The basis of taxation under the 4th Schedule of Income Tax Ordinance, 2001 is the Insurance Ordinance, 2000 and the Insurance Rules governing the Insurance Companies in Pakistan which are administered by the Securities and Exchange Commission of Pakistan.
Income Tax Ordinance, 2001 also relied on the two broad categories of Insurance companies - Life and non-life insurance and lays down the principles for taxation of each category.
The 4th Schedule of Income Tax Ordinance, 2001 is based on generalia specialibus non dergant, that is, special provisions of law would prevail over general provisions. This forms the basis that deeming provisions are inapplicable and the different heads of income are immaterial for the purpose of computing the taxable income of insurance business.
Owing to this reason, the gain or loss from the sale of modaraba certificates, listed redeemable capital, shares of public company and PTC Voucher shall be treated as Business Income and Loss. However, the dividend income falls under the PTR @5%.
Life insurance companies are required to maintain two separate funds for policy holders and shareholders and the surplus can only be attributable to the shareholder fund according to the advice of an appointed actuary which also forms the basis for computing the taxable business income.
This entails the fact that all the provisions and reserves maintained under the Insurance Ordinance for the purpose of computing statutory surplus are allowable deductions apart from the deductible profit and loss account expenses. In furtherance of deduction, any amount paid to, reserved for or expended on behalf of the policy holder but no account shall be taken as being the amount paid out or brought forward surplus from a previous inter valuation period.
However, if the amount reserved for payment to policy holder ceases to be so reserved, or is no longer payable, and has been allowed as deduction, I shall become the part of statutory surplus for the tax year. In further continuance of deduction, any amount written off or reserved in the accounts through the actuarial valuation for depreciation or loss on realisation of investment shall be allowed as deduction.
Consequently, any appreciation or reversal shall be treated as surplus. The provisions relating to General insurance business are almost similar except the fact that no one is allowed for any expenditure, provision, allowance or reserve in excess of the limit prescribed by the Insurance Ordinance, unless the excess is allowed by the Securities and Exchange Commission of Pakistan and is incurred in deriving income from business.
In furtherance, any expenditure, allowance, reserve or provision which is inadmissible in computing income from business is also inadmissible for the purpose of general insurance business. In summary, Income Tax Ordinance, 2001 and the related sections which follow it, contain the special provisions dealing with the taxation of insurance business.
All of the normal provisions relating to income tax apply, such as those relating to computation, deductibility, assessments and payment of tax. However, in the event of any conflict, the special provisions have priority. The law provides for different parts of the insurer's activities to be dealt with as separate businesses.
THE BASIC DIVISION IS BETWEEN:
-- general insurance business
-- Life insurance business.
Each is treated as a separate and distinct business, with its own special rules of as specified in the Insurance Ordinance and its related rules, so they can be viewed independently. It seems that the CBR is about to amend the existing 4th Schedule of Income Tax Ordinance, 2001 for providing the basis of Takaful Insurance Taxation and will primarily rely on the Takaful Rules, 2005.
However, the following analysis of 4th Schedule of Income Tax Ordinance, 2001 with global practice would be an eye opener for the CBR as to how the CBR is losing revenue by merely relying on the Insurance Ordinance and its related rules.
GLOBAL PRACTICE AND 4TH SCHEDULE It is worthwhile here to note that the Securities and Exchange Commission of Pakistan has failed to notify any limit for any type of reserves, while the 4th Schedule allows exemption to resident and non-resident companies both.
Both the authorities have failed to provide an environment for the promotion of the re-insurance industry in Pakistan as globally a specific percentage of re-insurance is not allowed as deduction, where the re-insurer resides outsides the country [Pakistan].
Globally, the general insurance business is normally divided into four broad categories, that is, General insurance, Inward Re-insurance, Offshore Insurance and marine/aviation/transit Insurance. Inward re-insurance applies to re-insurance policies where the risk under the policy is outside the country the [Pakistan] and the original insurance policy is issued by a non-resident insurer other than through a branch in the country [Pakistan] or by a resident insurer through a branch outside country [Pakistan].
Offshore insurance applies to insurance under general policies written by the insurer where the risk is outside the country [Pakistan] and the policy is issued by a resident insurer or by a non-resident through a branch in the country [Pakistan].
In furtherance, the risk in transit in country [Pakistan] is normally deemed to be treated as outside country the [Pakistan]. In the 4th Schedule, no separate provisions are provided for marine, aviation and transit insurance as the figure for the reserve of unexpired risk in the case of marine, aviation and transit policies.
Around the globe it is calculated at a specific percentage, within the range of 20% to 30%, of the net adjusted premiums. Net adjusted premium are gross premiums receivable less re-insurance premiums. For other types of policy, the amount calculated for accounting purposes is accepted, provided that the same basis is used consistently from year to year.
This may call for some apportionment of a general insurer's business results in order to calculate the 25% part. The income is normally segregated by calculation and the ratio of aggregate income from inward reinsurance, offshore Insurance or Marine/Aviation/Transit Insurance to the whole aggregate income of the insurance.
This ratio is then applied to the chargeable income of the insurer to calculate the different categories of incomes.
AGGREGATE INCOME FROM INWARD REINSURANCE
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Offshore Insurance or the Chargeable
Marine/Aviation/Transit Insurance X Income of
The whole aggregate income of the insurance. Insurer
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Following is the summarised chart for income and deduction used to calculate the adjusted income or loss from each of the broad categories.
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Income Deductions
Gross insurance premiums received less returns Claims incurred in connection with general insurance policies
Other gross income of the general insurance business, including Re-insurance premiums payable
commissions and income from investments of the general business Management expenses
Gross proceeds of realising such investments Commission payable and discounts allowed
Amounts received or receivable under re-insurance contracts Management expenses
Reserve for unexpired risks at the end of the previous period Reserve for unexpired risks at the
end of the current period
Cost of acquiring and realising any
investments disposed of
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RESULT = ADJUSTED INCOME OR ADJUSTED LOSS An insurance company usually carries on all of its general business as one operation. As a result, management expenses and depreciation capital allowances often have to be apportioned between the different types of business making up the general insurance business. Dividend income is treated in the same fashion as under the fourth Schedule of the Income Tax Ordinance, 2001.
It is worthwhile here to note that globally any life re-insurance business is treated as general business. However, life insurance is treated as one business with two sources - income of the life fund and income of the shareholders' fund in respect of life business.
In Income of the life fund, one deposits all the receipts which are attributable to the life business, including income from investments made from the life fund and is also used to disburse those liabilities and expenses which are properly attributable to the fund.
On the other hand, in case of Income of the shareholders' fund in respect of the life business, a prudent insurer also keep funds representing his capital and other resources which are not required as part of the law but which are held as part of the financial backing for the insurer's life business. Hence, the components to be taken into account in computing the adjusted income of each source are quite specific.
LIFE FUND SHAREHOLDERS' FUND GROSS INCOME
-- Income from investments made out of the life funds
-- Income from investments made out of the shareholders' funds
-- Gross proceeds of realising such investments
-- Gross proceeds of realising such investments
-- Actuarial surplus transferred from the life fund.
DEDUCTIONS
-- Cost of acquiring and realising the investments disposed of.
-- Cost of acquiring and realising the investments disposed of.
-- Actuarial deficit transferred to the life fund
RESULT = ADJUSTED INCOME OR ADJUSTED LOSS This strictly prescribed method of determining the adjusted income does not allow for the deduction of any costs such as commission or expenses of management. However, deductions can be made for the following, to the extent and at the level stated:
-- Depreciation including unabsorbed allowances brought forward, in arriving at the statutory income, but to the extent of the adjusted income of the life fund only.
-- Unabsorbed losses brought forward, in arriving at the aggregate income, but to the extent of the statutory income from the life fund only.
-- Current year adjusted loss in arriving at the total income of the insurer.
-- Qualifying gifts and donations in arriving at the total income of the insurer.
-- Advance tax credits for tax deducted at source in determining the tax payable.
The CBR is relying over the Insurance Ordinance and its related rules which are loosely defined in terms of reserves and are an open play ground for tax planning.
CBR must consider the global practices in respect of Insurance taxation and not solely rely on the existing laws but also do some homework. Harmonisation of laws is a good sign but at the cost of loosing revenue it is unacceptable.
(Concluded)
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