MANAGING TAX RISKS : VAT on insurance services

What you need to know:

  • Wilhelm Von Siemens, a German businessman, in the 1920s, was the first person to describe the idea of putting a tax on the additional value of output at each stage of its creation, instead of just at the retail sales end and a Frenchman, Maurice Lauré, a tax official, was the first to implement VAT in 1954 (OECD). Currently VAT is being implemented in over 150 countries, where it accounts on average for as much as about a fifth of the total tax revenue.

Value Added Tax is a consumption tax, paid by the consumer for goods and services whenever value is added at each stage of production and at the final stage of sale.

Wilhelm Von Siemens, a German businessman, in the 1920s, was the first person to describe the idea of putting a tax on the additional value of output at each stage of its creation, instead of just at the retail sales end and a Frenchman, Maurice Lauré, a tax official, was the first to implement VAT in 1954 (OECD). Currently VAT is being implemented in over 150 countries, where it accounts on average for as much as about a fifth of the total tax revenue.

The VAT Act, 2014 replaced the VAT Act, cap.148 of 1997. The VAT Act, 1997 was repealed one reason being broad exemptions.The set-up of the repealed VAT Law included three Schedules for:

• Zero rated supplies;

• Exempt supplies; and

• Special relief.

The above set up made it easy and possible to amend any of the Schedules and therefore negatively impacting the tax base.

Having a long list of zero rated supplies as well as relieved persons erodes the VAT base and the amount of refunds normally increases drastically.

A VAT Law with very few exemptions and controlled modalities for amending the list or descriptions for zero rated supplies and special relief is necessary to plug the loopholes.

Salient features of the current VAT law

VAT has two main principles of imposition on account of destination i.e where the supplier belongs principle; and where the customer belongs principle.

The current VAT Act, 2014 has the following characteristics:

• VAT imposition principle used is where the customer belongs;

• Special relief is provided by way of a provision in the main body of the Act;

• Zero rating principles are provided in the main body of the Act which makes it difficult to amend;

• There are very few exemptions.

Treatment of insurance services under the repealed VAT Act, 1997

The Second Schedule of the repealed VAT law had the provision of insurance services as exempt services. Other exempt services included the issue, transfer, receipt of or other dealing with money (including foreign exchange) or any note or order for the payment of money; the provision of any loan, advance or credit; the operation of any current, deposit or savings account; the issue, allotment or transfer of ownership of equity or security such as shares in companies and members interest in corporations and in participatory security such as unit trustsetc.

What is insurance?

The VAT Act, 2014 uses the terms life insurance and health insurance as being financial services and that are exempt supplies for the purposes of VAT. However to get the right perspective of value added tax on insurance it is vital to be familiar with insurance business from legal and practical perspectives. For instance, what determines life insurance policy or long-term insurance policy is section 51 of the Insurance Act. Section 52 clearly classifies insurance business into major categories, namely long-term insurance business and general insurance business.The Insurance Act defines life policy as a contract of insurance made or agreed to be made by an insurer classified under section 51 of the Insurance Act as transacting long-term insurance business.

Mr Makundi is a partner with Auditax International