IFRS 17, further divorce of accounting and tax reporting systems?
The International Accounting Standard Board recently issued IFRS 17 titled “Accounting for Insurance Contracts”, which the insurance sector must adopt by 1 January 2023 although early adoption is permitted. As this date is drawing near ,the hype is developing about the adoption of the standard within the insurance circles, but not so much noise is being made about the impact on tax reporting especially from an income tax perspective.Suffice to state that the standard will result in more transparent reporting of insurance contracts compared to IFRS 4.
Before we delve into the future of tax repoting under IFRS 17 ,there is need to take a short glance on the current income tax reporting system in Zimbabwe. As it stands, tax profits are calculated using the applicable accounting standards or International Financial Reporting Standards based on accrual method as the starting point. 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. The Income Tax Act provides for ringing fencing of taxation of insurance business from the rest of other businesses. Intra ring fencing also exist between life and short-term insurance businesses. The tax base of the short-term insurance business is the trading profits which are computed based on receipt and payment basis. Policyholders’ premiums and other incomes of the short-term insurance business are reported as gross income when received, premium on reinsurance and insurance claims are deductible only when they have been paid while technical reserves are generally not tax deductible. The only technical reserve that is recognized for tax purposes is the unexpired risk reserve. This reserve is treated as a deduction and brought back into gross income in the following year of assessment. Noncash flow items such as deferred acquisition costs are disallowed . The fact that a premium has been received in advance oe expense has been prepaid does not negate its inclusion in the tax base .The exclusion from tax base of prepaid income and expenses only apply to non-insurance businesses with effect from 1 January 2018. Tax rules are completely different for life insurance business. Its tax base is equal to the average accrual liabilities (open plus closing liabilities dividend by 2) multiplied by the insurer’s average rate of return (average rate of return more than 3.5%) on its investment income plus/(minus) profit/(loss) realised by the insurer on his Zimbabwean investments. The insurer is further granted an allowance for investing in prescribed assets and this is treated as a deduction. Concisely, the current settings create deferred tax issues in areas of premium received and paid acquisition as well as costs and permanent tax difference in areas of technical reserves or insurance liabilities among other areas.
Does the coming in of IFRS 17 change the above rules especially for short term business, or it’s a perpetuation of the current settings?. In our view ,IFRS 17 may have income tax Implications . One such implication for instance may emanate from the fact that the IFRS recognizes insurance premium on a receipt basis and yet under IFRS 4 insurance premium was accounted for on accrual basis.The approach advocated by IFRS 17 appears to align the accounting to tax reporting and is critical in the computation of short-term insurance business’ tax liability going forward. This would mean there will be no need to adjust accounting profit with the outstanding premium debtors or reinsurance creditors. In the context of onerous contracts the IFRS provides for the immediate adjustment of losses on the insurance contracts in the period in which the future loss is identified. This will influence the tax liability in that this estimated or forecasted loss which is a form of provision will have to be adjusted and disallowed when computing income tax liability of the insurer.The profit or loss on insurance contracts is adjusted under the concept called contractual service margin(CSM) .This quantifies the unearned profit that the insurer expects to earn as it fulfils the contractual obligation or as it provides services.The concept combines unearned premium ,deferred acquisition costs,other technical reserves in coming up with the unearned profit.It appears going forward there is disappearance of unearned premium reserves or unexpired risk reserves as line items in the insurance financial statements.Whereas under the current settings,unearned premium reserves or unexpired risk reserve is an allowable deduction for tax purposes whilst technical reserves for past liabilities such as Incurred But Not Yet Reported (IBNR),net outstanding claims are a prohibited tax deduction.The consolidation through the use of CSM may result in the short term insurers being disadvantaged from income tax perspective since UPR will not exist as a separate figure to facilitate its deductibility.While this may be my early assessments of the tax impact of the standard on the short-term insurance business,nevertheless policy makers and the insurance sector must dialogue on the standard in order to address the possible tax issues and adverse effects of the standard on both investment and revenue mobilisation.Tax Rules should always be adjusted to take into account the changing circumstances to facilitate ease of tax administration and reporting.In conclusion, the advent of IFRS 17 may trigger a fresh policy thinking and a dialogue between policy makers and the insurance sector is necessary.This is so because the standard is bringing forth new reporting , measurement recognition and disclosure requirements which may be at tangent with the current tax rules.