By Straton Makundi
Introduction
The International Accounting Standards Board (IASB) issued IFRS 17 Insurance Contracts which is effective for annual reporting periods beginning on or after 1 January 2023. Earlier application was permitted provided IFRS 9 Financial Instruments was also applied. IFRS 17 replaces IFRS 4 which was an interim insurance standard.
i) IFRS 17 Accounting Requirements
Unlike under IFRS 4, where insurance revenue was equal to the premium received in the period, IFRS 17 recognises revenue from a group of insurance contracts over the period an entity provides insurance contract services and is released from risk. IFRS 17 also requires recognition of losses immediately when a group of contracts becomes onerous (loss making).
ii) IFRS 17 Impact to Banks
IFRS 17 is applicable to Tanzanian banks with significant insurance operations. Also some banks issue financial guarantee contracts compelling them to compensate the contract holders for losses incurred due to a debtor failing to make loan payments when due. These contracts meet the definition of an insurance contract if the insurance risk transferred is significant e.g. those not backed up with collateral.
Tax Implications of IFRS 17 to Insurers, Banks and the Government
i) Current Tax Treatment of Insurance Business under ITA
Section 58 and 59 of the Income Tax Act (ITA) provides the basis for calculating taxable profits for insurance companies and separates them into Life and Non-life businesses. Non-life businesses are taxed on gross premium and other income earned. Tax deductions are allowed for reinsurance expenses, reserve for unexpired risks, claims and outgoings. Premiums and claims are not in the scope of corporate tax. This is to ensure consistent with broad, overall government policies e.g. where retirement savings and pensions are subject to special rules (e.g. preferential tax treatments), similar rules apply to life insurance.
ii) The Tax Implications of IFRS 17
Insurers and Banks affected by IFRS 17 should assess the impact of the standard on current income tax charge and deferred tax. The Government should also review the standard to align it with the ITA. Specifically the following are areas to pay attention.
a) Revenue Recognition Impact
There is a need to amend the Income Tax Act to take into account changes in IFRS 17 for non-life businesses, to allow income tax to be determined using insurance revenue instead of the premium income as it is now the case under the Income Tax Act. Insurance revenue should now cover both premium amortized for the period for the PAA and Contractual Service Margin (CSM) amortized for the period for the non-life contracts measured using the general measurement model. The taxation of life insurance business will not be affected as premiums are not recognized as taxable income for life insurance under ITA.
Also, as IFRS 17, requires recognition of losses immediately when a group of contracts becomes onerous (loss making), there is a need to amend the laws so as the losses may be tax deductible for non-life insurance. The best option will be for the CSM amount to be taxed as it is released into the income statement and for the onerous losses to be tax deductible on recognition for non-life insurance. This may result into a deferred tax liability.
b) Tax Impact of Transition from IFRS 4 to IFRS 17
Initial implementation of IFRS 17 will require insurance entities to make estimates for previous accounting periods as well as the current period as IFRS 17 is applied retrospectively, unless impracticable, in which case a modified retrospective or fair value approach may be utilized. Items in the opening balance sheet and comparative information will need to be restated. The amount of profits previously recognized in retained earnings for contracts issued before transition that will still be unearned at the time of transition should be included in the CSM and realized over future accounting periods. Thus profits previously recognized for income tax purposes based on financial statements prepared under IFRS 4 could be subjected to tax again under IFRS 17 through the recognition of the CSM in future years’ accounting net income. There is a need for ITA to be amended to protect taxpayers from the effects of any loss restriction.
iii) The Need Review Tax Laws when there are Changes in Accounting Standards
There is a need to regularly review tax laws when there are changes in accounting standards as they may affect tax accounting. For instance, there may a need to amend the ITA to define what is an insurance company for the purposes of Section 58 and 59 which may be different from the current definition regarding insurance revenue and the scope of the law regarding several entities with significant insurance operations.
Mr. Makundi is a Partner with Auditax International