Insurance and Taxation Quiz

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Questions and Answers

What is the duration over which capital amounts may be transferred back to the corporate fund without being subjected to tax?

Ten years

Eight years (correct)

Five years

Twelve years

What term did Jacobs use to describe the capital transfer related to new business?

'Tax-exempt capital'

'Locked-in new business' (correct)

'Capital strain'

'Business transfer'

What was a consequence of the punitive tax system imposed on life insurance proceeds?

Created more favorable tax conditions for investors

Led to a higher rate of new policy acquisition

Increased transparency in investment policies

Discouraged investor usage of the insurance product (correct)

How did the demarcation between life insurers and deposit-taking institutions occur?

By imposing a punitive tax system Signup and view all the answers

What is one of the effects of having an expanding office as noted by Hartwig?

Depressed tax payable levels Signup and view all the answers

What is the primary focus of the Jacobs Committee report from 1992?

Promotion of equal competition in financial markets Signup and view all the answers

Which document outlines recommendations for life insurance tax reform in New Zealand?

Life insurance tax reform: Officials’ paper No. 2 Signup and view all the answers

What does the variable ^R represent in the reserve build-up formula?

Increase in policyholder reserves Signup and view all the answers

What year was the Income Tax Act, No. 58 introduced?

1962 Signup and view all the answers

Which components are included in the equation ^R = Ip + P – B – Ep – T?

Investments, premiums, benefits, expenses, and taxes Signup and view all the answers

What was the primary concern of the LOA's circular regarding the proposed introduction of capital gains tax?

Investment income taxation Signup and view all the answers

What is indicated by the expression (Ip - Ep - T) in relation to policyholders?

A representation of the increase in policyholders’ interests Signup and view all the answers

Which document is NOT associated with the legislative amendments in South Africa in the late 1990s?

Taxing the Financial Sector: Concepts, Issues and Practices Signup and view all the answers

What should be excluded from the consideration of gains and losses according to the content?

Profits and losses from underwriting experience Signup and view all the answers

How should expenses related to a policy be handled for tax purposes?

They must be carried forward until sufficient taxable income is generated Signup and view all the answers

According to the proxy principle, what should be included in Ip for tax purposes?

Only elements an individual would be taxed on Signup and view all the answers

What is a reasonable conclusion regarding the 'gains' of some policyholders?

They are netted out, assuming they are balanced by losses to others. Signup and view all the answers

When is it reasonable to allow policy-related expenses as tax deductions?

Only when offsetting same policy income Signup and view all the answers

What is the proposed formula for calculating the appropriate apportionment ratio?

(I + R) / (I + R + D + G) Signup and view all the answers

Which of the following statements best describes the concern about the original s29?

High initial expenses were problematic due to their treatment. Signup and view all the answers

What does the adjusted formula rely on as a proxy due to concerns about G?

Income, dividends, and rental yield Signup and view all the answers

Why was the restriction of spreading initial expenses over 5 years lifted in s29A?

Due to high levels of initial expenses identified as a problem. Signup and view all the answers

What deficiency was identified regarding management fees in the policyholder fund?

They are fully deductible in the transferor fund. Signup and view all the answers

What ratio is suggested to determine the portion of transfer amounts to be deducted in the policyholder fund?

Taxable income to total income ratio Signup and view all the answers

What is the expected total return on property in relation to rental yield based on the proposed formula?

Around 3 times the rental yield Signup and view all the answers

What limitation was introduced in s29A regarding special transfers from s29?

Their extent of use was limited. Signup and view all the answers

What is the primary weakness of the current four funds basis in taxation of life insurance?

It applies a single tax rate to policyholders irrespective of their marginal tax rates. Signup and view all the answers

Which proposed solution aims to address the tax disadvantages for low income investors?

Treat pure investment policies separately from life insurance. Signup and view all the answers

How does the current four funds basis compare to other taxation models for life insurance?

It represents a theoretically sounder approach by appropriately separating incomes. Signup and view all the answers

What does tax neutrality in relation to life insurance imply?

Tax rates reflect the marginal tax rates of individual policyholders. Signup and view all the answers

What potential improvement does the four funds basis offer over the original framework developed by Hartwig?

It shows improvement in isolating individual versus corporate income. Signup and view all the answers

Which option describes a measure that could enhance tax equity among policyholders?

Introducing multiple policyholder funds based on income levels. Signup and view all the answers

What aspect of tax policy does the four funds basis not address effectively?

The varying marginal tax rates among policyholders. Signup and view all the answers

What could be a potential outcome of applying a median of marginal rates in the taxation of the proposed fund?

Greater tax equity among policyholders with diverse incomes. Signup and view all the answers

What is the tax-free capital gain threshold for individuals under 65?

R18 000 Signup and view all the answers

What determines the portion of expenses that can be deducted for a life policy?

Expense relief ratio Signup and view all the answers

How are capital gains on unit trusts taxed when units are sold?

At the point of selling the units Signup and view all the answers

What benefit can unit holders realize from the capital gains tax rules?

Deferral of tax until units are sold Signup and view all the answers

What affects the significance of tax deferral for unit holders?

Frequency of trading of underlying shares Signup and view all the answers

In what way do permitted deductions work for unit trusts?

They are made before distributing income to unit holders Signup and view all the answers

What is the tax-free amount of interest income for individuals over 65?

R26 000 Signup and view all the answers

What happens to capital gains tax liability in life-wrapped products?

The insurer pays on behalf of policyholders Signup and view all the answers

Study Notes

Taxation of Life Insurance in South Africa Revisited

This paper details the theoretical framework and historical development of the four funds basis for taxing life insurance in South Africa.
It evaluates the current basis and proposes potential changes.

Keywords

Life insurance taxation
Four funds basis
Trustee principle
South Africa

Introduction

The paper investigates the expense relief ratio formulas within the four funds basis.
It revisits the four funds basis, comparing it to Hartwig's (1994) seminal work on the topic.
The basis is unique globally in its approach to taxing life insurance, with limited public discussion.

Theoretical Framework

Applying normal income tax rules to life insurance presents several challenges.
Many countries, including South Africa, have established specialized tax rules for the life insurance industry.
The risk-pooling approach of insurance, in normal income tax, doesn't immediately show a problem.
However, the long-term nature of life policies creates a mismatch between premiums received and benefits and expenses paid in any given year.
There's the possibility of investment-related returns that policyholders might receive. Policyholders may benefit from the investment returns over the life of the policy.

Hartwig Model

The model developed by Hartwig aligns with the four funds basis proposed by the Jacobs Committee.
The model focuses on the net increase in policyholders' interests over a year, encompassing benefits received, premiums paid, and reserve increases.
A formula for calculating taxable income is presented, using components such as increase in reserves, benefits paid, and premiums paid, to arrive at the taxable income amount.

Taxation of the Corporate Entity

Taxing the insurer as a typical profit-making company would lead to a straightforward formula of total income less expenses and reserves set aside for policyholders.

An Adapted Model

The author highlights an oversight in the model's development, pointing out issues related to the derivation of the formula for the increase in policyholders' interests.
It underscores the importance of distinguishing between taxable and nontaxable portions of the income.

The Jacobs Committee Report (1992)

This report, a cornerstone, formally proposed the four funds basis for taxing life insurance.
It was developed after substantial debate and consultation with various stakeholders in the life insurance industry.
The four funds (Individual Policyholders' Fund, Corporate Policyholders' Fund, etc) are central to the basis.
The report outlines the different principles to consider in designing the system, such as the trustee principle, tax neutrality, and the competitiveness between life insurance and other financial products.

Calculation of Taxable Amount

The calculation of taxable amounts for each fund, within the four funds basis, aligns with Hartwig's model.
Adjustments are needed to selling expenses and the ratio of taxed income to total income.
Additional modifications were made (such as a spreading of selling expenses and the application of the expense relief ratio).

The Revenue Laws Amendment Act (1999)

This act incorporated major changes to the taxation of life insurers, reflecting feedback from stakeholders and the Jacobs Committee's recommendations.
It introduced changes related to expense deductibility and to the basis (framework) for calculating liabilities.
There were also adjustments to the allocation of profits to the various funds.

The Revenue Laws Amendment Act (2001)

This act extended the tax system by incorporating capital gains tax.
It recalculated certain components, such as the expense relief ratio, in light of the new capital gains tax provisions.

Evaluation of the Current Four Funds Basis

The current four funds basis is generally consistent with the theoretical framework developed and proposed by Hartwig.
However, certain areas differ. These include the valuation basis, the deductibility of transfers, and initial expenses.

Evaluation (against general tax policy objectives)

The four funds basis is assessed against several tax policy principles.
This includes issues of neutrality, treatment of both profits and savings income, administrative complexity, and compliance issues.

Alternative Tax Systems

The paper examines different approaches used internationally to tax life insurance.
These systems vary substantially in how they address specific aspects of life insurance taxation.

Taxation of Life-Wrapped Investment Policies

The taxation of life-wrapped investments is contrasted with taxation of unit trusts.
The paper explores the differences.

Expenses

The treatment of expenses in the four-funds basis and its effects is examined.

Conclusions

The four funds basis offers an elegant solution to the challenges of life insurance taxation, aligning reasonably with theoretical and practical implications.
It is further pointed out that an area of concern within the basis remains in the inequitable tax treatment amongst policyholders at an individual level.

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Description

This quiz covers key concepts related to capital transfers, taxation, and the structure of life insurance companies. It explores the implications of tax systems on life insurance proceeds and the differentiation between life insurers and deposit-taking institutions. Test your knowledge on these essential financial topics!