South Africa Consults On Long-Term Insurers’ CGT

With regard to the proposals announced in the South African 2012/13 Budget in February this year, the National Treasury has released for public comment details on how increased capital gains tax (CGT) rates will be applied to long-term insurers.
It is noted that long-term insurers have three sets of policyholder funds for tax purposes – the individual policyholder fund, the company policyholder fund and the untaxed policyholder fund.

The effective CGT rate for individual policyholder funds will increase from 7.5% (the pre-existing 25% inclusion rate applied to a tax rate of 30%) to 10% (with a new 33.3% inclusion rate). The effective CGT rate for company policyholder funds will increase from 14% to 18.6% (the pre-existing 50% inclusion rate increased to 66.6%, as applied at a tax rate of 28%). Untaxed policyholder funds will remain fully exempt from the payment of income tax and CGT.

It is thought that there will be the need for special rules, as any change in effective CGT rates for policyholder funds creates complications for insurers as trustees. In particular, if the higher rates apply only from a later date, all policyholders are notionally affected by an asset disposal.

Therefore, in order to remedy the misallocation of additional CGT among policyholders in an administratively viable manner (and without causing undue distortionary benefits vis-à-vis other classes of taxpayers), it is proposed that a deemed disposal and re-acquisition be applied to all policyholder fund assets.

Under this approach, long-term insurers would recognize all unrealized gains and losses arising before the March 1, 2012 (i.e. as of February 29), with the net result being to trigger a gain or loss for all policyholders. However, it is said, the practical tax impact would not undermine their savings because long-term insurers already charge policyholders with capital gains tax on a regular mark-to-market basis due to the trustee nature of the holdings.

Policyholders would then be freed from the higher CGT inclusion rates in respect of unrealized capital gains on assets acquired before March 1, 2012, even if the actual disposal of those assets occurs after the March 1, 2012 effective date.

It is further noted that the bulk of the assets within policyholder funds are typically held in the form of shares, bonds, derivatives and immovable property, and also in collective investment schemes. It is proposed that the deemed disposal/re-acquisition arising at the end of February 29, 2012, will apply to all asset classes. However, collateral adjustments will be required to avoid distortions.

The National Treasury also points out that the gains triggered by the deemed disposal/re-acquisition relate to amounts that have appreciated over many years (typically between three and 15 years). Given this long period of appreciation, the payment of tax in respect of all the unrealized gains may create a strain on liquidity for certain long-term insurers.

It is accordingly proposed that aggregate capital gains resulting from the deemed disposal rule be spread over a period of four years (the current year and following three years of assessment). Similarly, any aggregate capital losses stemming from this deemed disposal rule will also be spread over a period of four years.

It is also proposed that there should be an annual mark-to-market proposal for long-term insurers, such that capital gains and losses should simply be taxed annually. This annual taxation would be consistent with the approach already taken by long-term insurers, most or all of whom are annually setting aside capital gains tax potentially payable in respect of policyholder assets.
Just as the initial set of deemed gains and losses arising on February 29, 2012, future annual capital gains and losses will be spread over a four-year period, so as to create an averaging mechanism and reduce excessive annual upswings and downswings.
The public have been asked to send comments on the proposals to the National Treasury before May 14, 2012.

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