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Category Life Insurance

Section 11(w): Contingent Liability and Key Person insurance

23 July 2012 Lynette Gous: Legal Consultant at Allegiance Consulting and Anne-Marie Gous, Business Development Manager at Glacier by Sanlam
Anne-Marie Gous, Business Development Manager at Glacier by Sanlam

Anne-Marie Gous, Business Development Manager at Glacier by Sanlam

Lynette Gous:  Legal Consultant at Allegiance Consulting, Glacier by Sanlam

Lynette Gous: Legal Consultant at Allegiance Consulting, Glacier by Sanlam

Contingent liability insurance refers to a policy taken out by a business on the life of an employee or director who stands surety for the debts of the business. The amount of cover taken out should be equal to the loan amount.

When starting up, a business often needs to make a loan to cover start-up expenses and the owner stands surety for the loan in his personal capacity. For a business owner in this particular position, contingent liability insurance is essential to protect his new business and his family (usually the beneficiaries of his estate). In the event that the owner dies before the loan has been settled, the creditor has the right to claim the outstanding debt from the owner’s estate, of course at the expense of the owner’s heirs. The estate may in turn claim the outstanding amount from the business, which may force the business to sell its assets and even face liquidation in extreme circumstances.

Protection against contingent liability ensures that the outstanding loan amount is repaid in full, which means that the owner’s estate is absolved from further liability and the business is not placed under undue financial strain.

Section 11(w) of the Income Tax Act, which deals with premium deductibility, has changed so often that it’s left many of us confused, and some of us simply annoyed. The Association of Savings and Investment South African (ASISA) has intervened on behalf of industry members and has had frequent discussions with National Treasury regarding the new tax regime. They have subsequently issued a notification to members, clarifying the matters surrounding section 11(w).

In essence, the notification states that premiums for contingent liability policies are no longer tax deductible (these are seen to represent a capital expense).

The Sanlam Group has decided to follow the safest route with regard to section 11(w), as National Treasury has made it clear that members who are found to still sell contingent liability plans after 1 March 2012 on a tax deductible basis should regard themselves as “on notice”.

With immediate effect, the Sanlam Group will no longer issue tax-deductible contingent liability policies. Premium-deductible contingent liability policies issued since 1 March 2012 will retain their deductible status – bearing in mind that SARS may disallow the deduction for an employer if it finds that it covers a capital expense. Policies issued before 1 March 2012 will no longer retain their deductible status.

ASISA points out the positive side: Making the premiums of these policies deductible means that the proceeds are taxed. This necessitates an increase in the amount of cover in order to ensure that the insured ends up with the correct amount post-tax and this is often not in the client’s best interest.

Key Person Insurance

The loss of a key person (an employee or director) through death, disability or serious illness may have a huge impact on a business. It is for this reason that key person insurance is required - to provide a financial buffer for a business against the loss of such a valued individual.

Where premiums on key person insurance policies fall within the scope of section 11(w)(ii) a tax deduction will be allowed. The requirements are:

(i) The business is insured against any loss by reason of the death, disablement or severe illness of an employee or director;

(ii) The policy is a pure risk policy with no cash or surrender value;

(iii) The policy is not owned by a person other than the business at the time of payment of the premium; and

(iv) In respect of a policy entered into:

a. On or after 1 March 2012 the policy agreements stipulate that this section applies; or

b. Before 1 March 2012 it is stated in an addendum by no later than 31 August 2012 that this section applies.

For premiums paid in relation to a key person policy issued after 1 March 2012 to be tax deductible, section 11(w)(dd)(A) requires that such a policy must clearly state that section 11(w) applies to the policy. This will ensure that the tax deduction of premiums is allowed by SARS. Where the policy was, however, taken out before 1 March 2012, section 11(w)(dd)(B) requires that an addendum to the policy must be made by no later than 31 August 2012 to ensure the premiums are tax deductible. If this deadline is not met, premiums paid after 1 March 2012 will not be deductible.

In summary:

Type of risk

Premiums

Proceeds

Contingent liability

Tax deduction not allowed.

The proceeds will be included as gross income in terms of paragraph (m). The income will, however, be exempted in terms of section 10(1)(gH) and thus the proceeds will not be taxable.

Key Person

The business has a choice. After 1 March 2012 it may elect to deduct or not to deduct the premiums. If an election is made to deduct the premiums, then the life assurer must insert a statement referred to in section 11(w)(ii)(dd). In relation to policies entered into before 1 March 2012, an addendum with this statement has to be included before 31 August 2012.

The proceeds will be included as gross income in terms of paragraph (m). If the business elected not to deduct the premiums, then the income will be exempted in terms of section 10(1)(gH). The proceeds will be taxable if the business elected to deduct the premiums. Provision has to be made for the income tax payable and possibly estate duty as well when calculating the sum insured in this instance.

Please contact your Glacier representative for more information.

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