Tax is an issue that financial services business leaders cannot avoid. However, given the critical role played by the financial sector to the economy, the tax practices applicable to this sector should not inhibit the same sector’s ability to perform its respective roles.
Commissioner of Insurance, Pension and Provident Funds, Tendai Karonga, examines some of the key tax challenges facing the Insurance and Pensions Industry in Zimbabwe.
Here’s a closer look at some of the key challenges:
1. Complexity of Life Income Tax Model
Generally, when the law is complex, it is costly to comply with. When it is not complex, compliance costs fall away. Complexity thus equates to money. Across the world, tax matters are generally regarded as complex issues. Unfortunately, we have to deal with them in our personal capacities as well as in business.
With the shifting of tax systems from revenue office assessment to self-assessment systems, the onus shifted to taxpayers to make all decisions on how and when transactions should be characterised and to provide the revenue authority only with the conclusions reached.
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Rather than revisiting each return and each decision, revenue authorities use various risk assessment tools to identify taxpayers most likely to have reached conclusions that differ from those the authorities would have made and re-open these assessments.
The penalty regime accompanying self-assessment regimes provide the financial incentive for taxpayers facing complex uncertainty to incur costs as needed to remove or reduce that uncertainty.
As long as the cost of compliance is less than the cost of penalties for non-compliance (after accounting for the risk of actually being caught), taxpayers will be willing to bear the compliance costs attributable to the complexity.
The complexity of the life insurance income tax model for the life insurance in the Eighth Schedule of the Income Tax Act [Chapter 23:06] may be a threat to tax compliance. The current rules lack a degree of transparency as they are based on complex formulae for determining the tax base and this only exists for tax purposes and does not easily reconcile with actual financial results.
The formula is costly to comply with, since it requires actuarial calculations. One would think it is also complex for the Tax Authorities to audit and administer. A formula that is simple and compatible with the modern trend is required.
2. Delays Owing to The Current Practice in the Administration of Tax Assessments
Ladies and gentlemen, we understand that the current practice is that whenever an individual wants to access their terminal benefits or pension benefits, the employer or the fund, whichever the case maybe, has to write to ZIMRA for tax assessments to be made.
This in some cases result in fund members/former employees facing delays in accessing their income.
It will be less onerous if taxes were to be deducted at source to expedite processing of the same benefits. This is a situation where companies/or pension funds are empowered to do the tax computation and pay the members/former employees timely and then remit the tax to ZIMRA.
ZIMRA can put in place a system to monitor compliance. Such a proposal can improve the ease of doing business on the tax front.
3. Withholding Tax on Broker or Agent Commission
The law requires insurers to withhold tax on commission for freelance agents (independent insurance brokers and agents) and remit the amount so deducted to ZIMRA by the 10th day of the month following the month in which the payment was made or within such further time as the Commissioner-General may, for good, cause allow.
Failure to comply, attracts a 100% penalty and interest at 10% p.a. However, in practice, insurance brokers or agents deduct their commission before remitting premium to the insurer and hence insurers face the risk of non-compliance or paying the tax out of their own resources.
Parties involved, therefore, need to ensure mechanisms are in place to avoid non-compliance.
4. Transfer Pricing Tax Implications
One of the key tax issues affecting the insurance and pensions industry is transfer pricing. The industry needs to acquaint itself with the provisions of the 35th Schedule of the Income Tax Act [Chapter 23:06], which requires controlled transactions to be priced at arm’s length in order to avoid ZIMRA penalties.
This affects companies, which are part of group set-ups and those that transact with related parties, including reinsurance and retrocessionaire arrangements.
Tax issues in respect of transfer pricing are more relevant to short- term insurance because life insurance is taxed based on actuarial liabilities as opposed to the transactions that it conducts.
Companies that conduct transactions with related parties must therefore have adequate documentation to prove that the said transactions were conducted at arm’s length and not used for an “artificial” increase of expenditure or “artificial” cut of incomes for tax manipulation purposes.
If not properly managed, transfer pricing can negatively influence cash flow streams through additional corporate tax imposed by the tax authorities resulting in reduced resources at hand.
Investment decisions may also be affected where a jurisdiction frequently changes transfer pricing legislation as this will bring uncertainty for multinational companies thereby compelling them to exit the host country.
Transfer pricing can involve revenue or expense adjustments, which trigger double taxation – since transactions between two related parties are not subject to the same market forces as transactions between independents, over or under-pricing can affect the allocation of tax bases among the various jurisdictions in which the group operates.
By shifting profits from one jurisdiction to another, distorted transfer pricing can expose multinational companies to double taxation if two jurisdictions involved in a cross-border transaction claim taxing rights on the same profit.
Transfer pricing can help an organisation to identify opportunities for business optimisation – transfer pricing analysis involves a deep understanding of how the group’s business works, its key value drivers, and hence could indicate ways of improvement and/or optimisation.
Transfer pricing is subject to legal requirements – more and more countries have included transfer pricing in their local legislation imposing fines, penalties, additional tax or other forms of constraints for not complying with the regulations. Zimbabwe is no exception.
Those who have a good understanding of transfer pricing implications are likely to reap the benefits and have an edge over those failing to appropriately manage transfer pricing.
Taking a proactive attitude towards transfer pricing (i.e. analyse the inter-company transactions, setting a transfer pricing policy and prepare a solid transfer pricing documentation) could bring major benefits to a business in terms of fiscal protection by ensuring a defendable position in case of a tax audit. Your rule of action should be a “CONSISTENT transfer pricing policy!”.
5. Income Tax Model of General Insurance Business: Threats and Opportunities
Technical reserves such as Unearned Premium Reserve, net outstanding claims, Incurred But Not Reported (IBNR) claims, which are actuarially determined present a source of tax compliance risk.
Generally, reserves are income tax disallowed. Only liabilities actually incurred such as net outstanding claims and Unearned Premium Reserve (UPR) are income tax deductible.
Often also insurance businesses over-tax themselves by accounting for premium on accrual basis as opposed to cash basis in accordance with tax rules.
This calls for an accounting system that is designed to provide the necessary information for tax computation and compliance purposes whilst at the same time meeting IFRS reporting requirements.
Estimates relating to expected reinsurance and non-reinsurance recoveries affect the amounts used to calculate movements in the “outstanding claims reserve” (OCR).
Treatment for financial reporting purposes of these amounts may not necessarily comply with tax authorities’ preferences. For example, an insurance company may choose to be prudent and be very conservative on the amount that it can recover from reinsurers. By so doing, the amount of tax they will be liable to pay will be lower than if they were not conservative.
6. Offshore Subsidiaries and Tax Implications
Some Zimbabwean companies have offshore subsidiaries or have intentions to invest offshore.
Either way, the advice is, “Familiarise yourself with the host jurisdiction’s tax systems before committing money”. Get expert advice where necessary to ensure compliance.
This is an extract from a Keynote Address on Financial Services and ICT Sector, given by Commissioner of Insurance, Pension and Provident Funds, Tendai Karonga at a Tax and Business Interface Week held in Harare.