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Taxation
Monday, May 1, 1989
More budget details

From April 1st 1989 a new tax formula is to be introduced in respect of the taxed portfolio.
The untaxed portfolio (pension, retirement annuity and immediate voluntary annuity business) remains unchanged. This is the first step in a series of moves designed to bring the tax treatment of assurers into line with other taxpaying entities.
It is to be welcomed insofar as it discards the previous arbitrary basis of taxation in favour of the standard tax formula. The tax rate will be 45% - this rate being the maximum personal tax rate (as contrasted with the corporate flat rate of 50%). Thus it is in line with the trusteeship principle that a long term assurer administers funds on behalf of its policyholders.
The new formula is 45% of (Income less Expenses) expressed as “I” and “E” respectively. “I” apparently limits income to only being interest dividends (but only 2/3 thereof), rent and management fees. This excludes capital gains resultant from trading. “E” is limited to 55% of “allowable expenses”.
“Allowable expenses” are calculated as the sum of:
• the average selling expenses for the current and for the four immediately preceding years; and,
• other current expenses.
o less such proportion of the above total as relates to the exempt portion of dividend income.
If gross investment income was R600m and, of this amount, dividend income was 30%, or R180m, then 30%, orR60m is tax exempt. As a percentage of the gross investment income this is thus 10%.
The total expenses of R230m must be reduced by 10%, or R23m, leaving allowable expenses as R207m. But allowable expenses in turn are limited to 55% of the R207m, being R113,85m.


Example of the tax formula for long term assurers (before and after the Budget).
Before April 1st 1989:
Gross investment income of R100m.
This is full dividends, interest, rental and management fees, but excluding capital gains resulting from investment trading profits.
Deemed taxable income is 70%, or R70m. Tax on that at 50% is R38m.
After April 1st 1989:
Gross investment income of R100m. Only two-thirds of dividends, plus full interest, rental and management fees, but excluding capital gains resulting from investment trading profits.
Deemed taxable income is R100m less 55% of expenses allowed under the Income Tax Act.
Life assurers’ expenses calculation
The tax is levied at 45%, but the outcome depends on the following:
1) If total expenses are 40% of gross investment income, allowable expenses will be R22m (that is, 55% of R40m). In this case, then, the 45% tax rate is applied to R78m (R100m - R22m), or a tax bill of R35m.
Therefore the break-even point relative to the previous position (before April 1st 1989) is where tax deductible expenses are equal to 40% of gross investment income.
2) If total expenses are greater than 40% of gross investment income, then tax will be lower than before.
3) If total expenses are less than 40% of gross investment income, then tax will be higher than before.
The abolition of prescribed asset requirements
The obligation on assurers and pension funds to invest in prescribed assets (government and quasi-government stock and cash holdings) will fall away once enabling legislation is tabled in Parliament in the course of this year.
Life assurers are currently required to hold 33% of funds attributable to pension business in prescribed assets. The justification previously was, firstly, to ensure that solvency margins were maintained so that policyholders and pension fund members were more adequately protected.
They usually suffered lower investment returns on such invested monies than could otherwise have been achieved; and, secondly, to insure a greater flow of loan funds to the exchequer. The abolition of prescribed assets (subject to other solvency criteria being implemented) is designed, firstly, to free investment into those fields that lead to more job creation and, secondly, to facilitate the privatisation process.

Copyright © Insurance Times and Investments® Vol:2.5 1st May, 1989
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