Pay VAT on receipt of shortterm insurance compensation
Generally, businesses enter into insurance contracts to safeguard against future unforeseen adverse eventualities such as theft or fire. As with many business contracts, such contracts often come with embedded tax implications which must be known to avoid tax exposures. The purpose of this week’s article is to bring to the fore the VAT implications of receiving shortterm insurance compensation by VAT-registered persons from a short-term insurer.
The basics
Short-term insurance covers losses, damage, and liabilities in relation to property, business disruption or professional indemnity claims such as incorrect advice by a professional firm to a client. It also encompasses losses incurred by means of theft, fire or other means of destruction or dispossession. In particular, workman’s compensation is also regarded as short-term insurance. An indemnity refers to a contractual obligation for one party to provide compensation in the event of losses on the part of another. These arrangements are reduced to writing in contracts to indemnify a party which would have incurred the costs of any damages or losses in the event of an accident or claim.
Premiums may be paid monthly or on an annual basis. Typically, short-term insurance is for a period of one year and is renewable annually at the option of the insured. It can also be for an unspecified (indefinite) period.
The law
VAT of the receipt of short-term insurance indemnification is covered by provisions of the VAT Act Chapter 50:03. Furthermore, Section 2 of the same Act defines a shortterm insurance contract as a, ’contract of insurance, including reinsurance, or guarantee against loss, damage, injury, or risk of any kind, whether pursuant to any contract or law, and includes a renewal of such contract, but does not include a life insurance contract.’
Application
The said Act provides that where a VAT registered person receives an indemnity payment under a short-term insurance contract, such a receipt is deemed to be a payment for a supply of services performed by the insured person. Accordingly, the insured person will be required to account for output tax on the amount so received only if the short-term insurance conchargeable tract was to VAT at a positive rate such as 14% or 12%. The indemnity amount is deemed to be VAT inclusive, and VAT is extracted using the tax fraction.
Further, VAT registrants are also required to pay VAT to BURS from compensation paid to third parties by an insurance company. For example, if Co A’s vehicle rams into Retailer B’s premises and Co A’s insurance pays P11.4m to Retailer B, Co A is expected to, despite not receiving any monies, to pay VAT to BURS. The same applies in instances where an insurance company pays a garage, a union or an employee directly, i.e., the insured is required to still pay VAT to BURS regardless of the fact that he wouldn’t have received any monies. This is where many businesses break the law and underpay VAT.
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