The International Accounting Standard Board recently issued IFRS 17 titled “Accounting for Insurance Contracts”, which establishes principles for the recognition, measurement, presentation and disclosures of insurance and reinsurance contracts issued and held by entities. The standard, like IFRS 4, focuses on types of contracts rather than types of entities and hence, generally applies to all entities that write insurance contracts. The adoption of IFRS 17, is a most significant change in financial reporting for insurers. A short snippet on the differences between IFRS 17 and IFRS 4 from a financial reporting perspective shows that under IFRS 4, entities were free to derive their own interpretations of revenue recognition and calculation of reserves. For example, it was at the discretion of the companies to include risk adjustment in the liabilities under IFRS 4, whereas it is now mandatory under IFRS 17. Also, under IFRS 17, insurers need to assess if a policy holder can benefit from a particular service as part of a claim or irrespective of the claim/risk event.
Before we delve into discourse of determination of the tax liability under IFRS 17, there is need to take a short glance on the current income tax reporting system in Zimbabwe. In general, the tax liability for all other businesses is determined by making a few tax adjustments to the accounting profit determined using the applicable International Financial Reporting Standards. In other words, the tax computation is based on the accounting matching concept, subject to a few adjustments required for tax purposes. However, for insurance business the tax system is sightly divorced from accounting matching concept. Taxation rules for insurance business are ring fenced to the rest of other businesses and are in terms of s 20 as read with 8th Schedule to Income Tax Act (ITA). The same Act also provides for separate taxation rules for taxation of life insurance business which are different from rules for short term insurance contracts. Taxation of the short-term insurer is based on cash basis namely premium and other incomes received plus recoveries +/ (-) unexpired risk reserve (URR) LESS claims incurred, reinsurance premium paid, and operating expenses incurred. Whereas the income tax liability of a life insurance is based on actuarial liabilities that is average life actuarial liabilities multiplied by Internal Rate of return on investment (IRR) Plus/(Minus) profit/(loss) on sale of Zimbabwe investments LESS allowance for investing in prescribed asset. The critical question is whether IFRS 17 would warrant a revisit of the tax principles for insurance business for any alignment needed.
IFRS 17 replaced IFRS 4 and established new principles for entities to account for insurance contracts. It significantly altered the measurement of income from insurance contracts, particularly those that relate to life and other long-term insurance contracts. Under IFRS 17, reserves will continue to be determined actuarially when insurance contracts are sold. However, IFRS 17 introduced a new reserve, the contractual service margin (CSM), which represents a portion of the profits on underwritten insurance contracts that is deferred and gradually released into income over the estimated life of the underlying group of insurance contracts. Essentially, insurance revenue will now be reported on the basis of what has actually been earned or received during the period. The question is these measurement changes would also have an impact on the taxation of insurance contracts going forward?
The approach advocated by IFRS 17 appears to align the accounting treatment of short-term insurance to tax principles for insurance businesses as contained in the envisaged 8th Schedule to the Income Tax Act. This is critical in the computation of short-term insurance business’ tax liability going forward as it would mean there will be no need to adjust accounting profit with the outstanding premium debtors or reinsurance creditors. Reserve for future risks will now be reported as a single line item called liability for remaining coverage (LRC) and the reserve for past risks (comprised of IBNR, IBNER, NOC etc.) will now be reported as one line item called liability for incurred claims (LIC). The changes envisaged will result in the disappearance of unexpired risk reserve (URR) a critical adjustment in the determination of income tax liability of a short-term insurer, but otherwise the taxation of short-term insurance will remain the same. In application, one will have to remember that though they cannot get the URR, these have been incorporated in the LIC. From life insurance perspective, nothing has changed other than the fact that liabilities will be measured differently. Applying the current formula for taxation of life business as per 8th Schedule of the ITA, this may result in a very different profile of tax payment to ZIMRA from the industry. There may be a need for the Authority to revisit the rules in the 8th schedule to verify if they are still achieving the same goals i.e., if they are still taxing the same tax profile using the new terms and measurements methods brought about by IFRS 17.
A move to IFRS 17 demands a revisit by the government of terminology as per current Income Tax Act for alignment. In fact, income tax rules of the insurance sector, which remained constant since 1967 despite demutualisation of the sector in the 1990s, introduction of new and hybrids products, changes in the trading rules etc, requires a major overhaul. Short term insurers in the interim should be able identify the component of unexpired risk reserve within liability for remaining coverage so that they continue to enjoy this tax incentive.