The Insurance industry is a very important part of any economy as it generally acts as a shock absorber for businesses. Insurance is a key risk management tool which enables businesses hedge against the potential risk of a loss. This helps to reduce uncertainties and improves the chances of survival for businesses. In addition to protecting businesses from risks, the Insurance industry also contributes to the economic development of a country by guarantying stability, generating long-term financial resources for investments and encouraging a savings culture.
Unfortunately, the Nigerian Insurance industry has not performed optimally thereby denying the country the above benefits. The level of investments in the sector is inadequate as the insurance penetration rate is still below 1% compared to the penetration rate of about 16% for South Africa. In terms of GDP contribution, the sector accounts for less than 1% of Nigerian GDP while in South Africa, it accounts for 17% of the GDP. Hence, there is room for substantial growth in the industry and efforts should be made to attract the much-needed investments.
While there are myriads of factors adversely impacting the industry, one of the major challenges is the unfair tax regime under which the Nigerian insurance businesses are taxed. The existing tax framework is discriminatory and non-neutral, thereby making the industry quite uncompetitive compared to their counterparts in their financial services industry and other jurisdictions.
The importance of tax neutrality
There is a positive correlation between the level of tax neutrality and inflow of investment, as it reflects the level of competitiveness of an economy. If due to distortions in the tax system, economic decision makers view an industry/jurisdiction as tax advantageous compared to another industry/jurisdiction, investments will be directed away from the unfavorable industry/jurisdiction, thereby leading to stunted growth. This explains the current effort by various international organizations to achieve tax neutrality in the taxation of capital, consumption and income in cross border transactions.
Taxation of insurance businesses in Nigeria
In Nigeria, insurance businesses are licensed as General Insurance, Life Assurance or Reinsurance business. The major income of an insurance business is the premium paid by the insured entities. Aside the normal business expenses which are deductible from income, insurance companies are required to make provisions for certain technical reserves such as; unearned premium, unexpired risks, outstanding claims, claims incurred but not reported, contingent and statutory reserves prior to determining the net profit for the period.
Section 16 of the Companies Income Tax Act (GITA) provides for the taxation of insurance businesses in Nigeria. The section requires that the insurance companies should file separate tax returns for each class of business, in line with the provisions of the Insurance Act which requires separate books of account to be kept for each business. Consequently, composite insurance companies are required to file two separate tax returns; one for Life and the other for the General business.
Restriction of deductible expenses
Based on the GITA, the determination of taxable profit for a General Insurance business requires that allowable deductions are restricted to 25% of the total premium for the period. This contradicts the provisions of Section 24 of CITA which provides that all expenses that are wholly, reasonably, exclusively and necessarily incurred for a business should be deductible. This unfair provision restricts the deduction of validly incurred expenses and puts insurance businesses at a disadvantage when compared to businesses in other industries that are allowed to fully deduct their expenses. The impact of this provision is that insurance companies are unable to deduct critical business expenses such as claims, business acquisition and maintenance expenses, as well as technical reserve, which they are legally required to be provided for in their books.
Special minimum tax regime
CITA provides for a special minimum tax regime, for both general and life assurance businesses which is quite different from the minimum tax applicable to businesses in other industries. Specifically, Section 16 of CITA, requires insurance companies to have a minimum total profit of 15% of total premium earned and 20 % of gross income for general and life businesses, respectively. This results in a minimum turnover tax of 4.5% and 6%, respectively, when the 30% income tax rate is applied. This is quite excessive when compared to the minimum tax rate for other companies.
Restriction on carry forward of tax losses
The period for carrying forward unrelieved tax losses of insurance companies is currently restricted to four (4) years. A similar provision which used to apply to companies in other industries was expunged in 2007, but this was inadvertently retained for insurance companies. The current CITA Amendment Bill before the National Assembly (NASS) seeks to, amongst other things, eliminate this provision. However, the Bill is yet to be considered by the NASS and ii is unclear when it will be given become effective.
Practices in other jurisdictions
A review of the taxation of insurance companies in other jurisdictions show that they do not suffer such discriminatory provisions as their Nigerian counterparts. None of the jurisdiction reviewed restricts expenses in the manner prescribed in Section 16 of CITA.
In the United Kingdom for example, the deduction of expenses by Insurance businesses follow the general rule of tax deductibility. Business acquisition expenses and provisions for technical reserves such as; unearned premium reserve, outstanding claims, claims incurred but not reported and unexpired risk are generally tax deductible. Additional measures introduced through the General Insurers' Technical Reserves (Appropriate Amount) (Tax) Regulations 2009 requires the companies to give a confirmation to Her Majesty's Revenue and Custom that the provisions made in the accounts are not excessive. The confirmation is supported by an opinion in writing from an actuary or any other suitably skilled person.
Similarly, in South Africa, the deduction of expenses by General Insurance businesses also follow the general tax deductibility rules. Provisions for technical reserves are all allowable tax deductions. Technical expenses such as acquisition expenses and loss adjustment expenses incurred in relation to the insurance business are all allowed as tax deductible. Losses of previous periods are allowed to be relieved against current profit indefinitely and no minimum tax provision applies to companies in the sector.
The Nigerian insurance industry needs to attract the desired level of investments to maximize its potential and be in a position to play its vital role in supporting the rest of the economy. This can only be achieved if the industry can be made very competitive by addressing the myriad regulatory challenges affecting the industry. It is important that the persistent tax issues hampering the development in the industry are urgently addressed such that the tax regime is not discriminatory. The laws governing the taxation of the industry should be urgently reviewed to reflect international industry best practice for taxation.
Originally published by Business Day, 25 September 2018.
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