Consultations on tax implications of international accounting rules for insurance contracts (IFRS 17)
Accounting standards specify how transactions are recognized, measured, presented and disclosed in financial statements. While these standards are set by national accounting bodies, many countries, including Canada, follow the standards set by an independent international body, the International Accounting Standards Board (IASB). The movement towards global accounting standards reflects businesses’ increasing participation in the global marketplace. Investors also benefit from the consistency and reliability of international standards. Since 2011, Canadian publicly-traded enterprises have followed IASB’s International Financial Reporting Standards (IFRS), the same standards used in more than 100 other countries.
Insurers in Canada adopted IFRS reporting standards, including the standards pertaining to the reporting of insurance contracts (IFRS 4), in 2011. IFRS 4 was intended to be an interim standard for insurance contracts, pending the completion of a more comprehensive and uniform standard – IFRS 17.
Changes to the Accounting Standards for Insurance Contracts
On January 1, 2023, under IFRS 17, accounting standards for insurance contracts will substantially change financial reporting, primarily for two broad categories of insurance companies: life insurers – which includes annuity, accident and health insurance providers; and property and casualty (P&C) insurers – which includes auto, personal property, commercial property and liability insurance providers.
Income, as measured using generally accepted accounting principles, typically serves as the basis for computing a corporation’s taxable income. The current measurement of taxable income for insurers closely matches that of accounting income under IFRS 4.
IFRS 17 will significantly alter the measurement of corporate income from insurance contracts, particularly by changing deferred recognition into profits of a portion of insurance revenues, which is currently included in income when insurance contracts are sold. Deferring raises key tax policy questions about how profits from an insurance business should be measured for tax purposes.
The unique nature of insurance contracts, where premiums are pooled then invested in order to pay claims often years after contracts are sold, has led to specific rules regarding the computation of income. Special rules permit insurers to set aside tax-deductible reserves in recognition of the future claims to be paid from premiums received.
Reserves under IFRS 17 will continue to be determined actuarially when the insurance contracts are sold. IFRS 17 will introduce a new reserve, the Contractual Service Margins (CSM), that will contain a portion of the profits earned on underwritten insurance contracts to be deferred and gradually 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. 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.
Government of Canada’s Position
The government intends to implement changes that will generally support the use of IFRS 17 accounting for income tax purposes. However, adjustments would be made to recognize profits as taxable income so that it remains aligned with economic activities, as under current rules. More specifically, the CSM would not be considered a deductible reserve for tax purposes. This approach would largely preserve the existing tax rules.
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.
Consultation Process and Next Steps
The government is seeking input on how best to achieve the desired tax policy outcome in a way that facilitates implementation by insurance companies, and is auditable by the Canada Revenue Agency. The government is also seeking views on other potential taxation issues that could arise from the implementation of and transition to the new standard This consultation will assist the government in developing potential modifications to the Income Tax Act and other administrative tools.
Stakeholders are invited to provide comments by July 30, 2021. Comments can be sent to firstname.lastname@example.org.
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Department of Finance Canada
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