Insurance customers could face a significant financial burden as a result of a contentious proposal that has divided experts and insurance companies. The Finance Bill 2023 aims to introduce a new provision under section 17 of the Value Added Tax (VAT) Act, requiring individuals who receive compensation for their losses from insurers to pay a 16 percent tax.

According to the Finance Bill, if a legitimate owner of taxable supplies, who has already deducted input tax, receives compensation for the loss of those supplies, the compensation will be treated as a taxable supply. This means that if someone receives a compensation of Sh1 million from an insurance claim, they will be required to pay Sh160,000 as VAT. This potential tax burden is anticipated to adversely affect the appeal of insurance in a market with less than three percent penetration.

Industry professionals are urging Parliament to exclude insurance from the list of compensation income subject to the 16 percent tax. The insurance sector believes that implementing this tax would impede its growth, while the government aims to generate additional revenue for the 2023/2024 fiscal year.

Data from the Insurance Regulatory Authority reveals that general insurers paid out claims totaling Sh72.26 billion last year, compared to Sh64 billion the previous year, with Sh33.85 billion attributed to private and commercial vehicles.

If the proposal is approved, it would align Kenya with markets such as South Africa, where insurance payouts are regarded as a supply of goods and are consequently subject to VAT.

Prominent audit and advisory firms, including KPMG and PricewaterhouseCoopers (PwC), caution that taxing insurance compensation would have a negative impact on the general insurance business. The Association of Kenya Insurers (AKI), a sector advocacy group, is also lobbying for the exclusion of insurance compensation from VAT obligations.

KPMG highlights that the proposed provision would affect compensation received from insurance claims when input VAT has already been claimed. PwC argues that taxing insurance compensation contradicts the nature of VAT, as insurance payouts cannot be considered a supply of goods and services.

PwC further emphasizes the need for stakeholders to engage in discussions regarding the ambiguous rationale and framing of the law before its enactment.

Aware of the tax authority’s tendency to interpret tax laws in its favor unless courts rule otherwise, AKI urges Members of Parliament to amend the clause explicitly excluding insurance compensation from VAT. AKI has recently submitted its input to MPs and hopes that the Bill, which will be sent to President William Ruto for approval, will be revised to accommodate the exemption of insurance compensation.

AKI Chairman Tom Gichuhi asserts that insurance is VAT-exempt, and therefore, introducing VAT on insurance compensation contradicts its exempt status. He appeals to Parliament to either remove the amendment or explicitly exempt insurance business from VAT.

This proposal by the government mirrors the three-year legal battle between the Kenya Revenue Authority (KRA) and Sony Holdings, the owner of Westgate Mall. In this case, KRA sought Sh380.3 million in taxes from Sony for a Sh4.4 billion payout made by Kenindia Assurance Company as compensation in 2014. The owners of Westgate Mall argued that the tax authority unjustly classified part of the compensation as revenue rather than capital, justifying the tax demand.

KRA has previously been involved in legal disputes with insurance companies over taxes on the sale of salvaged motor vehicles. For instance, in 2016, Madison Insurance successfully argued before the Tax Appeals Tribunal that the proceeds from the sale of salvage vehicles should be considered part of the compensation paid to the insured and therefore exempt from VAT.

In a case where an insured person chooses to retain the salvage and receives additional funds to reinstate the vehicle, they would not be required to account for VAT on the salvage, according to the insurer’s argument.

Despite KRA seeking Sh21.28 million as VAT from Madison’s sale of salvage motor vehicles, the tribunal ruled in favor of the insurance company, stating that salvage is an integral part of the insurance business and thus exempt from VAT.