paid arrangement. As before the disability benefit is taxed as income when received by the disabled employee. What is not entirely clear is if the income benefits can continue to be paid to the employer, who then makes the necessary deductions and then onward pays the monthly income benefits to the disabled employee, or if the proceeds must be paid directly to the claimant. As the law now stands, it is not certain if the employer would get a tax deduction in terms of section 11(a) on the monthly benefits that are onward paid to the employee. Until written agreement is received from National Treasury and SARS, these issues will remain uncertain.
Taxation of proceeds
Where premiums were deductible, the policy proceeds are taxable in the hands of the Employer under paragraph (m) of the gross income definition. Where the policy is ceded to an employee, an amount equal to the cession value of the policy, which takes into account any latent value in the policy, is taxable in the employee’s hands. Where an employer cedes, or otherwise disposes of the policy, there is a deemed accrual in the employer’s hands.
Long-term insurance and taxation
Long-term insurers are taxed on a different basis to other taxpayers, according to Section 29A of the Income Tax Act.
Tax legislation applying to life insurers
Section 29A of the Income Tax Act provides for the so-called trustee principle of taxing accruals attributable to policies underwritten by long-term insurers.
Taxation of Long Term Insurers
This system requires policyholder assets to be allocated to one of three policyholder funds:
- The untaxed policyholder fund (which is exempt from income tax) holds assets equal in value to the insurer’s liability in respect of:
- Business conducted with and any policy of which the owner is an approved pension, pension preservation, provident, provident preservation, or retirement annuity fund.
- Any policy, the owner of which is a person or body, the income of whom or which is exempt from tax in terms of Section 10 of the Act.
- Annuity contracts.
- The company policyholder fund holds assets equal in value to the insurer’s liability in respect of policies issued to companies, close corporations and non-property unit trusts. The taxable income of the company policyholder fund is taxed at a rate of 28%.
- The individual policyholder fund holds assets equal in value to the insurer’s liability in respect of policies issued to persons other than companies, tax exempt organisations and retirement funds. The taxable income of the individual policyholder fund is taxed at a rate of 30%.
Where a trust is the policyholder, allocation to a policyholder fund will be decided by the status of the trust beneficiaries.
Accruals which are not attributable to policyholder funds are accounted for in the corporate Fund (in essence a fourth Fund), which represents the insurer’s trade income and is taxed at a rate of 28%.