Sovereign loses $82m row with IRD

Last updated 05:00 02/02/2014

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ASB bank subsidiary Sovereign Assurance has lost an $82 million stoush with the Inland Revenue Department over reinsurance arrangements.

The country's largest life insurer failed in an appeal against a 2012 High Court judgment in which Justice Robert Dobson found it hadn't given the right tax treatment to reinsurance arrangements with three German reinsurers in the 2000 to 2006 tax years.

The Court of Appeal upheld the High Court finding, leaving Sovereign open to a potential liability of up to $90m, the judgment said. But Sovereign said the amount was only $82m as the figures provided to the court were estimates only. It had already provided for the full liability in its financial statements.

Sovereign said it was reviewing the Court of Appeal judgment and considering whether to seek leave to appeal.

CEO Symon Brewis-Weston said the issue had been a long-running one involving the technical application of the income tax rules to resinsurance contracts. There is no allegation of tax avoidance, he added.

Sovereign had consistently disclosed the issue in its financial statements since 2004, he said.

"Full disclosure has also been made to our financial strength rating agency, AM Best, and the outcome of the Court of Appeal proceedings will not impact Sovereign's A+ financial strength rating," Brewis-Weston said.

The Takapuna-based life insurer was founded in 1989 by Chris Coon and Ian Hendry and was bought out 10 years later by Commonwealth Bank of Australia subsidiary, ASB.

At issue in the tax dispute was components of reinsurance contracts or treaties made by Sovereign with Gerling, Hanover Re and Colgone Re. The fledgling company had three financial constraints. It solved the first in the normal way by passing on the risk of mortality claims made under the life insurance policies it sold through treaties with the German resinsurers.

The second financial constraint was funding the cost of establishing the policies which substantially surpassed the initial premiums paid by policyholders and the third obstacle to growth was the need to have sufficient balance sheet reserves for potential future liabilities.

It eased these cash flow problems by arranging for the reinsurers to pay refundable commissions on the life insurance policies issued. It would then repay those commissions plus interest on top over a number of years.

Under dispute was the correct taxation treatment of these two-way commission flows.

Justice Dobson said Sovereign had accounted for the refundable commissions received and repayments of them, plus interest, on the basis that the refundable commission were treated as income in the years they were received, while the repayments, plus interest, were treated as expenses in the years they were paid.

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He agreed with the IRD Commissioner that the refundable commissions and their payment amounted to a financial arrangement that fell under the accrual rules of the Income Tax Act. This meant only the portion of the repayments above the amount received by Sovereign (essentially the interest cost on using the principal) could be tax deductible.

Sovereign's appeal against the High Court ruling was limited to arguing the commission payments and repayments were items of a capital nature rather than revenue.

It said all the money flows were exempt from the accrual rules because they related to components of an insurance contract and the two sets of money therefore couldn't be unbundled.

- Sunday Star Times

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