Taxes and fulfilment cash flows
Following KPMG’s recent article identifying several of the key tax issues arising under the new IFRS 17 Insurance Contracts accounting requirements, we are diving deeper into these issues. This post will focus on the tax payments that are taken into account when developing the cash flows required to measure insurance liabilities under the new standard.
IFRS 17 requires a determination of the future profit in an insurance contract, which is generally the excess of the insurance contract liability over the risk-adjusted present value of probability weighted estimates of future cash flows (IFRS 17.IN6). These future cash flows — referred to as “fulfilment cash flows” — include all the future cash flows “within the boundary” of each affected contract (IFRS 17.33). Importantly, certain tax amounts are included in the definition of fulfilment cash flows.
As described in paragraph B65 of IFRS 17, cash flows within the boundary of an insurance contract are those that relate directly to the fulfilment of the contract. Cash flows within the boundary include certain transaction-based taxes, such as premium taxes, value added taxes, and goods and services taxes. Cash flows within the boundary also include levies, such as guarantee fund assessments and fire service levies, that arise directly from existing insurance contracts or that can be attributed to them on a reasonable and consistent basis. Cash flows within the boundary include payments by the insurer in a fiduciary capacity to meet tax obligations incurred by the policyholder, as well as tax payments specifically chargeable to the policyholder.
Cash flows within the boundary also include any other costs specifically chargeable to the policyholder under the terms of the contract. In some jurisdictions, this can include certain income taxes, such as policyholder taxes, that are within the scope of IAS 12.
These various types of taxes are described and defined differently across multiple jurisdictions. As a result, the determination of whether a particular tax is included within the boundary of an insurance contract is subject to detailed analysis, together with a strong understanding of the IFRS 17 requirements. Additionally, tax professionals in affected insurance companies will need to carefully review the provisions of each contract type to understand the nature of the taxes underlying the economics of the contracts and how these taxes are funded. For example, tax professionals will need to determine whether the insurer is making certain tax payments in a fiduciary capacity, or whether taxes are specifically chargeable to a policyholder, including to a policyholder’s account value. For some product types and participating fund structures, this may not be straightforward.
Several practical considerations arise in how to treat tax items when preparing cashflow forecasts. For example, companies may encounter challenges in determining which taxes are directly attributable to fulfilling insurance contracts, such as unrecoverable value added taxes. For those jurisdictions where some of the IAS 12 Income Taxes are specifically chargeable to policyholders similar challenges arise, particularly where there are variances between actual and expected tax.
Insurance companies and their tax teams will be presented with novel issues as they implement IFRS 17, not least of which will be the identification of transaction-based taxes and levies that are attributable to policyholders, when income taxes are specifically chargeable to a policyholder under the terms of the contract, and how to track all of this information. As previously indicated, there is much to be reviewed and understood as IFRS 17 is implemented.