Insurers face double hit from new accounting rules and new taxes

The leaders of Canada’s life-insurance companies, already unhappy they’ve been lumped in with banks for a new tax on financial institutions, have now learned they’ll face another multibillion-dollar hit when the government adopts new accounting rules when calculating their taxes.

The federal budget, released last Thursday, revealed the final decision on how Canada’s tax code will incorporate IFRS 17, a complicated new global accounting standard for the insurance industry. In development for years, the new accounting rules will be in place in 2023.

The government said it will adopt the changes wholesale – except for one accounting rule that would have allowed life insurance companies to recognize certain profits, and therefore pay the taxes on them, over many years. Instead, the government wants insurers to pay the taxes upfront, when insurance contracts are signed.

That will bring in an extra $2.35-billion in federal revenue over the next five years, the government estimates. Insurers say provincial corporate income taxes could add $2-billion more over the same period.

The extra costs for insurers will come on top of a new one-time tax on profits earned by Canada’s largest banks and insurers, and a permanent hike to their annual corporate tax rates, both outlined in the budget last week. These are expected to cost $6.1-billion over the next five years, although the hit is less severe than originally forecast in the Liberals’ campaign promises last fall.

Debates about whether to recognize taxable profits over several years versus an upfront payment might typically be relegated to academic tax journals or accountants’ client bulletins. But the government’s decision – however well-telegraphed via industry consultations last year – seems to add insult to injury, insurers say.

Stephen Frank, chief executive officer of the Canadian Life and Health Insurance Association (CLHIA), said his group urged the Department of Finance in 2021 not to reject the accounting rule, and was “surprised and disappointed” to learn last week it had failed to persuade the government.

“This puts Canada offside every other jurisdiction globally,” he said Monday in an interview with The Globe and Mail. “Companies are going to have to fund this tax liability somehow, and I’m not sure how that’s going to work. So we’re disappointed with the direction they’ve gone here.”

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What the government has done, however, is not so much create a new tax as fail to extend a tax-deferral benefit to the insurers that would have occurred under the new accounting rules, accountants and analysts say. Very broadly, current accounting rules, as well as Canadian tax rules, allow for the recognition of losses and profits when insurance long-term contracts are signed.

The government’s view, as outlined in its request for comment published last year, is that IFRS 17, if adopted for tax purposes with no changes, would “introduce an asymmetrical treatment of profit and losses, as only profits will be deferred through the [new rules].” Insurers would continue to recognize expected losses upfront for tax purposes, the Department of Finance says.

If the government did not reject that one portion of the new IFRS standard, “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.”

The industry strongly disagrees with this assertion. In its submission to the government last year, CLHIA said the deferred profits haven’t yet been earned by the insurer, but the new rules will tax them as if they have been. “The government’s proposal ... assumes that all ‘economic (income-earning) activities’ are performed at inception of an insurance contract. ... The CLHIA respectfully disagrees.”

CHLIA says it surveyed companies representing 85 per cent of the life-insurance business in Canada, and more than two-thirds said they’ll see “a substantial increase in taxable income in the 2023 taxation year.”

In an update to clients, the law firm Osler, Hoskin & Harcourt LLP said “the budget materials implausibly suggest that the deferral of unearned profits is ‘undue’ and that 90 per cent of the insurer’s ‘key economic activities’ under a long term insurance contract (often with a term in excess of 20 years)occur upon contract issuance.”

Nigel D’Souza, an equity analyst for Veritas Investment Research, says “the post-IFRS 17 income tax accounting is going to be similar to the pre-IFRS 17 income tax accounting. So if they didn’t make that change, tax revenue would have been lower.”

“I think what it comes down to is ... what is the rationale to justify variation between financial reporting and tax reporting?” Mr. D’Souza said. “And in this case it is justified in order to maintain consistency. And to me that makes sense.”

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