The Commercial Code defines “life insurance” (article 588) as the contract by which “the insurer undertakes, in accordance with the modality and limits established in the contract, to pay a sum of money to the contracting party or to the beneficiaries, if the insured dies or survives the stipulated date.” For its part, the CMF points out that “life insurance” should be understood as “that contract that provides compensation to the beneficiaries, in case of death of the insured due to a cause covered in the policy.”
Under these definitions there are different modalities of life insurance: individual or collective, credit life insurance, whole life, temporary life, endowed life, life with savings, life with voluntary pension savings, etc.
Current tax situation:
Currently, the sums received by the beneficiaries of life insurance qualify as non-taxable income (NTI). Therefore,, they are not considered “taxable” or subject to a complementary first category or global tax. In addition, they are not considered in the Inheritance and Donations Tax, as the payment is made by a third party, and the insurance amount is not part of the deceased person’s wealth.
In general, this is consistent with the majority of countries’ treatment of life insurance. This is because, usually, life insurance is considered to fulfill a desirable social security function. Additionally, the life insurance industry has a regulated character and provides depth to the financial market. Life insurance is intrinsically, long-term savings instruments, and insurance companies must make longstanging investments with the policies they obtain from insurers. Thus, as a way to promote this “saving” and the social benefit that it carries, most laws establish a preferential tax treatment for them.
Life insurance with a saving component:
Life insurance with savings or “insurance with a single investment account”, in addition to the characteristics of ordinary life insurance, contain an investment account that generates profits. This profit-earning can be completely variable, or have a minimum guaranteed by the insurer. Likewise, the insured may have different levels of control over the investments made through the account. The funds in the single investment account can be withdrawn by the insured prior to death, in accordance with the deadlines and requirements indicated in the policy, or they can be accumulated to the compensation perceived by the beneficiaries at the time of the insured’s death.
Investment accounts emerged as an alternative to improve the benefits that life insurance pays. The variable disposal of the rentability of the investment account limits the risk of the insurer, and in most cases, allows to improve the compensation paid by life insurance. However, this tool that emerged to improve life insurance, in some cases is so predominant that makes the “insurer” disposition disappear from the life insurance. Such is the case denominated as “wrapper”, which is a life insurance associated with an investment account in a bank, controlled directly or indirectly by the insured, and in which the compensation paid by the insurance is limited almost exclusively to existing funds in the investment account.
Many countries have established rules to distinguish when life insurance is an insurance as such, and when it is a “wrapper” for an investment account. Limits are established on the incidence that the amount saved in the investment account may have on the total payment. For example, an insurance established with an investment account of USD 45.000, and that on the death of the insured pays the greater amount between the balance of the investment account and USD 1.000.000, in most cases it would be respected as life insurance, because the preponderant element is the “insurance” factor. On the contrary, an insurance that is established with an investment account of USD 985.000 and that the death of the insured pays the greater amount between the balance of the investment account and USD 1.000.000, normally would be assimilated to a bank investment account, and not insurance. The formulas are somewhat more complex, because they take into consideration the age of the insured, the deadline of the insurance and the mortality tables to determine if the insurance with an investment account keeps the nature of an “insurance”.
In relation to insurance with a single investment account, the Chilean IRS has established the following distinctions:
- The indemnities paid to the beneficiary upon the death of the insured are not affected by income tax or inheritance and donations tax. In other words, they are treated equally as any life insurance payment. This is consistent with the destination of the funds in the investment account, and with the fact that the investment account is a way to improve the efficiency of life insurance. Our legislation does not carry out an analysis of the substance or nature of the instrument.
- In relation to redemptions and withdrawals charged to the amount saved, the IRS established that these are amounts subject to income tax. That is, that non-taxable income of article 17 N ° 3 or the LIR is not applicable, since it is an income and different from the payment of an indemnity established in a life insurance policy due to the death of the insured. Thus, in view of an eventual withdrawal or redemption of such amounts of the insured, the income determined to be withdrawn is taxed. Besides, if the redemption of the amounts saved and invested by the insured is in favor of the beneficiary of the policy and not the insured, said operation can be subsumed in the broad concept of donation, since there is a free disposal of goods in favor of third parties, and consequently the donation tax is levied.
Proposed legal modifications and implications for the taxation of life insurance:
In order to finance the pension reform that is under discussion in the Congress, the Executive has proposed eliminating a series of tax exemptions.
Regarding the tax treatment of compensation for life insurance contracts, in article 8 the proposal eliminates the word “life insurance” from article 20 of Law 16.271, rule that made inheritance tax inapplicable to the compensation received under this type of contract.
Consequently, the project makes indemnities that originate in life insurance contracts subject to inheritance tax, always providing that said contracts are concluded from the date of publication of the law. Thus, the beneficiary taxpayers must consider the sums received by virtue of a life insurance in the hereditary mass, making up the tax base, in order to pay taxes for said concept, observing the general exemption and reduction rules of the inheritance tax.
It is relevant to mention that the bill, regarding the elimination of the exemption from inheritance tax for sums received by virtue of life insurance, has not suffered indications that modify its content in the Labor Commission of the Chamber of Deputies, and still waiting for the indications that the Finance Commission may introduce.
The proposed reform is extremely criticized. First, it arbitrarily discriminates between existing contracts and future contracts. Tax regulations can change and affect unconsolidated situations. Under the logic of the reform, the DFL2 should not be eliminated to those who have homes that already enjoy the benefit, VAT should not be applied to service contracts already concluded and the income tax should not be modified to companies or people whose income derives from pre-existing contracts. Second, reform is a shot at the flock. It does not distinguish between the different types of life insurance. The correct thing to do would be to distinguish between those life insurance such as, with respect to which a preferential tax treatment is justified, and to maintain it, from those that are simple investment instruments involved in a policy. It’s what multiple jurisdictions do. Finally, the project does not take care of structural aspects. The beneficiaries of life insurance may not be residents of Chile or be institutions or entities; the insured may not be a Chilean resident; the death of a third party who has no connection with the payment of the policies can be insured; and the insured life can be that of a non-resident person in Chile. All these variations would make it impossible to apply the inheritance and gift tax. The bill is not put into either of these scenarios.
