Taxation of general insurance business

Section YA 1 of the Income Tax Act 2007 and section OB 1 of the Income Tax Act 2004

Changes have been made to the definition of "outstanding claims reserve" (OCR) to clarify that that the amount calculated should be net of amounts receivable for reinsurance or non-reinsurance recoveries. The change ensures that amounts calculated for financial reporting purposes can be used for taxation purposes.

Background

The Taxation (International Taxation, Life Insurance, and Remedial Matters) Act 2009 clarified that movements in a general insurer's OCR, as determined by applying International Financial Reporting Standard (IFRS) 4, are deductible. The rules allow a deduction for claims paid in an income year and for the movement in the OCR between the beginning and the end of the year.

The OCR is the amount an insurance company sets aside which, when invested, will provide sufficient funds to cover the liabilities for outstanding claims in the future. The value of these claims is estimated, as they generally have either been reported but not been paid at balance date, or an insured event has occurred but the insurer has not been notified about the claim by its balance date. The amount of expected future payments is discounted to reflect present value.

Estimates relating to expected reinsurance recoveries and non-reinsurance recoveries affect the amounts used to calculate movements in the OCR. For financial reporting purposes these amounts are treated as income and are discounted. For taxation purposes, however, the law was silent about how these expected recovery amounts should be treated.

The rules in the Income Tax Act 2007 which allow a deduction for movements in a general insurer's OCR have been clarified and now recognise, on a discounted basis, recoveries that insurers expect to receive from third parties, by way of reinsurance or directly from those parties.

Key features

The definition of "outstanding claims reserve" in section YA 1 of the Income Tax Act 2007 includes reference to amounts an insurer expects to receive by way of recoveries.

A corresponding change has been made to section OB 1 of the Income Tax Act 2004.

Application dates

The changes apply from the 2009-10 income year.

For taxpayers that elect, the change can be applied earlier - beginning from the first income year IFRS is adopted for financial reporting purposes.