Short-term insurers should relook at Value-Added Tax opportunities and costs

“There are several value-added tax areas in the short-term insurance industry which can present either opportunities or risks to short-term insurers” says Dorwin Nyaga, Manager: Indirect Tax, PricewaterhouseCoopers (PwC).

One of these relates to claim recoveries and excess recoveries. In some instances, a short-term insurer may have a ‘knock-for-knock’ agreement (an agreement between motor insurers where after an accident each insurer pays for repairs to its own policyholder’s vehicle regardless of the party in fault) in place with other short-term insurers, in order to recover damages suffered by its own insured. But in cases where this agreement is not in place, it recovers from a third party or third party’s insurer.

Nyaga explains that in such circumstances, the insurer is not obliged to declare output tax on the claim recoveries received from the third party or third party’s insurer. “This is on the basis that there is no contract of insurance between the insurer and the third party or his/her insurer. Therefore, the recovery received by the insurer would not constitute consideration for a supply of services. Also, where the insurer recovers an excess amount from a third party or third party insurer, such excess recovery would not be subject to VAT as the insurer is acting as an agent of the insured. It is the obligation of the insured to account for VAT on the excess recovery where it is a VAT vendor,” says Nyaga.

Insurers are therefore advised to review their VAT systems to determine that output tax is not being declared in respect of these claim and excess recoveries. And where output VAT has been mistakenly declared, the insurer may apply for a refund from SARS retrospectively for a period of five years.

Nyaga cautions that while VAT declarations may not be required in respect of these third party recoveries, the insurer should ensure that VAT is declared in relation to claim recoveries from local reinsurers and also on salvage recoveries.

A second focus-area relates to third party claim payments – being where the insurer is now the one paying a third party or third party insurer. The insurer should ensure, in this scenario that it deducts input tax on the payments made, as the payment constitutes an indemnity payment as it is in respect of a settlement of a claim. Nyaga says that where the insurer does not claim the input tax within the five-year prescription period, the input tax would regrettably then not be recoverable, creating a burdensome and additional tax cost to the business.

Another area of relevance is that of car hire and temporary accommodation. Often, an insured may require temporary means of transport or accommodation while damaged vehicles or homes are under repair. Nyaga says, “The question here is whether the insurer can recover input tax in respect of the car rental or accommodation costs incurred as the general principle in the VAT Act is to prohibit recovery of input tax on expenses relating to car hire and accommodation (i.e. entertainment).”

Where the insured is paid a sum of money by the insurer, in respect of car rental or accommodation, and where such payment is covered by the policy agreement, the insurer is entitled to an input tax deduction on such payment.

However, if the insurer hires the car or accommodation for use by the insured, input tax may not be claimed as VAT law specifically restricts recovery of input tax in respect of car hire and accommodation. This approach is further supported by the argument that the supply in this instance is made to the insured at the expense of the insurer, and is not on-supplied to the insured.

Nyaga concludes, “Short-term insurers should be examining their VAT treatments, with regard to all these issues, as non-compliance could mean penalties of up to 200% plus interest. However, they may pleasantly find they are allowed to claim for taxes not previously claimed or erroneously paid over – and they may do so retrospectively for a period of five years. With cash flows and cost savings under the spotlight in these tough economic conditions, insurers should seek out savings where possible and avoid unnecessary penalties.”