Bangladesh tax revenue

by Dhiman Chowdhury

OUR Income Tax Ordinance 1984 (the Fourth Schedule) requires corporate tax to be determined by the higher of the two: (i) external earnings and (ii) surplus or deficit by actuarial valuation. External earnings are noncore items such as interest, dividends and rents minus management expenses (maximum 35 per cent of gross premium). Noncore items cannot be the measure of performance (profit or loss) of a business which has core items such as premium income and claims and benefits paid. Also, external earnings are financing and investing activities but life insurance premium and claims are principally operating activities. Consequently, all companies always showed losses by this method and the government did not get any tax. For example, Popular Life Insurance Company reported external earnings of Tk 2,194 million in 2014 whereas; its allowable management expenses were Tk 2,318 million resulting in a loss of Tk 124 million. Similarly, Delta Life Insurance’s 2014 external earnings were Tk 3,034 million, allowable management expenses were Tk 1,535 million and losses were Tk 1,499 million. This loss scenario is true for all other companies during their history.

The second method
THE second method of measuring profit involves two disciplines of knowledge: accounting and actuary science. Since I am not an actuary I would accept their actuary valuation but their applied system of accounting is faulty. Their actuary surplus is equal to year-end balance of revenue account minus year-end liabilities due to the policies maturing after the accounting year, plus the premium to be received from these policies. The problem here is that both the year-end balances are accumulated from the past and as a result the surplus or deficit is not the current year’s result. Thus, tax calculated on this surplus will not be tax on current year’s surplus (profit). This method of determining profit (surplus) involves past (beginning balance of revenue account), present (current year’s premium and other incomes) and future (ending balance of insurance liabilities). Importantly, ending insurance liabilities of policies maturing after the accounting year is not disclosed in the balance sheet. Their surplus valuation and corresponding tax determination violates the accounting principle of periodicity. This accounting principle is an accounting fundamental well accepted throughout the world for all business organisations. Under this principle, performance of a business measured by profit (surplus) is related to a particular period of time, usually one year. This method also violates another basic accounting principle — matching principle — where all the current period’s revenues are matched with all the current period’s expenses.

Further accounting flaws
OUR life insurance companies do not prepare a profit and loss account in its annual report. A business organisation without a profit and loss account is fundamentally wrong. All business organisations must prepare a profit and loss account every year to determine their profit and pay tax on such profit after some adjustments by the tax authority. Our life insurance companies prepare a revenue account but not a profit and loss account. This practice is inconsistent with the global accounting standard and practice.

Suggested method
THE United Kingdom and the United States America life insurance businesses (Legal and General, Royal London, Metlife, Foresters) prepare a standard income statement (profit and loss account) not revenue account, determine their yearly performance and tax on that performance or profit. An income statement takes into account all revenues including premiums received and due, external earnings like interest, dividends and rents, expenses including insurance claims and benefits paid and intimated, and management expenses such as agents’ commission and allowances and administrative expenses. To these, one more item has to be added: the potential claims and benefits of policies maturing beyond the current year, but may fall due in the current year. This item of expense in the UK, USA and India is called changes (movement) in policyholders’ liability which is the difference between ending and beginning liabilities to policyholders. It has to be mentioned with emphasis that this difference or change between ending and beginning is the claims expenses relevant for the current year. And the difference which is charged in the income statement can be verified by comparing the two years’ balances in the balance sheet. For example, ICICI has charged insurance claim increase of Rs 101,550 in 2011 income statement which is the difference between insurance liabilities balances in the balance sheet, Rs 641,204 in 2011 and Rs 539,654 in 2010. The estimation of liability for death benefits uses actuarial science where for each policyholder, the probability of dying is taken from the mortality table. Estimates for other claims and benefits by maturity, surrender and survival use various assumptions for interest, inflation, expenses, target profit, market competition and other contingencies. Indian companies like LIC and ICICI prepare a revenue account (also called policyholders’ account and technical account) and a profit and loss account (also called shareholders’ account and nontechnical account). Revenue account deals with insurance related business revenues and expenses, and profit and loss accounts deals with incomes (gains on sale of investments) and expenses not directly related to insurance businesses such as bad debts. In essence, these two accounts are the split of the profit and loss account because revenue account shows the operating revenues like premiums and operating expenses like claims and the balance is transferred to the profit and loss account.

Government revenue loss
SURPLUS determined in our life insurance companies does not relate to the current year rather it relates to past, present and future. For taxation purpose, profit and its various elements during a year is more relevant than the surplus on a particular date. For transparency, verifiability, and for determining allowable deductions, movements in the accounts are more helpful than their beginning and ending balances. Both accounting and actuarial assumptions are imperfect and therefore, profit or surplus determined using these imperfections involving the current year will be more accurate than bringing the past data (revenue account beginning balance and future [ending insurance liabilities]). It is to be specifically mentioned that profit and loss account does not include any past profit (unlike our revenue account), rather it includes all current profit, and it does not include any ending balance of insurance liabilities, rather it includes changes or differences between the ending and beginning balance which really relates to the current year. I calculated an average income tax paid as a percentage of net premium from 2013 to 2014. Our life insurance companies paid income tax, Pragati 0.87 per cent, Progressive 1.19 per cent, Popular 1.51 per cent, Rupali 1.57 per cent, Meghna 2 per cent and Delta Life 3 per cent. Whereas, UK companies paid during the same period, Aviva 2.62 per cent, AIG 4.87 per cent, Legal and General 6 per cent, Royal London 7.5 per cent, USA companies paid, Metlife 4.11 per cent, Foresters 2.69 per cent, Indian companies paid, LIC 3.2 per cent and ICICI 8.2 per cent (2002).

Final words
OUR Insurance Act 2010 (and also previous 1938 Act) in fact has provision for profit and loss account for all classes of insurance business (section 27 (1b)). But our companies are not complying with the regulation partly because of the flaws in the Fourth Schedule of our Income Tax Ordinance 1984.
Dr Dhiman Chowdhury is professor of Accounting at Dhaka University

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