Proposals to the tax treatment of individual–based insurance policies to be delayed by a year

Treasury’s decision to postpone the implementation of the individual-insurance policies tax reforms is welcomed by major stakeholders.

On Wednesday September 11, Treasury presented the draft response document to the draft Taxation Laws Amendment Bill, 2013 to Parliament's Standing Committee of Finance. "One significant proposal which drew attention was the tax treatment of individual-based insurance policies”, says Erich Bell, Tax Technical Assistant with the South African Institute of Tax Practitioners (SAIT).

"Under the current state of affairs, there are two types of disability insurance plans that are offered to individuals; capital protection plans and income protection plans. And both of these disability plans are being treated differently for tax purposes”, explains Bell.

With capital protection plans, the individual takes out cover against a loss of their income earning capacity. Typically cover is provided in the event that an individual losses a limb or becomes mentally incapacitated and the individual's ability to perform their employment duties is affected. The premiums paid on these policies do not qualify for a deduction and, similarly, the pay-outs are not taxable.

In contrast, with income protection plans the premiums qualify for a deduction and the pay-outs are taxable. "The Explanatory Memorandum on the Taxation Laws Amendment Bill, 2013 states that the key difference between the two plans is that the income protection plans focus more on the negative impact of the disability rather than the disability itself,” explains Prof Sharon Smulders, SAIT Head of Tax Technical Policy and Research.

Considering that both types of plans are aimed at providing a level of financial cover to the insured or their family in the event of death or disability, the Treasury has now proposed to treat both income protection plans and capital protection plans as the same for tax purposes. Therefore, premiums paid by natural persons in respect of life, disability and severe illness policies will no longer be deductible per se if the policies are aimed at income protection. However, all pay-outs on life, disability and severe illness policies will be tax-free, irrespective of whether the pay-out takes the form of a lump sum or an annuity.

The SAIT, through its technical committees, prepared a detailed written submission and presented it to the Standing Committee of Finance last month. "SAIT supports Treasury's proposal, since the benefits of these plans are often economically the same which makes the proposal more equitable”, says Smulders. "The proposal will also ensure that there is a greater amount of certainty, because all personal insurance cover will be treated equally for income tax purposes.”

However, it must be noted that the Institute and other stakeholders raised a number of concerns regarding this proposal, warns Bell. "The most significant concern is the fact that employees and employers would need to unwind and renegotiate all their disability policies, since they will otherwise be over-insured. This would create a very challenging administrative burden.”

During the feedback session on Wednesday in Parliament, the Treasury conceded that the renegotiation of income protection policies will be administratively difficult and consequently delayed the implementation of the proposal by one year,” according to Bell. "The effective date of this proposal will now be 1 March 2015.”

SAIT is pleased to learn that the Treasury will delay the effective date by one year. "This shows that Treasury is serious about involving all stakeholders in the legal drafting process. This helps to ensure that the economic growth of South Africa is achieved with the least amount of disruptions as possible,” adds Smulders.