Insurance customers will start parting with 16 percent tax on the money paid to them by insurers as compensation for their losses, if the proposal whose interpretation has split tax experts and insurance firms, is adopted.
The Finance Bill 2023 is proposing to introduce a new sub-section to section 17 of the Value Added Tax (VAT) Act to allow for the owner of taxable supplies who is compensated for the loss of the goods to pay 16 percent VAT.
“Where a bona fide owner of taxable supplies, who has deducted input tax under subsection (1), is compensated for the loss of the taxable supplies, the compensation shall be treated as a taxable supply,” reads the Finance Bill.
A 16 percent tax could mean that a person receiving Sh1 million compensation from an insurance cover will part with Sh160,000 as VAT, a move tax experts say is likely to hurt the attractiveness of insurance in a market where penetration is below three percent.
Underwriters are asking Parliament to exclude insurance from the list of compensation income that is being targeted for 16 percent tax as the State eyes additional money to fund the budget for the 2023/2024 financial year.
Insurance Regulatory Authority data shows general insurers last year paid out claims amounting to Sh72.26 billion compared with Sh64 billion a year earlier, with Sh33.85 billion related to private and commercial vehicles.
The move, if passed, will mirror that of markets such as South Africa, where an insurance pay-out is regarded as a supply of goods in terms and, therefore, subjected to VAT.
Audit and advisory companies including KPMG and PricewaterhouseCoopers (PwC) are warning that the move to tax compensation will hit the general insurance business, even as the Association of Kenya Insurers (AKI) the sector lobby group, pushes for the exclusion of insurance compensation from VAT payment.
KPMG said the proposed provision is likely to impact the compensation from insurance following the loss of taxable supplies where input VAT had already been claimed.
PwC says the move is contrary to what VAT is levied on since insurance compensation cannot be deemed to be a supply of goods and services.
“In our view, this proposed change is bound to have a significant impact on the general insurance sector and the ambiguity in the rationale and framing of the law should be subjected to engagement with stakeholders before being passed into law,” says PwC.
AKI, aware of cases where the taxman naturally interprets tax laws in its favour unless ruled otherwise by courts, is asking members of Parliament to amend this clause and state expressly that insurance compensation is excluded from VAT.
The lobby recently sent its input to MPs and is hoping that the Bill that will be sent to President William Ruto for signing will be updated to exclude insurance compensation.
“Insurance is VAT-exempt so you cannot introduce VAT on insurance compensation unless you are removing it from VAT-exempt status,” said Mr Tom Gichuhi, chairman at AKI.
“Our prayer to Parliament is that if this amendment is going to be retained, then it should expressly exclude insurance business since insurance business is VAT exempt.”
The plan for the government to go for part of insurance compensation mirrors the three-year court battle between Kenya Revenue Authority KRA) and Sony Holdings, which owns Westgate Mall.
KRA lost the case in which it was seeking Sh380.3 million in taxes from Sony on a Sh4.4 billion payout that Kenindia Assurance Company remitted to Westgate in 2014 as compensation.
Westgate owners had argued that the taxman had unfairly classified part of the compensation as revenue instead of capital to justify the tax demand.
KRA has in the past also been in court demanding taxes from insurance companies for the sale of motor vehicle salvages.
Madison Insurance in 2016, for instance, successfully argued before the Tax Appeals Tribunal that the proceeds from the sale of salvage vehicles are part of compensation paid to the insured and, therefore, exempt from VAT.
The insurer argued in court that in a case where an insured person opts to retain salvage and receives a top-up of the amount required to reinstate the motor vehicle, they would not be required to account for VAT on the salvage.
KRA was seeking Sh21.28 million as VAT from Madison’s sale of salvage motor vehicles from customers but lost the case.
“The argument that salvage is additional to the business of insurance is incorrectly given that it is part and parcel of insurance business and therefore an exempt supply under the VAT laws,” ruled the tribunal.