Value-Added Tax
1306. Insurance premiums and payments received under a policy of insurance
June 2005 – Issue 70

 

 

Introduction

Most businesses probably deal with the VAT paid on premiums due under short-term insurance policies correctly, but often overlook how VAT must be accounted for in those cases where a payment is received from the insurance company as a result of an insurance claim that is settled. It is appropriate to consider briefly the rules pertaining to the deduction of input credits paid on insurance premiums as well as the obligations facing business in respect of payments received under an insurance policy.

 

Premiums payable under a long-term insurance policy

It must be remembered that, in accordance with section 2 of the Value Added Tax Act No. 89 of 1991 (the VAT Act) the premiums paid under a long-term insurance policy are regarded as a financial service and are thus exempt from VAT. Section 2(1)(i) of the VAT Act includes in the definition of "financial services":

 

"The provision, or transfer of ownership, of a long-term insurance policy or the provision of re-insurance in respect of any such policy: Provided that such an activity shall not be deemed to be a financial service to the extent that it includes the management of a superannuation scheme;"

 

Thus, any premiums paid by a business over the lives of the directors or employees will be exempt from VAT, with the result that no input credit will arise on the premiums paid under such a policy. If the business receives a payment under a long-term insurance policy as a result of the death of an employee or director, such payment will not attract VAT as is the case with short-term insurance policies.

 

The nature of the policy concluded will also determine the deductibility or otherwise of the premiums paid for normal tax purposes. If the policy is one that conforms to section 11(w) of the Income Tax Act No. 58 of 1962 (the Act) the business will generally be entitled to claim as a deduction the premiums paid under the policy. In the event that a payment is received under the policy the proceeds will belong to the business and will be subject to normal tax. Where a second-hand policy has been acquired by a taxpayer as an investment, the proceeds received thereon, on the part or full surrender or disposal of such a policy will not give rise to VAT. This is because such disposal will fall into the definition of financial services contained in section 2(1)(i) of the VAT Act. The business will in such a case be liable, so long as it can show that the gain arising on the policy is capital in nature, to Capital Gains Tax (CGT) in accordance with the rules contained in the Eighth Schedule to the Act.

 

VAT payable on premiums due under a short-term insurance policy

Where a vendor registered for VAT purposes insures the business assets and pays premiums of insurance the VAT paid thereon will generally be recoverable under the provisions of the VAT Act.

 

Where, however, the business is engaged in rendering both taxable and exempt supplies it will be necessary to apportion the VAT on the insurance premiums and indeed other expenditure in order to determine what portion of the VAT paid can be recovered.

 

An example would be a business that owns a building that comprises both residential accommodation and commercial premises. The VAT due in respect of the insurance of the residential accommodation will not be recoverable in that the provision of residential accommodation is exempt from VAT under the provisions contained in section 12(c) of the VAT Act. However, the VAT payable on the insurance attributable to the commercial accommodation, such as shops and offices, will be recoverable under the provisions of the VAT Act.

 

Section 17(2)(c) of the VAT Act prohibits as a deduction any input tax incurred in respect of the acquisition of motor cars owned by the business, other than a business that is engaged in the continuous and regular supply of motor cars, whether by way of sale or under an instalment credit agreement or companies engaged in the renting out of cars.

 

However, the VAT incurred in respect of repairs and maintenance, general running costs of the vehicle such as insurance, tyres, servicing etc are recoverable and do not fall within the prohibition contained in section 17(2)(c).

 

Section 17(2)(a) prohibits as a deduction, those amounts of input tax incurred in respect of goods or services acquired that constitute entertainment. In principle therefore, any VAT incurred in respect of insurance premiums paid to cover catering equipment and a kitchen owned by a business which supplies meals to the vendor’s staff or clients is similarly not recoverable for VAT purposes.

 

The definition of enterprise was amended with effect from 1 January 2001 to specifically include therein:

 

"the activity of underwriting insurance business by Underwriting Members of Lloyd’s of London, to the extent that contracts of insurance are concluded in the Republic, shall be deemed to be the carrying on of an enterprise".

 

Prior to that amendment it was possible to argue that premiums of insurance paid were not subject to VAT in South Africa because they were underwritten by members of Lloyds. Where the contracts of insurance are concluded in South Africa with members of Lloyds, they will in principle attract VAT on the grounds that the conclusion of such contracts of insurance are specifically regarded as the carrying on of an enterprise in South Africa.

 

Payments received under policies of insurance and the VAT payable thereon

Businesses are at some stage more than likely to be audited by the Commissioner: SARS to ensure that they have complied with their obligations contained in the VAT Act. One of the areas that attracts attention and is often overlooked by a business is the VAT consequences arising on payments received as a result of a claim lodged under a short-term insurance policy.

 

Section 8(8) of the VAT Act provides as follows:

 

"For the purposes of this Act, except section 16(3), where a vendor receives any indemnity payment under a contract of insurance or is indemnified under a contract of insurance by the payment of an amount of money to another person, that payment, or indemnification, as the case may be, shall, to the extent that it relates to a loss incurred in the course of carrying on an enterprise, be deemed to be consideration received for a supply of services performed on the day of receipt of that payment or on the date of payment to such other person, as the case may be, by that vendor in the course or furtherance of his enterprise: Provided that this subsection shall not apply in respect of any indemnity payment received or indemnification under a contract of insurance where the supply of services contemplated by that contract is not a supply subject to tax under section 7(1)(a): Provided further that this subsection shall not apply in respect of any indemnity payment received by a vendor under a contract of insurance to the extent that such payment relates to the total reinstatement of goods, stolen or damaged beyond economic repair, in respect of the acquisition of which by the vendor a deduction of input tax under section 16(3) was denied in terms of section 17(2) or would have been denied if these sections had been applicable prior to the commencement date."

 

Thus, in the event that a business claims under a policy of insurance as a result of a fire and receives an amount from the insurance policy for loss of profits or in respect of stock that was damaged and the business assets lost (excluding the total reinstatement of goods where input tax was denied) the vendor has an obligation to account for VAT on the amount received under the contract of insurance.

 

Thus, in the event that the business receives an amount of R1 million from the insurance company in settlement of the aforementioned types of loss, the business is obliged to account for output tax in the amount of R122 807, that is R1 million x 14/114.

 

Where, for example, the business received a payment of R200 000 in settlement of damages suffered to a motor car as defined in the Act no output tax is required to be accounted on the amount received by virtue of the fact that the business was unable to recover the input tax incurred when the motor car was first acquired by the business.

 

The output tax is required to be accounted for in the correct VAT period under the general rules contained in section 9 of the VAT Act dealing with the time of supply. Generally, the time of supply shall be deemed to take place at the time an invoice is issued by the supplier for the recipient in respect of that supply or the time any payment is received by the supplier in respect of that supply, whichever time is earlier. Thus, where the business receives the consideration from the insurance company and no invoice is issued, or the invoice is issued at the same time as payment is made to the vendor, the vendor will be required to account for the output tax in the period in which the date of payment falls.

 

Completion of VAT return

Amounts received under a short-term insurance policy that are subject to VAT must be reflected on the VAT return in part A of the return dealing with the calculation of output tax. According to the SARS VAT Guide for vendors, VAT 404, payments received under insurance policies should be reflected at block 12, that is the section marked "other" in the VAT return. The payment received from the insurance company does not arise from the sales of goods in the ordinary course and must therefore be shown separately on the VAT return at the part indicated.

 

Reinstatement of goods

The vendor is only required to account for output tax where they receive an indemnity payment from the insurer directly or where the indemnity payment is made to a third person.

 

Where, however, the insurer chooses to replace stock that was damaged in a fire, the insured is not required to account for output tax thereon as such replacement of stock does not constitute an indemnity payment as envisaged in section 8(8) of the Act.

 

The Commissioner previously indicated by way of a commentary on VAT dealing with deemed taxable supplies as follows:

 

"Where the indemnification of the insured taxpayer by way of a replacement of goods or by way of a means other than a payment of money to him by the insurer, no liability for output tax will arise in the hands of the vendor insured."

 

Thus, in the event that the business suffers a fire and the insurer chooses to settle the insurance claim by replacing the destroyed trading stock, no output tax will be required to be accounted for as no indemnity payment is received. The replacement of the stock will not give rise to output tax becoming payable by the insured.

 

Conclusion

Businesses need to remember that the input tax payable on insurance premiums due under short-term insurance policies can, generally, be recovered under the VAT Act. However, when a payment is received under the insurance policy as a result of an insurance claim, output tax may be accounted for on those assets for which input tax was recoverable. VAT will always be payable on compensation received in money from an insurance company in respect of loss of profits and similar losses. The failure to properly account for the output tax on insurance payments received can give rise to interest and possibly additional tax where these amounts are identified by the Commissioner on an audit conducted on the vendor’s affairs.

 

Edward Nathan (Pty) Ltd

 

VAT Act:S 2(1)(i);

VAT Act:S 8(8);

VAT Act:S 9;

VAT Act:S 12(c);

VAT Act:S 16(3);

VAT Act:S 17(2)

 

IT Act:S 11(w)