Heavy dividend tax could force out policyholders to bank deposits
Sri Lanka’s life insurers may have thought all troubles they underwent from the time they segregated their composite businesses and adopting risk-based capital are finally over.
But the challenges are far from over as the new Inland Revenue Act, which was passed a fortnight ago, has slapped additional taxes on the sector, dampening their ability to generate higher profits.
Meanwhile, the industry will also face an uphill task of selling new life policies because the bonuses given to policyholders are taxed at a rate of 14 percent, making a bank fixed deposit more attractive than saving in a life policy, which only has a tax of 5.0 percent on interest.
According to LOLC Securities, which analysed the tax impact on the life insurers’ profitability, said the life insurers would incur higher tax expenses from April 1, 2018, when the tax law comes into effect.
“Several corporate tax and dividend tax-related changes pertaining to life insurance industry as illustrated below have been approved under the new bill, creating a negative profitability impact to life insurers,” the LOLC group stockbroking arm said in a note.
Under the existing income tax law of section 92 of the Inland Revenue Act No.10 of 2006, the profits of a life insurance company deem for tax are calculated by deducting the management expenses such as claims, admin expenses, agents’ commission and finance cost from the investment income.
However, under the new law, the taxable profit of a life insurer will include the ‘surplus attributable to shareholders generating from premium’, in addition to the excess of investment income over the said management expenses, resulting in a higher taxable profit and thereby a higher tax expense.
LOLC Securities expects the higher taxes to hit hardest on specially the new and mid-tier life insurers such as Softlogic Life, HNB Assurance, Janashakthi and Union Assurance, “who enjoyed low-income taxes on the grounds of a higher gross written premium (GWP) growth over investment income to absorb substantial hit into their bottom line while reflecting this negativity in market pricing as well with a possible downside”.
Meanwhile, the stockbroking firm also said the life insurance products would also become less attractive as under the new act, the policyholders will be taxed at 14 percent on bonuses and dividends issued to them by the companies up to three years.
Hence, the proposed 14 percent dividend tax on policyholders could shift some of them into bank deposits, which will entail only 5.0 percent withholding tax on interest income, which is also up from the current 2.5 percent.
Meanwhile, the restriction on deduction of losses (35 percent of statutory income) from life insurance businesses has also been removed by the new act and can now be claimed in full, “but can be carried forward only to six years instead of indefinite period previously”, it added.
During the recent quarter, despite the challenging economic conditions, the insurance sector faired modestly well in terms of earnings and GWPs compared to the corresponding quarter last year.
But the changing tax landscape could question the ability of reporting higher earnings from next April onwards unless there is a marked improvement in new business.
Sri Lanka’s life insurance penetration stands woefully low at less than 2.0 percent in terms of GWPs and the industry is overly crowded.