New tax legislation in Germany has implications for life and health insurance business.
On 1 January 2004 a slew of new German tax provisions came into effect, bringing many changes to several areas of the German tax system.
One of these changes relates to the health and life insurance industries, sectors which have faced some difficulties due to the so-called 'half income procedure' which was introduced into the German tax laws in 2001 to replace the imputation system. As a result of the implementation of the half income procedure and the weak economy in 2003, many insurance companies found themselves paying taxes on a deemed income which they never achieved. In order to overcome this, the German government decided to cancel the tax exemption of dividends and capital gains derived out of the sale of shares in a corporation as far as health and life insurers are affected (section 8b paragraph 8 Corporate Income Tax Code (CITC)).
Special tax provision
One source of the difficulties which hit the insurance industry is a special tax provision which applies to insurance companies only (section 21 CITC). Pursuant to section 21 CITC, certain premium reimbursements from the insurance companies to those insured are treated as a deductible item for tax purposes. Thus, in the tax balance sheet a respective provision has to be shown which decreases the taxable profit. The gist of this provision is that an insurer which makes profits and is therefore obliged to partially pay back the premiums shall be treated as if it had claimed a lower premium from the beginning. Thus, the reimbursements or the provisions to be shown in the balance sheets are treated as deductible items rather than a profit or a profit distribution.
A consequence of the half income procedure was that the income corporations derived from dividends and/or income derived out of capital gains from the sale of shares in corporations was tax exempt. As a result, the insurance companies attained tax-exempt dividends and capital gains which were shown in the commercial balance sheets. The profits shown in the balance sheets build the basis for the reimbursement obligations and the creation of reimbursement provisions of the insurance companies which were to be treated as tax deductible. Thus, the insurance companies benefited twice. Firstly, the dividends and capital gains were tax exempt, and secondly, the basis to determine the tax-deductible premium reimbursement obligation took the tax-free income into account and was high. This resulted in a low profit or a loss.
The other side of the half income procedure is that capital losses or write-offs of shares in corporations are generally not effective for tax purposes. In those cases in which a write-off or capital loss decreases the profit shown in the commercial balance sheet and therefore results in a low premium reimbursement obligation, the profit for tax purposes is still high and results in a taxation of deemed profits rather than in a taxation of actual profits.
The German government has now reversed the half income procedure with respect to health and life insurers insofar as the dividend-bearing shares are to be allocated to the capital investments of these insurers. Capital gains and dividends attained by life and health insurers are taxable as of 1 January 2004; and capital losses or write-offs of shares in corporations are tax-effective on the other hand. However, losses shall not be accepted for tax purposes if shares are acquired from a related entity and a capital gain of the related entity was tax exempt.
The health and life insurer may elect for a retroactive application of the new tax law for the years 2001 through 2003. In these cases, however, only 80% of the capital gains and dividends are tax exempt and only 80% of the capital losses and write-offs of shares in corporations are tax effective. The insurers have to irrevocably file for application by 30 June 2004 at the latest.
The changes only affect health and life insurers. They suffered extraordinarily under the old regime as they were obliged to reimburse or to build corresponding provisions for tax purposes of at least 80% (health insurer) or 90% (life insurer) of the capital income. The aforementioned provisions also apply for pension funds.
- Ralf Eckert is a partner in the Munich office of law firm McDermott, Will & Emery.