If risk is like a smouldering coal that can spark a fire at any moment, then insurance is our fire extinguisher. The institution is as old as human existence with the first insurance policy being written in ancient times on a Babylonian obelisk monument with the code of King Hammurabi carved into it. It was practiced by early Mediterranean sailing merchants and Chinese traders who sought methods to minimise risks.
The concept of insurance has expanded and become more refined over the ages, its successes and travails have become more symmetrical to a country’s economic growth (or lapse). Because of the peculiarity of insurance and its relevance to an economy, the Nigerian government has put a lot of effort into making the insurance industry what it is today. These efforts are showcased by the implementation of numerous Acts over the years such as the National Insurance Commission Act 1997 and the Nigerian Council of Registered Insurance Brokers Act 2003 (which is to ensure the proper administration and functioning of the insurance sector), as well as the passing of several reforms.
However, amendments made in the Companies Income Tax (Amendment) Act 2007 (CITA) have created changes within the sector that have led to an unwelcome higher tax burden for insurance companies, which has in turn led to a fall in the number of businesses operating in the industry.
Nigeria’s insurance sector has undergone two rounds of recapitalisation over the past 14 years to restructure a company's debt and equity mixture, most often with the aim of making a company's capital structure more stable.
The first round of recapitalisation happened in 2003 when the Insurance Act was passed, which required insurance companies to increase their capital bases from:
- NGN20 million ($65,000) to NGN150 million for “life businesses”, which are companies that protect against the loss of income that would result if an insured individual died. In this circumstance, the named beneficiary would receive the proceeds and would thereby be safeguarded from the financial impact of the death of the insured;
- NGN70 million to NGN300 million for “non-life businesses”, which are companies that are typically involved in any insurance that is not determined to be a life insurance policy but that provides payments depending on the loss from a particular financial event; and
- NGN150 million to NGN350 million for reinsurance businesses, which is a company that accepts a portion of the potential obligation in an insurance contract in exchange for a share of the insurance premium, in order to reduce the likelihood of an insurance company paying a large obligation resulting from an insurance claim.
The 2003 changes led to the liquidation of 14 Nigerian insurance companies out of 117 registered in the jurisdiction.
In September 2005, another capitalisation requirement was announced to increase the capital base to NGN2 billion for life businesses, NGN3 billion for non-life businesses and NGN10 billion for reinsurance. This – again – resulted in numerous consolidations that led to the number of liquidating insurance companies falling from 103 to 49. In the first quarter of 2014, the total assets and liabilities of insurance companies was NGN517.2 billion.
A diminishing asset base
The asset base has continued to dwindle every year for the industry because of sections in CITA that penalise it. These sections have compelled insurance companies to pay out their capital in the form of a minimum tax because they are almost always in a never-ending refund cycle with the tax authorities. Originally, the CITA was meant to amend and simplify controversial aspects in its policy, instead it has made it more obscure particularly for the insurance sector.
As with any other business, the tax liability of an insurance company is based on figures contained in its annual published accounts and it is subject to similar assessment and collection procedures by the tax authorities. However, certain special features arising from the nature of the industry mean that profits are taxed slightly different than other sectors.
Simply put, in section 16(2)(a) of the CITA, the profits of a life business insurance company are calculated by taking management expenses, including commission, subject to subsection (8)(b) of the Act from gross income (investment income and revaluation surplus).
For non-life businesses, section 16(1)(b) states that profits will be calculated for tax purposes by deducting the reinsurance cost and a reserve for unexpired risk (the premium corresponding to the time period remaining on an insurance policy), subject to subsection (8)(a) of the Act from a gross premium, interest and other income receivable in Nigeria.
The relevant subsections of CITA are listed below:
“(8) An insurance company, other than a life insurance company, shall be allowed as deductions from its premium the following reserves for tax purposes:
(a) for unexpired risks, 45 percent of the total premium in case of general insurance business other than marine insurance business and 25 percent of the total premium in case of marine cargo insurance;
(b) for other reserves, claims and outgoings of the company an amount equal to 25 percent of the total premium, so that, after allowance under the Second Schedule to this Act as may be restricted, has been allowed for in any year of assessment, not less than amount equal to 15 percent of the total profit of the company for tax purposes.
(9) An insurance company, in respect of its life insurance business shall be allowed the following deductions from its investment incomes and other incomes:
(a) an amount which makes a general reserve and fund equal to the net liabilities on policies in force at the time of an actuarial valuation;
(b) an amount which is equal to 1 percent of the gross premium or 10 percent of profits (whichever is greater) to a special reserve fund and accommodation until it becomes the amount of the statutory minimum paid-up capital;
(c) all normal allowable business outgoing, except that after allowing for all the outgoing and allowance under the Second Schedule to this Act as may be restricted under the provisions of this Act for any year of assessment, not less than an amount equal to 20 percentof the gross incomes shall be available as ‘total profit’ of the company for tax purposes.”
For both life and non-life insurance businesses, the basis for computing minimum tax seems punitive at 20% of gross income and 15% of total profit, correspondingly. To compound the tax burden little solace was given to the industry when they suffer losses.
A thorough review of subsection (8) in the CITA Act exposes the inadequacy of parts (a) and (b). The former imposes a limit on unexpired risk while the latter restricts the deductibility of expenses. Section 16 (9) (c), in the case of life insurance business, introduces a new basis for minimum tax. In practice, the newly introduced minimum tax usually exceeds the minimum tax provisions of section 33 in the CITA. This puts the insurance industry in an unfair situation of paying a higher minimum tax than their peers in other industries in cases when the loss or a total loss of profits result in no tax being payable, or a tax charge that amounts to less than the minimum tax.
The insurance industry has long campaigned to correct this anomaly but it is yet to yield the desired result.
Reforming the CITA
Between 2009 and 2010, the Nigerian Insurance Association (NIA) and KPMG worked with the Federal Inland Revenue Service (FIRS), Federal Ministry of Finance and National Assembly to discuss the dire effects of the CITA 2007. It established regulatory amendments that intended resolve the problems. Unfortunately, the necessary amendments are yet to be passed into law while a tax reform bill, which would enact the amendments, continues to be debated in the National Assembly.
Taxation of losses
Section 16(7) of the CITA restricts insurance companies to carrying forward tax losses for a maximum of four years. Losses that are not fully relieved after four years by an insurance company cannot be carried forward. Companies are made to pay taxes irrespective of the losses accumulated from preceding years.
Similarly, the restriction of deductibility for operating expenses that are 25% of the total premium of a company, regardless of the expense passing the wholly, reasonably, exclusively and necessarily (WREN) test, is counter intuitive. It also violates the principle of fairness and equity in taxation because the WREN test would have sufficed to deduct all operating expenses for companies in other industries.
Furthermore, the tax authorities expose part of the insurance companies’ unearned premiums to tax. This stems from limitations placed on provision for unexpired risks to 45% of total premium for general insurance and 25% for marine insurance businesses. Consequently, if the total amount of claims from the unexpired risks during the fiscal year exceeds provisions made for tax purposes, the insurance company bears the burden as it receives neither a refund nor a credit.
Another issue which is hindering relief is that the profits referred to in subsection 9(b) are not defined. Because of this, profits could be interpreted as the total taxable profit, assessable profit or profit before tax. Clearly, the resulting figures from using any of these bases will differ.
At the risk of stating the obvious, to justify the reasons why the government needs to address the sections of the tax laws which burden the insurance industry, a comparison of global markets is apt.
In the US, the Internal Revenue (IR) Code successfully created a more friendly terrain for its insurance industry that permits growth and expansion.
Firstly, there is no minimum tax that applies to insurance companies. However, there is an alternative minimum tax (AMT) that applies across all industries. The AMT can result in an AMT credit, which can be used to reduce regular tax where it exceeds the AMT in a future accounting year. Moreover, the tax credit does not expire because the credit relates to taxes already paid and the entire credit represents a component of the deferred tax asset. The AMT regime in the US means that insurance companies are not unduly disadvantaged, upholding the principle of equality in taxation.
Secondly, the IR Code treats the period of recovery from loss differently. A company that loses money in a particular year experiences what is known as a net operating loss (NOL). No corporate tax is due when a company has a NOL because they do not have profits. In addition, a NOL can be “carried back” and deducted from up to two years’ taxable income. The company is then eligible for a refund equal to the difference between previously paid taxes and taxes owed after deducting the present year’s loss. If the loss is too large to be carried back, it may be “carried forward” for up to 20 years and used to reduce future tax liabilities. Under this rule, insurance companies can only carry back losses for three years and carry forward losses for 15 years. Nonetheless, several proposals such as “the camp proposal”, call for life insurance companies to benefit from the same loss tax treatment as other companies.
As a result, allowing for the carry back of losses reduces the distorting effects of taxation on investment and, in turn, increases economic efficiency. The government, by allowing NOL carry backs, effectively enters into a partnership with taxpayers to share both the return to investment (tax revenue) and the risk of investment (revenue loss). When companies have losses, past and future tax liabilities are reduced through loss carry backs, reducing risk. The further back in time that losses can be carried, the less distorting taxation becomes on investment. It is simply fair. Additionally, the ability to carry back losses encourages equity by helping to prevent two firms that earn the same amount over a given time period, but differ in the timing of when the income is earned, from paying different amounts in taxes.
Thirdly, the US provides a special deduction for qualifying small life and non-life insurance companies equal to 60% of their income computed without regard to the deduction. This and many more measures capture how a developed economy sets a healthy environment, based on tax laws, for the domestic insurance industry to thrive.
South Africa and Brazil
A cursory look at the tax laws of selected emerging economies reveals that for both South Africa and Brazil, there are no restrictions placed on provisions for unexpired risks, provisions for other reserves, claims and outgoings, and periods for the recovery of losses. Both economies also do not have a minimum taxable profit for their insurance companies.
Meanwhile, India has no restrictions on provisions for unexpired risks, but does apply a minimum tax on the profits of insurance companies on provisions for other reserves, claims and outgoings. The country also places a restriction on the period of recovery of loss but it still provides eight years, compared to the four years offered in Nigeria.
Nigeria needs to act now to save the sector
Taking a cue from these countries, the Nigerian government needs to act fast to save the insurance industry.
Nigeria does not follow best practices and the insurance industry gets severely short-changed as a result of the tax treatment. It is further at risk with countries such as the US, Brazil, South Africa and India that are actively competing with Nigeria for the world’s foreign direct investments.
When a potential foreign investor compares the Nigerian insurance industry index with that of a fast developing economy, the hostile tax laws governing the industry could work against Nigeria.
Imposing taxes is not the problem, especially considering it is pivotal to the functioning of the machinery of government. However, what should not be celebrated but quickly redressed is an unfair tax system. Its negative ripples are immeasurable. If the US could resist the huge tax subsidy received by the East India Tea Company from British government (against small American companies) then taxpayers and stakeholders in the insurance industry should persist until the government sees the positives in this line of thought for the industry and economy at large.
Reform should be pushed to fairly place insurance companies with other Nigerian companies and to align with what applies in developed economies – setting the pace among peers and other developing economies – positioning our economy to be more competitive.
If restrictions are successfully removed and losses are carried forward in perpetuity, it will relieve the insurance companies of all undue tax burdens, improve their profit takings and grow their capital. A healthy insurance industry will strengthen the Nigerian economy as it pushes for a place among the world’s top 20 economies.
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