June 10, 2021 by David Gambrill
Canada’s finance department is looking to avoid a situation in which the new IFRS 17 accounting standards may give Canadian P&C insurers a tax advantage over other Canadian business sectors.
Canadian P&C insurers are working hard to update to new International Financial Reporting Standards (IFRS) before a deadline of Jan. 1, 2023. The aim of IFRS 17 is to standardize insurance accounting globally to improve comparability of financial data across organizations, as well as to increase the transparency of financial statements.
Currently, the Department of Finance Canada taxes insurer profits according to IFRS 4 standards. But the new IFRS 17 reporting standards add a new wrinkle: Under a special new reserve established under IFRS 17, insurers will be allowed to defer a portion of their profits until later years.
Unless the current way of taxing profit is tweaked, the federal government says, this new reserve could essentially give insurers an unfair tax advantage over other business sectors. That’s because insurers would be able to defer tax payments made on the deferred profits contained within the new reserve.
At the heart of the matter is a new “Contractual Service Margins (CSM)” reserve to be created under IFRS 17. The CSM will contain a portion of the profits earned on underwritten insurance contracts to be deferred; gradually, they would be released into income over the estimated life of the insurance contracts.
“If adopted for tax purposes, the introduction of the CSM mechanism would lead to a deferred recognition of profits into taxable income,” as the Department of Finance Canada explains on its website. “IFRS 17 will also introduce an asymmetrical treatment of profit and losses, as only profits will be deferred through the CSM. If, at the moment of underwriting, a group of contracts is expected to generate a loss over its lifetime, then the insurer will be required to immediately deduct the loss against income.”
Under IFRS 4 standards, upon which the current taxation of profit is based, special rules permit insurers to set aside tax-deductible reserves in recognition of the future claims to be paid from premiums received. The Department of Finance thinks the CSM should not be considered a deductible reserve for tax purposes.
“This approach would largely preserve the existing tax rules,” the finance department states on its website. “In the absence of such adjustments, profits from insurance policies — both new policies and policies existing at the time of transition — would no longer be aligned with the timing of economic activity.
“IFRS 17’s CSM would allow insurers to defer the recognition of profits until years following the taxation year in which the economic (income-earning) activities occurred. Deferring the recognition of profits for insurance contracts would result in deferred tax payments, which would raise equity concerns vis-à-vis other sectors of the economy. The proposed asymmetrical treatment between the profits and losses under IFRS 17 would exacerbate this concern.”
The finance department has established a consultation process with Canadian life and property and casualty insurers to figure out an approach for auditing and taxing profits under the new IFRS-17 standards.
Insurance industry stakeholders are invited to provide comments by July 30, 2021. Comments can be sent to email@example.com.
Feature photo courtesy of iStock.com/ridvan_celik