Strategic Tax Planning.The changing economic landscape presents opportunities for those well-versed in tax law. Insurers must consider the impact of taxes--international, federal, value-added and state--as they make strategic decisions about the future of their business. In particular, they must base decisions on their overall domestic or global tax position rather than on the tax position of individual operations within a subsidiary, product line or geographic area. Effective strategic tax planning Tax planning Devising strategies throughout the year in order to minimize tax liability, for example, by choosing a tax filing status that is most beneficial to the taxpayer. is an even bigger challenge when considered in the context of such market trends as financial-services convergence and the recent Financial Services The examples and perspective in this article or section may not represent a worldwide view of the subject. Please [ improve this article] or discuss the issue on the talk page. Modernization Act, competition for savings, the Internet and globalization globalization Process by which the experience of everyday life, marked by the diffusion of commodities and ideas, is becoming standardized around the world. Factors that have contributed to globalization include increasingly sophisticated communications and transportation . If done well, however, tax planning can boost earnings and market capitalization Market Capitalization A measure of a public company's size. Market capitalization is the total dollar value of all outstanding shares. It's calculated by multiplying the number of shares times the current market price. This term is often referred to as market cap. . It also can provide the savings necessary to make a winning bid or a strategic investment. The stakes are high, indeed: According to according to prep. 1. As stated or indicated by; on the authority of: according to historians. 2. In keeping with: according to instructions. 3. 1997 annual statements, taxes paid by U.S. insurers exceeded $33 billion, representing 45% of net income before federal income taxes and 3.7% of total revenues (excluding employer-paid employment taxes). The Convergence Trend Financial-services convergence is one area where tax rules and the authorities responsible for applying them are not able to keep up with the rapidly changing market. Because tax rules differ for life insurers, property/casualty insurers, banks and other financial intermediaries Financial intermediaries institution that provide the market function of matching borrowers and lenders or traders. , this lag will present both opportunities and hurdles for firms striving for effective tax planning. Opportunities will arise because an organization providing several different kinds of financial services may have the flexibility to use the tax rules that provide the most tax-efficient answer for a specific investment or product. For example, federal tax rules treat interest from tax-exempt bonds Tax-exempt bond A bond usually issued by municipal, county, or state governments whose interest payments are not subject to federal and, in some cases, state and local income tax. tax-exempt bond See municipal bond. differently, depending on whether an insurance company, bank or other type of financial institution owns the bonds. If a company manages its investment portfolio on an organization-wide basis, it can select which entity should hold the tax-exempt bonds so that the company as a whole increases its after-tax return. (See "Tax Rules" on page 138.) As financial services converge, hurdles to achieving the optimum tax position loom larger for the inexperienced. For example, tax inefficiencies may arise when a company extends its products and services into an area where it has no expertise and the rules are different. The tax rules that apply to each traditional segment of the financial-services industry, such as insurance and banking, are complex and vary greatly from one to another. It used to be that the segments were neatly divided; tax departments and tax professionals specialized in single segments. But an organization that offers a supermarket of financial services and delivery channels is now less likely to have the expertise needed to maximize tax efficiency. This creates the possibility of omissions and errors in corporate tax-reduction efforts. State and local tax systems present their own set of opportunities and traps. State governments and local municipalities have varying tax requirements for different types of financial services companies, as well as different rules for each jurisdiction. This diversity of rules in states and localities increases both the opportunities for tax planning and the potential for tax inefficiencies. Financial intermediaries must monitor the expansion of their activities and their state and local tax burdens to ensure that they do not pay more taxes than necessary. Financial-services convergence encompasses the bringing together of insurance, banking and other financial businesses within a single organization as well as the merging of capital markets and insurance products. Examples of the assumption of traditional insurance by the capital markets include the creation of catastrophe bonds catastrophe bond A debt security with a payoff tied to the relative severity of a natural disaster such as a hurricane or earthquake. Bondholders are paid with insurance premiums but may have to accept reduced principal repayment in the event the specified and swap instruments, for which investor returns are contingent on Adj. 1. contingent on - determined by conditions or circumstances that follow; "arms sales contingent on the approval of congress" contingent upon, dependant on, dependant upon, dependent on, dependent upon, depending on, contingent some catastrophe or weather-related event, and the Chicago Board of Trade's exchange-traded futures contracts Futures Contract An exchange traded agreement to buy or sell a particular type and grade of commodity for delivery at an agreed upon place and time in the future. Futures contracts are transferable between parties. linked to insurance risk. The tax system is an obstacle to the expansion of this type of convergence, in that it still has separate rules for financial instruments and insurance products. As the market merges them, it creates uncertainty about which set of tax rules should apply. The confusion caused by different sets of rules however, presents opportunities to structure new instruments or products to obtain a more favorable tax result. Given the pace of the introduction of creative new instruments, it is unlikely that the tax rules will catch up with the convergence of capital markets and insurance risk. More Competition for Savings As the markets evolve and financial-services convergence continues, companies must decide which services will attract consumers savings dollars. As organizations make their choices, they will need to better understand how current tax law and possible future changes will influence the growth rate of different investment vehicles. Over the past several years, various tax proposals have been made that would have a dramatic impact on life insurance products and annuities. These include taxing fund transfers within a variable annuity Variable Annuity An insurance contract in which, at the end of the accumulation stage, the insurance company guarantees a minimum payment. The remaining income payments can vary depending on the performance of the managed portfolio. , increasing the capitalization of acquisition costs for tax purposes and changing the way tax reserves are computed. These proposals would either increase the price of products or diminish their investment return, which would decrease demand for them or reduce their profit margins relative to alternative products. Other examples of potential tax law changes that could affect the demand for investment products include a reduction in the capital-gains tax rate and increases in contribution limits to individual retirement accounts. A capital-gains tax cut would make mutual funds more attractive relative to variable annuities Variable annuities Investment contracts whose issuer pays a periodic amount linked to the investment performance of an underlying portfolio. . And higher IRA Ira, in the Bible Ira (ī`rə), in the Bible. 1 Chief officer of David. 2, 3 Two of David's guard. IRA, abbreviation IRA. contribution limits also could have an impact on the variable-annuity market, enabling banks, mutual funds and broker-dealers to regain some of this business. Finally, there is Social Security reform, which is still being debated on Capitol Hill. Revision of the Social Security system could represent the largest partial conversion from a defined-benefit to a defined-contribution plan Defined-Contribution Plan A retirement plan wherein a certain amount or percentage of money is set aside each year for the benefit of the employee. There are restrictions as to when and how you can withdraw these funds without penalties. ever contemplated. Congress is considering different forms of private retirement-savings accounts that would supplement or partially replace Social Security. The impact of this potential reform and its tax effects on the financial-services marketplace could be extensive, with financial intermediaries competing aggressively for new savings dollars. Internet Taxes Before these efforts could gain much headway, however, the United States Congress preempted virtually all conceivable forms of Internet taxation. The purpose of the 1998 Internet Tax Freedom Act was to nip in the bud these incipient taxation efforts. Congress has imposed a temporary moratorium on new Internet See Web 2.0 and Internet2. taxes so the Internet can grow unimpeded unimpeded Adjective not stopped or disrupted by anything Adj. 1. unimpeded - not slowed or prevented; "a time of unimpeded growth"; "an unimpeded sweep of meadows and hills afforded a peaceful setting" while a comprehensive Internet-taxation regime is developed. The early stages of the debate have focused on Internet sales and use taxes Sales and use tax refers to:
v. o·bliged, o·blig·ing, o·blig·es v.tr. 1. To constrain by physical, legal, social, or moral means. 2. to collect tax for sales in a state unless it has "nexus" with the state, which generally requires a physical presence in the state. In a world of electronic commerce, a physical presence is not required to provide goods and services In economics, economic output is divided into physical goods and intangible services. Consumption of goods and services is assumed to produce utility (unless the "good" is a "bad"). It is often used when referring to a Goods and Services Tax. to the consumer. States always have taken the position that they may collect premium tax from insurance companies for sales in their state, and this is also their position vis-a-vis sales made over the Internet. Indeed, the moratorium on Internet taxes has an exception for existing taxes (including sales taxes sales tax, levy on the sale of goods or services, generally calculated as a percentage of the selling price, and sometimes called a purchase tax. It is usually collected in the form of an extra charge by the retailer, who remits the tax to the government. and premium taxes). Nevertheless, the Internet still might figure into an insurance company's tax planning. For example, if insurance or other financial services are purchased over the Internet, a company may more easily direct the premium or fees to the affiliated insurer or other service provider whose federal or state tax treatment is the most favorable. Impact of Globalization The Internet also raises challenging international income-tax issues. International tax systems generally place great emphasis on the source of income to determine its tax treatment. Determining the source of information and services sold over the Internet raises challenging administrative issues for taxing authorities because such sales can be made anywhere in the world without the vendor's physical presence. The Internet may require governments to fundamentally change their international tax policies, a development that would have a tremendous impact on the financial-services industry As with other market trends, the globalization of the insurance industry especially U.S. carriers' growing appetite for foreign operations, comes with its own set of tax issues. A particular challenge for insurers expanding abroad is the deferral deferral - Waiting for quiet on the Ethernet. of income earned by foreign subsidiaries. Generally, a U.S.-based company may defer federal income tax on income earned by foreign subsidiaries until the earnings are actually repatriated. But U.S.-based insurers are excluded from this rule and typically must pay income tax on the earnings of foreign insurance subsidiaries as that income is earned. Some progress has been made in achieving parity for insurers. In 1997, Congress enacted a provision for 1998 that permitted U.S.-based insurance companies to defer tax on income from foreign subsidiaries earned from insuring risks in the subsidiaries' country of domicile domicile (dŏm`əsīl'), one's legal residence. This may or may not be the place where one actually resides at any one time. The domicile is the permanent home to which one is presumed to have the intention of returning whenever the purpose . Congress re-enacted the provision, in modified form, for 1999 and recently through 2001. Ideally, the provision would be made permanent, a move currently prevented by its substantial revenue loss to the government. As U.S.-based insurers expand abroad, this tax deferral tax deferral The delay of a tax liability until a future date. For example, an IRA may result in a tax deferral on the amount contributed to the IRA and on any income earned on funds in the IRA until withdrawals are made. will be increasingly important to their ability to compete, especially in countries with lower tax rates than the United States United States, officially United States of America, republic (2005 est. pop. 295,734,000), 3,539,227 sq mi (9,166,598 sq km), North America. The United States is the world's third largest country in population and the fourth largest country in area. . As is the case with financial-services convergence, globalization will require U.S.-based insurers to address complicated tax issues. But international tax planning can provide numerous savings opportunities, justifying the expenditure. Globalization also will be a challenge for the large number of financial services organizations that do not coordinate their international operations Internal Operations (I.O., IO or I/O) is a fictional American Intelligence Agency in Wildstorm comics. It was originally called International Operations. I.O. first appeared in WildC.A.T.S. volume 1 #1 (August, 1992) and was created by Brandon Choi and Jim Lee. centrally. A firm that operates in several countries is likely to have many opportunities to improve its overall tax efficiency. To benefit from these opportunities, it must be able to globally coordinate its tax-planning efforts. This means making decisions based on the organization's overall tax liability rather than that of the operations in each country. This will demand new management information processes, additional expertise and a new global mindset mind·set or mind-set n. 1. A fixed mental attitude or disposition that predetermines a person's responses to and interpretations of situations. 2. An inclination or a habit. for solving problems. The new shape of the financial-services market brings new business models and operations that are not addressed in current U.S. and foreign tax laws. Insurers who marshal the necessary resources to optimize taxes on an enterprisewide basis are poised to see a more profitable bottom line and increased shareholder value. Terry A. Jacobs is a partner and national director of insurance tax services, and Thomas S. Neubig is a partner and national director of policy economics and quantitative analysis Quantitative Analysis A security analysis that uses financial information derived from company annual reports and income statements to evaluate an investment decision. Notes: . Both are with Ernst & Young LLP LLP - Lower Layer Protocol , Washington.
Assets Under Management
The portion of total investments managed by financial-services
providers has shifted since 1978.
1978 1998
Banking 62% 30%
Insurance 15% 13%
Mutual Funds 2% 18%
Pensions 15% 24%
Other 6% 14%
Source: Federal Reserve Board of Governors, Flow of Funds
Tax Rules
Tax treatments differ by industry segment.
Life Nonfinancial
Insurers P/C Insurers Banks Companies
Tax-Exempt Policyholder's 15% of tax- Pro-rata Interest
Interest share of tax- exempt portion of disallowed
exempt interest interest only for
interest disallowed expense borrowings
disallowed- allocated used to
generally to tax- purchase tax-
40%-95% exempt exempt bonds
bonds
disallowed
Consolidation Limits No limits No limits No limits
State tax Generally pay Generally pay Pay tax on Pay tax on
tax on gross tax on gross income income
premiums premiums
International Generally Generally Generally Subject to
(Value-added tax) exempt; no exempt; no exempt; no value-added
credit for credit for credit for tax; credit for
input tax input tax input tax input tax
Source: Ernst & Young LLP
|
|
||||||||||||||||||
Printer friendly
Cite/link
Email
Feedback
Reader Opinion