VAT on insurance service and the new law

The New VAT and SD Act 2012 was enacted to overcome the weaknesses in the VAT Act 1991 by including cutting-edge issues. In particular, the new Act is said to have been enacted to be implemented in an online environment. The Act specifically addresses the Value-Added Tax (VAT) treatment of new business sectors such as telecommunications, secondhand goods, vendor machines (s.44), and includes few new definitions such as periodic and progressive supply, tax fraction and lay-by agreement. Scrapping tariff value for VAT is an improvement over the old Act because tariff values were arbitrary for specific products. In the new law, it is the transaction value (price actually paid or payable) which is the basis for taxation.

A beauty of the new VAT law is the timing for remitting VAT to the government. The new VAT law allows tax to be paid to government when the tax return is due (the 15th of the following month). It eliminates the requirement under the VAT System of 1991 for manufacturers and some service providers to pay VAT in advance (i.e. deposit money to keep positive balance under the old Account Current System) before clearing goods from factories or providing services. The new law is thus more business-friendly. The Regulations increase the current registration threshold from Tk. 8 million to Tk. 30 million per annum. This change seems to have been welcomed by business community and small traders.

This new Act, however, suffers from few definitional issues. For example,  definition of "tax [S 2(24)] means VAT, turnover tax, supplementary duty, and shall, in relation to realisation of arrears, also include any interest, monetary penalty or fine. Inclusion of interest, penalty or fine in the definition of tax seems confusing and not intuitively appealing. Tax is compulsory unrequited payments; interest, monetary penalty or fine does not have the identical feature of tax. As such these three items may be taken out from the definition of tax. According to GFS (2014, IMF), in principle, fines and penalties charged on overdue taxes or penalties imposed for the evasion of taxes should be recorded in fines and penalties category and not as taxes. However, if payments of fines or other penalties cannot be separated from the taxes to which they relate, the fines and penalties relating to a particular tax are recorded together with that tax; and fines and penalties related to unidentifiable taxes are classified as other taxes. 

Among these weaknesses, the issue of VAT on insurance services seems critical and warrants elaboration. A reading of the New VAT Law finds charging section (S. 4, 15) that allows imposition of VAT on services. There is however, no procedure for imposition and collection of VAT on insurance services. Rule 34 only mentions few instances of increasing and decreasing adjustments. Contrary to the current law, specific guidelines were in place for assessment and collection of VAT from insurance firms under the previous VAT law/Rules of 1991. This paper aims to provide a description containing the relevant issues for VAT collection from Insurance Service.

VAT ON INSURANCE SERVICE: In general insurance, VAT/GST should apply to the insurer's taxable value added, where value added is the difference between premium receipts and claim payments. A review of VAT legislation of a number of countries (e.g., New Zealand, Australia, Tanzania) reveals that their legislation/regulations clearly mentions the base value for imposition of VAT on general insurance service.  For example, New Zealand applies VAT on insurance company premiums (fire and general insurance company), commissions and other income (such as proceeds from the sale of damaged assets); deductions are allowed on outward reinsurance, on VAT paid on purchases (including goods purchased to settle claims) and tax fraction of payments made in satisfaction of claims. This is the basis of imposition of VAT on insurance service. Such provision is absent in our VAT and SD act 2012.

Taxing General Insurance under Credit Method VAT: To use the credit methods of VAT in the case of insurance, premiums received should be defined as sales while payment of claims as purchases. It means that the full amount of premiums should be taxed at applicable VAT rates. And VAT applicable on claims shall be creditable as input taxes against VAT due on premiums.

NECESSITY OF GUIDELINE FOR VAT ON INSURANCE: Unlike comprehensive provisions with regard to VAT on insurance services in the legislation of other countries, VAT and SD Act 2012/Rules 2016 lacks provisions on which value VAT will be imposed or how will payout (indemnity payment) be treated in assessing VAT.  Rule 34 is the only rule that mentions about the increasing and decreasing adjustments to be made in the preparation of VAT return and calculation of VAT liability. It does not contain necessary issues such as scope of tax, value on which VAT will be assessed on insurance service, input tax credit, treatment of claim payment and the issue of Dual insurance and Reinsurance in assessing VAT liability. As stated earlier, such issues had been there in the NBR General Order (no-10/mushak/2002 and 03/mushak/2003 issued under VAT Act 1991) and Rules 1991 respectively. A comparison of current rules/provisions with the general order of 2002/2003 gives an impression that we have gone backward instead of going forward in having necessary provisions for VAT on insurance service. All rules, orders and guidelines issued under the (repealed) VAT Act 1991 AND VAT Rules 1991 stand rescinded with the issuance of the SRO (no 170-ain/2019/27-mushak dated June 13, 2019). Thus, with  the effect of VAT and SD Act 2012 and Rules 2016 from FY 2019-20, the rules or orders made under the 1991 Act/Rules are no more in existence. In other words, a vacuum exists in having provisions/orders concerning VAT on insurance under our new VAT law. It is therefore necessary to issue Rules/General Order detailing VAT collection guideline on insurance services without delay.

The general orders issued in 2002 and 2003 may be taken as a guiding factor in this regard. Provision for VAT collection on the premium of dual insurance policy (when the same person is insured with two or more insurers separately against the same interest in the  same subject matter against the same risk for the same period of time) is enshrined in 2(ga) of the general order 10/mushak/2002. Although dual insurance  is often subject to conditions (such as 'other insurance' clause, principle of contribution to be followed to restrict indemnity to the value of insurable interest) VAT will be applicable as the 2nd insurer is getting premium for issuing the dual insurance policy. So this provision may be included in the guideline to be issued by the NBR. The earlier General orders however did not have express provision on 'input tax credit' and 'treatment of reinsurance'. As reinsurance is not a new policy i.e., reinsurance does not involve individual policies, but is more a matter between insurance companies (e.g., Sadharan Bima Corporation known as SBC will not issue any insurance policy to the ceding company for taking reinsurance cover from the SBC) -- an arrangement (treaty) of transferring risks, there is no scope to collect VAT from the ceding company. Reinsurance premiums are essentially inter-company transfers that spread out the companies' risks. Reinsurance is, therefore, usually exempted from the payment of VAT and it is logical to do so. National tax authorities however enjoy authority to make different laws. 

Canada's federal tax authority was  moving to enforce a three-year-old rule that slaps a value-added tax on reinsurance premiums, paid out by Canadian insurance units to their overseas affiliates. It is pertinent to mention that the premium on the underlying insurance policy is subject to VAT and reinsurance premium is usually paid out of the premiums received from the underlying insurance policy. Imposition of VAT on reinsurance premium may result in double taxation. The OECD countries except New Zealand and to a limited extent Finland exempt all forms of reinsurance from the VAT.

CLARIFICATIONS NEEDED ON SUB-RULES OF RULE 34: VAT Rule 34 of Bangladesh allows a decreasing adjustment by the insurer for making a payment to another person under a contract of insurance subject to four conditions. It is not clear if the payment is made as compensation (to indemnify) under the policy. The second and third conditions also do not seem relevant. For example, condition no 34(1) 'kha' mentions that -"the payment is not made in respect of a supply to the insurer or an import by the insurer". This condition gives an impression that the insurer and the insured are engaged in some activities other than the insurance matters. Other transactions or businesses should not get a place in this situation. The only issue that seems pertinent here is "indemnity payment against claim". As such, other issues (other than payment of indemnity) should not be linked (and it is rather irrelevant) to make the matter complex.  It seems logical to allow decreasing adjustment for VAT which is equal to the tax fraction of the payment made as indemnity. If these four conditions are to be kept in the rule, then illustrations with rationale and examples have to be developed/circulated or borrowed from the country from which this rule were copied in toto (i.e.  Section 76 of the Tanzanian VAT Act, 2014).

Similarly, Rule 34 (2) (a) of the VAT & SD Rules 2016 needs an analysis. This rule reads: "Any registered insurer shall be able to make an increasing adjustment, if - (a) the insurer collects any money (except worse or precedent setting damages) by applying his acquired rights under the insurance contract" This sub-rule needs discussion as it may be difficult to understand due to its technicality; it deals with the  'subrogation principle', a basic principle of general insurance. An explanation has been attempted in the following paragraph to justify the increasing adjustment.

INCREASING ADJUSTMENTS FOR PAYMENTS UNDER SUBROGATION: Rule 34 (2) (ka) provides for increasing adjustment for VAT applicable on money received through application of subrogation rights. If the insurer receives any money because of his being stand in place of other" (i.e. by dint of subrogation to exercise the right of the other person], an increasing adjustment will be made.  Subrogation is the right of one person to stand in the place of another in the application of the law. This (subrogation) is one of the six basic principles of general insurance. Subrogation principle is applied to preserve the principle of indemnity and to prevent the insured party from making profit out of any loss arising in terms of a contract of insurance.

This principle provides rights to the insurer to take whatever steps it deems necessary to recover the amount of the loss from the third party (that caused an insurance loss to the insured), after the insured party has been compensated for that loss by the insurer.

WHY INCREASING ADJUSTMENT: In general insurance, VAT/GST is usually applied to the insurer's taxable value added, where value added is calculated by deducting the indemnity payouts (and taxable purchases) for the loss incurred from the premium receipts. In this case, indemnity payouts reduce the 'valued added amount' and thus reduce VAT liability. When the insurer collects/receives money from the liable third party by applying the substitution rights (acquired under the principle of subrogation), his indemnity amount gets reduced by the amount collected through subrogation. This in turn increases his value added and as such an increasing adjustment (for VAT applicable on money recovered through subrogation) may be made to assess the proper amount of VAT payable by the insurer.

An example is given below:

Premium amount= Tk. 50000, Indemnity payment: 30,000, VAT liability = (50,000-30000) *15 per cent= Tk. 3000.

If the insurer had paid indemnity of Tk. 30000 to the insured and recovered (collected) Tk. 10,000 from a third party (who was found liable for the damage) by applying his substitution rights under Subrogation principle, the insurer's VAT liability will be:

VAT amount: Tk. 3000+ increasing adjustment (15 per cent on Tk. 10,000) = Tk. 4500

  This VAT amount can also be assessed in the following alternative way:

  VAT rate* (50,000-30,000) + amount recovered through acquired rights under subrogation principle (Tk. 10000)

=15 per cent (20,000+ 10,000) =Tk. 4,500

VAT RETURN FILING PRACTICE BY INSURANCE FIRMS IN BANGLADESH: An examination of the VAT return filed by a general insurance company (Company X) reveals that the insurance companies make increasing or decreasing adjustments in the case of policies issued on co-insurance basis.

Increasing adjustment-- Leader Company shows amount of VAT payable on its part of the total premium receipt (say Tk. 1, 00,000 VAT of which Leader's share is Tk. 90,000 and Non-leader's share Tk. 10,000). As leader company's share is Tk. 90,000, it will have to make increasing adjustment for VAT payable on non-leader's part of the premium i.e., on Tk. 10,000 to show the total VAT of Tk. 100,000 payable on the insurance policy. This is in line with the provision of the repealed NBR general order 10/mushak/2002 that -'the leader company shall collect and pay total VAT to the government'.

This is illustrated in the following example:

Say, total VAT on general insurance premium is Tk. 1,00,000

  Leader's share: 90,000

  Non-leader's share: 10,000

Leader's VAT return:

Payable VAT 90,000 + Increasing Adj: 10,000 (for receipt from non-leader)

Total Treasury/Net payable) --100,000

Decreasing adjustment-- In the case of Co-insurance, usually leader is liable to pay VAT on the total premium. And VAT is shown in Leader Company's VAT return. Other non-leader companies share the premium and risk for their proportion. In such cases, non-leader insurance companies take decreasing adjustment for VAT payable on their portion (paid by the leader) of the insurance policy issued

Example of Non-Leader's VAT return

Payable VAT= 10,000

Decreasing adjustment (10,000)

Total Treasury deposit-- 000

CONCLUSION: The discussions made so far makes it clear that there exists a gap in our new VAT system with regard to imposition and collection procedure of VAT from insurance firms. It is imperative to issue standing orders/guidelines narrating the calculation method of value on which VAT is to be assessed on insurance service, the treatment of indemnity payment (payout) to the insured, treatment of reinsurance and if there will be any scope to take input tax credit by the insurance firms. The scope of exemption i.e., insurance services/types that will enjoy exemption from VAT needs to be specified.

Detailing out provisions concerning VAT treatment on reinsurance, input tax credit, value for VAT imposition and the scope of exemption (life insurance is exempted under the 2nd Schedule of VAT Act 2012) is necessary. The National Board of Revenue (NBR) may consider issuance of orders/guidelines under the VAT & SD Act/ Rules specifying the aforesaid issues so that no grey area is left; and both the tax payers and tax collectors get a uniform idea about the scope and methods of VAT on insurance service

Mohammad Abu Yusuf, PhD is a VAT analyst and trainer on Customs and VAT,

Foundation of Chartered Taxation of Bangladesh (FCTB) and Institute of Chartered Secretaries, Bangladesh (ICSB).

[email protected]