Taxes – more than just a cost

Apparently, it was Benjamin Franklin who said “In this world, nothing can be said to be certain, except death and taxes.” Without going into a detailed analysis of whether death is certain, and whether there are tax-haven countries with sufficiently low taxes to stretch the point a little, I have some comments to make on the throw-away use of the word “certain”.

Taxes are not certain. Even if some amount of tax is unavoidable, the actual tax payable is not certain. This is not a massively complex idea, but does require a shift in mindset to consider taxes as something other than merely a cost that must be paid, something that reduces profits and returns to the owners of a business. I’m not even talking about optimising the amount of tax paid through careful tax structuring (which can be a good idea, if it is legal, and if the loophole stays open long enough to be beneficial, and if the extent of structuring makes business and moral sense).

I’m talking about considering the impact that tax has on business strategy, target market selection, business mix choices and competitive advantage.

A current example for me is the taxation of life insurance companies in Lebanon. Corporate tax on profits is 15% in Lebanon. However, for life insurers, the tax authorities have deemed it too difficult to nail down a clear measure of insurer profitability (another point for another blog, but in fairness to the tax authorities, insurers are rather notorious for adjusting actuarial reserves to arrive at the desired financial result …). Thus, insurers are taxed on “assumed profit” which is set to be 5% of revenue (mostly premiums written, which are considered as revenue, and investment income).

Some things to note:

  • The tax calculation is thus simple, which for most business is a good thing.
  • The effective rate of tax is then 15% x 5% x revenue = 0.75% x revenue.
  • If a company can make a higher margin than 5% of revenue, then they will benefit from the simplified tax system. If a company’s margins are thin and their net profit is less than 5% of premiums, they will pay a disproportionately large amount of tax.

The last point is where tax becomes interesting, and this is particularly ironic because in this case tax is more certain than usual (given it depends only on a single factor, revenue, rather than revenue and expenses). I’ll expand in my next posts on two important impacts this has for insurers and the economy as a whole.