In December 2024 the Cape Town tax court found that an additional assessment made by SARS in relation to a contingency policy premium was out of time and had prescribed. In doing so, the court made some important findings regarding the nature of contingency insurance that properly recognise the nature of modern insurance.

The citrus farming company (taxpayer) took out a contingency policy to cover risks inherent in citrus farming activities particularly citrus black spot and a pest called false codling moth for which the taxpayer had borne its own losses till they took out a structured insurance product in 2017. The premium was R10 million, the underwriting charge was 4% and the risk transfer limit was 20% (the risk cover amount was therefore R12 million). The amount was broken down and allocated to specific fields or orchards identified by number and type of citrus, suggesting some form of risk assessment was done.

According to the policy: claims were limited to the policy indemnity limit; the insurer paid claims from the balance of an “experience account” and if the total claims exceeded the balance of the account, as a policy payment; the policy could be cancelled on 30 days’ notice at any time entitling the insured to payment of the balance of the experience account; the initial underwriting fee was levied; a monthly statement of the experience account was issued; and the policy could be pledged as security.

In finding that there was no misrepresentation for the purposes of section 99(2) of the Tax Administration Act, the court made the following findings:

“[99] The SARS argument was that the premium paid was unusual or unconventional for an insurance contract, and that having regard to certain characteristics of the contract, it did not meet the requirements of section 11(a).

[100] While commercially an insurance premium that gives rise to a risk benefit over a short period in an amount of 120% of the premium may be unusual, the insurance contract in fact entitles the taxpayer to payment of the full risk benefit in exchange for the premium. Thus if, on the day after the policy was taken out, the taxpayer had in a storm lost fruit in the insured orchards with a value equal to or higher than R12 million it would have been entitled to claim insurance cover payments for R12 million. Thus there was an insurance premium that was paid.

[101] The fact that the taxpayer may have cancelled the insurance contract and recovered an amount approximating the premium does not mean that, while the contract is in force, it does not entitle the taxpayer to the benefits of insurance cover in the event of a peril eventuating as a quid pro quo for the premium paid.”

While not strictly necessary for the finding (and stated in case there is an appeal which deals with the merits rather than prescription), the court pointed out that the taxpayer’s payment was an amount owing under the policy and there was a shift in assets. The transaction was different from the deposit of an amount in a bank account. The premium payment was not equivalent to a deposit in an accessible account. The taxpayer acquired contractual rights (in the form of an insurance policy) to a greater payment than the amount expended, which differentiates the policy from a temporary housing of the amount. The insurance was aimed to protect the taxpayer against losses in fruit sales as a result of the insured events occurring. Its purpose therefore was to fill a hole in the taxpayer’s income-earning stream as a result of one of the protected risks eventuating, and not to compensate for the loss of a capital asset. The accrual of notional interest on the experience account does not render the payment one that acquires an independent income-producing concern.

The court refused to consider an argument under section 23(e) of the ITA because of its prima facie view that the insurance premium, albeit an unusual one, that accrued to the insurer’s estate and gave rise to countervailing insurance obligations for the duration of the policy differed from a deposit fund and did not bear the hallmarks of “income carried to any reserve fund or capitalised in any way”.

The judgment shows a clear understanding of contingency policies and insurance law. It is a pity that a contingency policy is described as unconventional insurance. It is either insurance or it is not; and it is insurance. There are many examples of insurances that do not exactly match traditional thinking like cell captive insurance, captive insurance, parametric insurance and other insurance arising from the need to cover modern commercial undertakings and catering for limitations on insuring risks under standard policy wordings.

The judgment demonstrates that SARS has been aware of experience accounts since at least 2017 and has clearly understood and accepted the nature of these transactions, except in the few cases where they have sought to extract additional tax and penalties. Contingency insurance is an essential right of policyholders to manage their risks through regulated insurance structures.