Life savings insurance and taxation issues
Insurance is a regulated business in Azerbaijan and consists of two main areas, being life and general (non-life) insurance.Below we present a summary on life savings insurance by EKVITA's partner Sharaf Asgarova and tax consultant Brilliant Aliyeva.
Life insurance consist of five categories of personal insurance depending on the object of insurance:
- term life insurance;
- annuity insurance;
- endowment insurance;
- insurance against the loss of ability to work;
- insurance of incurable diseases.
Endowment insurance and annuity insurance are legally referred to as life savings insurance. Life savings insurance is a form of life insurance that provides for the collection of insurance premiums, which are paid by the insured on a regular basis, as fixed-term savings on the insurer. In spite of the fact that both endowment insurance and annuity insurance are forms of life savings insurance, there are fundamental differences between them.
Endowment insurance envisages the payment of insurance in the event that the insured passes away during the period of validity of the insurance contract or lives up to the age or period specified in it. This means that if the insured lives until the end of the period specified in the endowment insurance contract (or reaches the age specified in the contract), he/she receives an insurance payment from the insurer within the insurance amount specified in the contract. If the insured dies within that period, the sum is paid to the beneficiary (namely, the heir of the insured). Thus, the essence of endowment insurance is that the insurer pays the insurance premium both in the event of the death of the insured during the period specified in the contract and in the event of living until the end of this period.
Annuity insurance provides for periodic insurance payments in the form of pensions or rents in favor of the insured in case of reaching a certain age, disability or illness, loss of professional ability to work due to age, loss of the breadwinner of the family, unemployment, decrease in personal income and other cases causing loss of it. Under the annuity insurance contract also called pension insurance, the insurer makes monthly, quarterly, semi-annual or annual payments to the insured in the cases mentioned above and reflected in the contract (depending on the contract). For instance, in case of loss of the professional capacity to work or reduced income of a person over a certain age due to other reasons, in accordance with the terms stipulated in the annuity insurance contract the person may be provided with periodic insurance payment for the rest of his/her life in exchange for the annual insurance premium paid by him/her up to that age.
In essence, life savings insurance is similar to a bank deposit, but the fact, that it allows the insured to earn more than their actual salary, makes it a superior investment tool. Another advantage is that people's lives are objects of the insurance. That is, if the insured dies or loses his/her professional ability to work during the insurance period, the amount to be collected potentially at the end of the period, is paid by the insurance company to the insured or his relatives.
Since the logical response of the above-mentioned insurance relations is to make a certain payment (to obtain a certain income), it is important to assess the issue in terms of taxation. In this regard, let's look at the main points provided in the tax legislation.
Pursuant to Article 102.1.8 of the Tax Code, insurance premiums paid by the employer on life savings insurance and pension (annuity) insurance to the insurers of the Republic of Azerbaijan from the part not exceeding 50 percent of the taxable income of the insured under the contract concluded for a period of not less than three years, any amount paid to the insured and the beneficiary after the expiration of a period of three years from the date of entry into force of the contract on life savings insurance and pension insurance are exempt from income tax for natural persons. Exemption from compulsory state social insurance (social insurance premiums deducted from the employee and calculated by the employer) is regulated by Article 15 of the Law “On Social Insurance”.
Since income tax rates and state social protection fund premiums differ for those working in the public and oil and gas sector and those engaged in the private sector, to better illustrate the insurance benefits we present two case scenarios.
Example 1. The salary indicated in the employment contract of an individual working in the public/oil and gas sector is 3,000 AZN (gross). If this employee is insured for life savings insurance in the amount of 50% of their taxable income, employer will transfer 1,500 AZN (3,000x50%) to the insurance company and 1,198 AZN (after mandatory state contributions)) to the employee. It should be noted that the legislation does not limit the amount to be transferred to the insurance company as a life insurance, but simply sets the limit for application of exemption. On the other hand, if the employee has any status to which the tax exemption is applied, the amount of the relevant exemption is deducted from the amount of the gross salary.
Example 2. Salary indicated in the employment contract of an individual who works in private sector (non-oil and gas) is 3,000 AZN. If 50 percent of this employee's taxable income is insured under life savings insurance, the enterprise transfers 1,500 AZN (3,000x50%) to the insurance company as insurance premiums, and 1,319 AZN (after mandatory state contributions) to employee as his/her salary.
In practice, it is possible for an employer to pay 22% of 1,500 AZN, namely 330 AZN, to an insurance company in favor of an employee. In this case, given amount will be considered income from employment, and as a result, the employee's income will be calculated 3330 AZN, instead of 3000 AZN. Hence, the employer pays 1830 AZN (1500 + 330) to the insurance company. 1665 AZN being exempt from income tax and compulsory state social insurance premium is transferred to employee as his/her salary.
Note. Since exemptions from unemployment insurance and compulsory medical insurance (effective of 1 January 2021) are not envisaged by legislation, these deductions are calculated from the full salary.
It should be taken into account that the difference between insurance premiums paid by the insured or paid in his favor and insurance payments under the life insurance is considered income from non-entrepreneurial activities and is taxed at the source of payment at the rate of 10 percent (Tax Code, Articles 99.3.9 and 123.4).
Termination of the contract for any reason. According to Article 116.3 of the Tax Code, in case of early termination of the insurance contract, the paid insurance premiums are taxed by the insurer at the source of payment. In this case, employer must submit a certificate on tax and social insurance premiums deducted from the insured’s income for the duration of the contract, and the tax and social insurance premiums to be collected from the employee must be calculated by the insurer.
Social insurance premiums to be paid by an employer must be calculated and paid by the employer himself. For this purpose, the calculations by the insurer and the employer must be declared for the reporting period in which the payment is made (payments must be made by the insurer) and calculated separately for each month.