The Gains and Profits of a Long-Term Insurance Business as related to Tax

Summary
In Kenindia Assurance Company Limited v Commissioner of Domestic Taxes [2020] eKLR the High Court of Kenya (the High Court) found that section 19(5)(b) of the Income Tax Act, Cap 470 was only applicable to a Life Fund created under section 45 of the Insurance Act, Cap 487 (Insurance Act).

Background
In 2004, the appellant created a statutory reserve under sections 45 of the Insurance Act, by effecting a transfer of an amount of Kes.159,875,000/= from the appellant’s retained earnings of both its life and general business to the Statutory Reserve for the life business created in the year 2004. This transfer was reported in the restated audited financial statements for the same year.

Following the recommendation of its actuary, the appellant, in 2010, transferred from its life fund, an actuarial surplus amounting to Kes.25,000,000.00, which transfer was duly taxed in accordance with section 19(5) of the ITA. In the same year, the appellant, with the intention of strengthening its capital base, capitalized an amount of Kes.111,338,000/= which was part of the retained earnings amounting to Kes.159,875,000/= that was transferred to the statutory reserve created in 2004. This was reflected in its statement of changes in equity for the year of income 2010.

The respondent conducted an in-depth audit on the appellant for the financial year 2010. By a letter dated 7th June 2013, the respondent issued an initial assessment number 030520100010/4 for Kes.32,377,800/=. The appellant objected to the assessment under section 84(1) and (2) of the ITA by its letter dated 5th July 2013.

In the objection, the appellant argued that the respondent erred in the interpretation of section 19(5) of the ITA relating to taxation of insurance companies on the basis that under the provision, a transfer would amount to taxable income only if appropriated from the life fund for the benefit of shareholders. It pointed out that there existed two reserves at the time the transfer took place, the Life Fund and the Statutory Reserve and that the amount capitalized was not appropriated from the Life Fund but from the Statutory Reserve. It showed that the Statutory Reserve decreased while the Life Fund was not affected.

It explained that the 2010 actuarial surplus of Kes.25,000,000.00 transferred from the life fund was appropriately taxed under section 19(5) of the ITA. It argued that the assessment disregarded statutory provisions, was unfair and inconsistent with good tax practice as it subjected the same income to double taxation.

The respondent confirmed the objection by the letter dated 12th February, 2014, thus precipitating an appeal to the Tax Appeals Tribunal (the Tribunal). On 15th April 2016, the Tribunal delivered its judgment in favour of the respondent. It concluded as follows:

“The Tribunal finds in the circumstances that the amount of Kshs. 111,338,000 capitalized in the year 2010 from the statutory reserve by the Appellant was taxable transfer for the benefit of the shareholders and the assessment of tax respect thereof by the Respondent was appropriate. The Section 19(5)(b) of the Income Tax Act, CAP 470 of the Laws of Kenya is clear and applicable to circumstances precipitating in the filing of this Appeal.”

The appellant was aggrieved by the decision of the tribunal and filed an appeal in the High Court of Kenya (the High Court) against the said decision. The gravamen of the appellant’s case in the High Court was that the Commissioner and Tribunal misconstrued section 19(5) (b) of the ITA as read together with sections 45 and 46 of the Insurance Act by holding that the capitalization from the Statutory Reserve of Kes.111,338,000 in the year 2010 was a taxable gain for purposes of section 19(5)(b) of the ITA which defines a gain or profit of a life insurance company. The appellant raised two issues, i.e.

(a) Whether the capitalisation of Kes.111,388,000.00 in the year 2010 is a taxable gain for purposes of section 19(5) of the ITA.

(b) Whether Kes.111,388,000.00 had been subjected to double taxation of income.

The respondent, on the other hand, was of the view that the issue for consideration was whether Kes.111,388,000.00 capitalized in the year 2010 from a “Statutory Reserve’’ held within the long-term funds is a taxable transfer. Thus, the thrust of its case was that the Statutory Reserve was a fund within the Life Fund and that a transfer from it, such as the capitalisation in this case, for the benefit of shareholders fell within section 19(5)(a) of the ITA.

Held
The High Court found that the appellant created two funds; a Life Fund and a Statutory Reserve. The High Court further found that the Life Fund is a mandatory requirement for an insurance company like the appellant to carry on long-term insurance business and is specifically provided for under section 45(1) of the Insurance Act to support that business and to protect policy holders. The High Court found that the Life Fund is separate and distinct from the Statutory Reserve which was created by the appellant in 2004 and which is for the benefit of shareholders. The High Court thus found that the transfer of Kes.111,338,000.00 which the Commissioner subjected to taxation under section 19(5)(b) of the ITA was from the Statutory Reserve and not the Life Fund and was therefore not chargeable with tax under the aforesaid provision which only applies to a, “transfer from the life fund for the benefit of shareholders.”

Relying on several cases, such as the Cape Brandy Syndicate v Inland Revenue Commissioners [1921] KB 64, the High Court restated that a tax statute must be construed strictly. The High Court found that the use of the word “the life fund” in section 19(5)(b) of the ITA was very deliberate and was intended to apply to statutory fund created under section 45 of the Insurance Act specifically in relation to the life assurance business and that the said words were not intended to cover any other funds outside the province of section 45 of the Insurance Act or in relation to other classes of long-term insurance business.

The High Court, thus, overturned the decision of the Tribunal.

Our comment
Section 19 (5) of the ITA provides that “The gains or profits for a year of income from the long term insurance business of a resident insurance company, whether mutual or proprietary, shall be the sum of the following (a) the amount of actuarial surplus, as determined under the Insurance Act and recommended by the actuary to be transferred from the life fund for the benefit of shareholders (b) any other amounts transferred from the life fund for the benefit of shareholders and (c) thirty per centum of management expenses and commissions that are in excess of the maximum amounts allowed by the Insurance Act. Section 45 of the Insurance Act expects an insurer carrying on or commencing long term insurance in Kenya to establish and maintain a statutory fund under an appropriate name in respect of the long-term insurance business. It is only a transfer of money from the Life Fund for the benefit of shareholders that is caught by section 19 (5)(b) of the ITA.