Taxation of life insurance business – matching expenditure to income
Partners Life is seeking a legislative change to restore its tax position to what it was before the enactment of an amendment to the financial arrangement rules made by the Taxation (Livestock Valuation, Asset Expenditure, and Remedial Matters) Act 2013.
The submitter has proposed two ways of achieving this outcome (discussed below).
Changes made to the financial arrangement rules by the Taxation (Livestock Valuation, Asset Expenditure, and Remedial Matters) Act 2013 were directed at countering arrangements that sought to re-characterise capital expenditure as revenue expenditure using a compliance cost-savings measure in those rules. The change prevented taxpayers from making an election that an “excepted financial arrangement” is a “financial arrangement” for short-term agreements for the sale and purchase of property.
Officials had not anticipated (and could not reasonably be expected to anticipate) that the change would have an impact on taxpayers seeking to spread expenditure that would ordinarily be classified as being on revenue account, such as commission expenses incurred in relation to the sale of life insurance policies. Practice in the life insurance industry is that such expenditure is deducted in full (that is, not spread) when the expenditure is “incurred” for tax purposes. Inland Revenue accepts this practice.
Partners Life has adopted an alternative interpretation and spreads life insurance brokerage commission expenses against future premium income to better match expenditure and income for taxation purposes. A benefit of slowing the recognition of expenditure is that the taxpayer does not generate a large volume of tax losses (created when deductions exceed taxable income), when in fact in commercial and accounting terms it is profitable. This outcome is of concern when the losses could be lost through the operation of the loss continuity rules given that Partners Life is a start-up company and undertaking on-going capital-raising.
Partners Life submits that there are two options to restore its tax interpretation; either:
- restore the drafting of the relevant provision previously relied on by Partners Life to match its deduction against income – section EW 8 of the Income Tax Act 2007; or
- provide a new set of rules in the Income Tax Act 2007 that would allow, at the insurer’s election, commissions to be spread.
Officials have considered the implications of both options.
The first option is within the scope of the bill as it already contains changes to the financial arrangement rules. Given the impact the change to section EW 8 of the Income Tax Act 2007 has had on Partners Life and the fact that it was unanticipated, officials consider there is a case for restoring in some limited form the scope and application of the election permitted under section EW 8 (before it is was amended by the Taxation (Livestock Valuation, Asset Expenditure, and Remedial Matters) Act 2013), subject to some modification to deal with the base integrity concerns that officials had with the original section.
Officials recommend that section EW 8 be amended, with retrospective effect, to restore an election allowing taxpayers to treat certain “excepted financial arrangements” as “financial arrangements” on the condition that the expenditure was on revenue account (that is, it does not rely on the election allowed by section EW 8 to deem the expenditure as on revenue account). This condition is intended to address the policy concern behind the amendment made by the Taxation (Livestock Valuation, Asset Expenditure, and Remedial Matters) Act 2013.
The proposal is designed to restore Partners Life to the situation before the change. This should not be taken as a comment on the interpretation taken by Partners Life, which is a function of the application of the law to the taxpayer’s specific fact situation. The change allows Partners Life to prepare tax returns on the same basis and relying on the same statutory provisions that it used before the amendment of section EW 8 of the Income Tax Act 2007. This would be consistent with Partners Life’s financial reporting. For tax purposes, spreading brokerage commission expense is out of step with industry practice, but of itself is not objectionable from a policy perspective.
Officials have consulted with the submitter about the proposal. Partners Life agrees that the suggested solution meets the concerns raised in its submission.
There are no direct fiscal consequences arising from accepting the submission.
Officials have also considered Partners Life’s second option, which involves adding a new set of rules to the Income Tax Act 2007 to facilitate spreading life insurance brokerage commissions. Officials consider that this option, while conceptually correct, has wider implications for the life insurance industry and, in our view, is not a change that should be made without further or more considered consultation with the industry using the generic tax policy process.
That the submission be accepted. The amendment to section EW 8 made by the Taxation (Livestock Valuation, Assets Expenditure, and Remedial Matters) Act 2013 be repealed and the election permitted under section EW 8 of the Income Tax Act 2007 be restored, provided that the expenditure to be spread is on revenue account (that is, it does not rely on the election allowed by section EW 8 to deem the expenditure as on revenue account).