iBusiness, 2013, 5, 58-63
doi:10.4236/ib.2013.51b013 Published Online March 2013 (http://www.scirp.org/journal/ib)
The Study on the Personal Income Tax of the Policyholder
Dividends and Its Impact on Chinese Insurance Industry
Wen Yan
School of Public Administration, Southwest Jiaotong University, Chengdu, China.
Email: sherrywen.001@163.com
Received 2013
ABSTRACT
The policyholder dividend of participating insurance is essentially different from the usual equity and bond profit. There
are disputes on taxing methods in theory and practice, and different countries adopt different taxing methods. This paper
designs a basic framework of the personal income tax system on participating insurance policy. This policy is based on
the reality that the participating insurance accounts for a higher proportion in the Chinese insurance market, which is
conducive to increase the demand for insurance and the tax sources. The author believes that levying taxes is allowed,
but there is no basis to tax on the total policyholder dividends, while tax on the part of policyholder dividends is rea-
sonable. Finally, this paper analyzes the impact on the demand of life insurance industry and the total tax revenue to
levy personal income tax on policyholder dividends. The author concludes that the taxing method designed in this paper
is better than the taxing method levying tax on the total policyholder dividends.
Keywords: Income Tax; Policyholder Dividends; Chinese; Insurance; Industry
1. Introduction
Life insurance and tax are two important concepts in the
modern economy; they display the social management
functions both in the micro and macro economy. The
relationship between life insurance and tax reflects that
on one hand, the tax policy may encourage or inhibit the
demand and supply to life insurance and on the other
hand, the development of life insurance industry also
affects the government's tax revenue to a certain extent.
As the leading product of the life insurance industry in
China, since 2002, the proportion of participating insur-
ance premium income in the total premium income of
life insurance has been more than 50% for a long time. It
was up to 57.09% in 2008. Therefore, how to design a
reasonable personal income tax system on the dividend
income from participating insurance has a significant
impact on the stable development of China’s life insur-
ance industry and even the insurance industry. The pre-
vious research in this area is mostly limited to the discus-
sion of whether to levy tax, but lacks systematic study
and plan design on the tax system. This paper designs a
concrete plan on how to levy personal income tax on
participating insurance in China; at the same time, the
paper analyzes the possible impact and makes a empiri-
cal test on the impact.
2. The Introduction of Personal Income Tax
System on Policyholder Dividends from
Participating Insurance
By the analysis on the personal income tax system on
policyholder dividends from participating insurance in
the developed insurance market, the personal income tax
system can be divided into two categories and four proc-
essing modes.
2.1. Levying Personal Income Tax on
Policyholder Dividends
The first category is the levying personal income tax on
policyholder dividends. This mode stipulates to exact
personal income tax from policy holders within a certain
range. In the practice of insurance tax, it may be divided
into two modes according to the different calculations.
The first mode is the premium not be exempted from
the taxable income. Take US and Canada as representa-
tives. U.S. Internal Revenue Service defines the policy-
holder dividend as the part refund of premium paid by
policy holders, which reduces the cost of policy holders,
should not be included in income. 1So whether to tax
depends on the total amount of policyholder dividends. If
the total amount of policyholder dividends surpasses the
1IRS,2004, “Your Federal Income Tax” (for individuals for use in pre-
p
aring 2004 returns), www.irs.gov.
Copyright © 2013 SciRes. IB
The Study on the Personal Income Tax of the Policyholder Dividends and Its Impact on Chinese Insurance Industry 59
net premium of insurance policy, the excess should be
levied; on the contrary, it should not be taxed. Canada
also regards the policyholder dividend as the part refund
of premium paid by policy holders and its mode of tax
collection is similar to that of the United States.
The second mode, the premium is exempted from the
taxable income. Take Japan as representative. Unlike the
United States, the Japanese tax law stipulates that the
premium paid by the policy holders can be exempted
from the taxable income, while the dividend is consid-
ered a return of premium. Therefore, in the calculation of
taxable income, the policyholder dividends should be
subtracted from the exemption premium, namely:
Taxable income = the taxable income before insuring
(the premium the policyholder dividends) (1)
2.2. Exempting from Personal Income Tax on
Policyholder Dividends
The second category: exempting from personal income
tax on policyholder dividends. There are also two proc-
essing modes: First, take the United Kingdom as repre-
sentative, its tax exemption was mainly determined by its
special dividend distribution; 2Second, take Hong Kong
and Singapore as representatives, they regard the whole
policyholder dividends as a return of premium, therefore
the policyholder dividends are completely tax-free.
3. The Tax System Designed on the
Policyholder Dividends of the
Participating Insurance in China
In view of current contradictions and problems in par-
ticipating insurance business and tax collection, I believe
that we should proceed in two aspects: One is whether
we should levy tax? Another is how to design the basic
framework of the tax system?
A) on the question of whether should levy tax, the
viewpoint of this paper is that levying tax is allowed, but
there is no basis to levy tax on the total policyholder
dividends, while levy tax on the part of policyholder
dividends is reasonable. The reasons are as follows:
First, from the view of the nature of policyholder
dividends, it has a dual nature, that is, it is com-
posed of the premium return and investment in-
come. Policyholder dividends derives from three
benefits(the benefit from the actual mortality is
lower than the hypothetical mortality, the benefit
from the actual investment rate is higher than the
hypothetical investment rate, the benefit from the
actual expenses rate is lower than the hypotheti-
cal expenses rate), the benefit from the actual
mortality is lower than the hypothetical mortality
and the benefit from the actual expenses rate is
lower than the hypothetical expenses rate can be
viewed as the return of premium, because they
come from the cautious pricing of insurance
companies. while the benefit from the actual in-
vestment rate is higher than the hypothetical in-
vestment rate cannot be treated as a return of
premium, because the buying behavior of the
policy holders should be regarded as an en-
dorsement of the hypothetical rate, therefore the
benefit from the actual investment rate is higher
than the hypothetical investment rate should be
regarded as the benefit of insurance company
investment, namely it should be treated as in-
vestment income of policy holders.
Second, from the view of the functions of par-
ticipating insurance, the safeguard function of
participating insurance has replaced the social
function of the national finances to some extent,
therefore there should be granted a tax exemp-
tion for the safeguard part of participating insur-
ance, while we should levy tax on the investment
part of participating insurance.
Third, from the view of insurance premium
structure of participating insurance, the invest-
ment part can be regarded as non-voting shares
3of the insurance company, so it should be levied
personal income tax according to the existing
personal income tax law.
Fourth, from the perspective of cumulated poli-
cyholder dividends and foreign experience, , the
excess should be levied tax when the cumulated
policyholder dividends exceed the cost of insur-
ance, such as the U.S., Canada, Japan and so on.
B) The basic framework of the personal income tax
system on participating insurance policy in China
The personal income tax system on participating in-
surance must follow the principles of fairness and effi-
ciency, it cannot lose a tax should be levied. At the same
time; we should try to avoid the impact of taxation on the
life insurance market. By learning from foreign experi-
ence and following the operating characteristics of the
life insurance industry, the basic framework of the per-
sonal income tax system on participating insurance in
china includes the following four aspects:
First, the tax source and the tax base. the tax
source and the tax base of participating insurance
include three benefits (the benefit from the actual
mortality is lower than the hypothetical mortality,
3Nonvoting shares refers to the shares which does not entitle the hold-
ers the right to operate and manage the Corporation according to the
laws or the company's Charter, but the shareholders can still participate
in the general meeting.
2Unlike the United States, Canada and Japan, policyholder dividends
are usually added to the insurance amount in England, therefore the
p
olicyholder dividends is tax-free.
opyright © 2013 SciRes. IB
The Study on the Personal Income Tax of the Policyholder Dividends and Its Impact on Chinese Insurance Industry
60
the benefit from the actual investment rate is
higher than the hypothetical investment rate, the
benefit from the actual expenses rate is lower
than the hypothetical expenses rate) as well as
the accumulated interest of policyholder divi-
dends. In the situation that the accumulated in-
terest of policyholder dividends is less than the
policy cost, the benefit from the actual mortality
is lower than the hypothetical mortality and the
benefit from the actual expenses rate is lower
than the hypothetical expenses rate included in
policyholder dividends are completely tax-free,
while for the benefit from the actual investment
rate is higher than the hypothetical investment
rate in the policyholder dividends should be lev-
ied tax, the accumulated interest of policyholder
dividends should also be levied tax;
Second, the taxing method. The personal income
tax system on participating insurance adopts tax-
deferred4 withholding5 taxing method, the taxa-
tion time point has been deferred the end of the
policy period. This method not only saves the
administrative cost, but also produces a incentive
effect on policyholders.
Third, the determination of the tax rate. Due to
the social management function of life insurance
industry, certain preferential taxation should be
reflected in the tax rate determining. This paper
proposes the preferential tax rate is set at 10%;
Fourth, the implementation time of the personal
income tax system on participating insurance .Be
consistent with other investment products, it
should be introduced at the right moment.
4. The Analysis of the Impact on Life
Insurance Industry to Levy Personal
Income tax on Policyholder Dividends
A) The economic analysis of the impact on the life in-
surance industry to levy personal income tax on policy-
holder dividends
Levying personal income tax on policyholder divi-
dends will undoubtedly affect the life insurance demand.
Currently, the main motivation for participating insur-
ance policyholders is to obtain an investment return
which should be higher than the market average invest-
ment rate. The impact path of taxation on the life insur-
ance demand are that levying personal income tax on
policyholder dividends leads to the decline in expected
return rate of policyholders. On the one hand, compared
with other investment products, the participating insur-
ance becomes more expensive; on the other hand, the
actual income of the participating insurance policyhold-
ers declines. Rising relative price and falling real income
make participating insurance policyholders turn to other
financial products as an alternative. The above lead the
overall decline in the life insurance demand. Specific
shown in Figure 1:
In Figure 1, the x-axis represents the participating in-
surance demand; the y-axis represents the demand to
other investment-oriented financial products, the line-AX
and the lineAN represent separately the Pre-tax and
Post-tax budget lines while the income stays at the same
level. Before levying on policyholder dividends, the de-
mand of the participating insurance is x3 when the budg-
et line-AX is tangent to the Difference Curve in the De-
mand - U1. After levying on policyholder dividends, the
demand of the participating insurance is x1 when the
budget lineAN is tangent to the Difference Curve in
the Demand – U2. In the Figure, the distance between X2
and X1 represents the demand reduction to the partici-
pating insurance. The reason leading to the reduction is
that the rising relative price of the participating insurance
makes the policyholders turn to other alternative invest-
ment products, which is the substitution effect. Likewise,
the distance between X2 and X3 represents the demand
reduction to the participating insurance, while the reason
leading to the reduction is that the rising relative price of
the participating insurance causes the decline in actual
income, which is the income effect. The distance be-
tween X1 and X3 aggregating the substitution effect and
the income effect is the demand reduction to the partici-
pating insurance caused by the introduction of the per-
sonal income tax on policyholder dividends.
B) The empirical analysis of the impact on the life in-
surance industry to levy personal income tax on policy-
holder dividends
On the difference between the tax system of partici-
pating insurance designed by this paper and the tax sys-
tem stipulated by the tax authorities, we will analyze
their impact on the life insurance industry and the total
tax revenue next:
4Deferred taxing method means a tax policy that the taxpayers will pay
the tax after obtaining an income.
5Withholding taxing method means the tax amount shall be withheld
and paid to the tax authorities by the enterprises and individuals obli-
gated to pay tax according to the tax law from the taxpayer's income.
Figure 1. the income effect and the substitution effect of
levying personal income tax on policyholder dividends to
participating insurance.
Copyright © 2013 SciRes. IB
The Study on the Personal Income Tax of the Policyholder Dividends and Its Impact on Chinese Insurance Industry 61
1) Data selection
This paper takes the proportion of participating insur-
ance premium income in the total homochronous life
insurance premium income as the output variable, and
takes the investment rate as input variable. For the poli-
cyholders purchased participating insurance, their par-
ticipating insurance investment rate is based on that of
the previous year, which means, if they buy the partici-
pating insurance in period T, they will refer to invest-
ment rate in period T-1. This paper selects the proportion
of participating insurance premium income in the total
homochronous life insurance premium income for the
year of 2001-2008 and insurance fund investment rate for
the year of 2000-2007 in China as the sample data, as
shown in Table 1:
2) Research methods
This paper adopts the output contribution ratio to the
input to analyze the relationship between the proportion
of participating insurance and investment rate. The con-
tribution ratio is an indicator of analyzing the economic
efficiency. It refers to the ratio of the effective or useful
results and the resource consumption or occupancy,
namely the ratio of the output and the input, or the ratio
of the obtained and the consumption. The formula is:
Contribution ratio (%) = Contribution (output,
the obtained)/Input (consumption, occupancy) × 100%(2)
This paper will take the investment rate as the input,
and take the proportion of participating insurance pre-
mium income in the total homochronous life insurance
premium income as the contribution. The Contribution
ratio that the investment rate to the proportion of partici-
pating insurance premium income refers to the propor-
tion of participating insurance premium income in the
Table 1. the development situation of participating insur-
ance for year of 2001-2008 and insurance fund investment
rate for the year of 2000-2007 in China.
Period
T
the proportion of
participating insurance
premium income in the
total homochronous life
insurance premium
Income (%)
Period
T-1
investment
rate of
insurance
fund (%)
2001 36.64 2000 3.59
2002 49.3 2001 4.3
2003 57.84 2002 3.14
2004 56.54 2003 2.68
2005 56.89 2004 2.9
2006 59.37 2005 3.6
2007 49.76 2006 5.8
2008 57.06 2007 12.17
total homochronous life insurance premium income cor-
responding to per unit of investment rate. Under the as-
sumption that the contribution ratio of the participating
insurance is T
in period T, the proportion of partici-
pating insurance premium income in the total homo-
chronous life insurance premium income is T in pe-
riod T, the investment rate is
y
1T
in period T-1, that is:
1
the proportion of participating insurance premium income in the
total homochronous life insurance premium income in period T
the investment rate in period T-1
T
T
T
y
(3)
3) Data analysis
According to Equation(3) and the data in Table 1, the
contribution ratio that the participating insurance to the
investment rate in China for the year of 2001-2008 can
be obtained. It is shown in Table 2:
Table 2 shows that during 2004to 2008, the contribu-
tion ratio that the participating insurance to the invest-
ment rate in China has been rising rapidly, while in
2004-2008, the contribution ratio came down gradually.
The reason is that from 2001 to 2004, the capital market
in china has been in a bear market over a long period of
time. There are not many other investment products in
the financial market, while the dividend rates of the par-
ticipating insurance were much higher than the homo-
chronous bank deposit interest rate. So the participating
insurance got a rapid development. From 2001 to 2004,
the capital market became active gradually; lots of in-
vestment products began to emerge. During this time, the
stimulating effect of the dividend rates to participating
insurance demand decreased gradually.
Table 2. the contribution ratio of the investment rate in
China for the year of 2001-2008.
Period
T
the proportion of
participating insurance
premium income in the
total homochronous life
insurance premium
income (%)
Period
T-1
The
Investment
Rate (%)
The
contribution
ratio of the
investment
rate (%)
200136.64 2000 3.59 10.21
200249.3 2001 4.3 11.47
200357.84 2002 3.14 18.42
200456.54 2003 2.68 21.10
200556.89 2004 2.9 19.62
200659.37 2005 3.6 16.49
200749.76 2006 5.8 8.58
200857.06 2007 12.17 4.69
Average52.925 4.7725 13.82
opyright © 2013 SciRes. IB
The Study on the Personal Income Tax of the Policyholder Dividends and Its Impact on Chinese Insurance Industry
62
Dividends rate is 5%, the personal income tax rate is
10% on policyholder dividends, the market interest rate
is 0, the extra policy dividends more than the insurance
cost accounts for 80%. According to the calculation for-
mula of the contribution ratio, this paper selects the av-
erage contribution ratio between 2005 and 2008 as a ref-
erence point to the impact degree of the participating
insurance, which is 12.35.Take 2007 as the example:
First, let us analyze the tax system stipulated by the tax
authorities. The total Post-tax policyholder dividend is
400*5%*(1-10%)*10=180 Billion Yuan; Taxable per-
sonal income amounts to 400*5%*10%*10=20 Billion
Yuan. After the taxation, the proportion of participating
insurance premium income in the total homochronous
life insurance premium income refers to 49.76% -
5.8*10%*12.35=42.6%, dropping by (5.8 * 10% * 12.35
/49.76%) *100%=14.39%. After the taxation, the pre-
mium income of the life insurance industry drops by
(5.8*10%*12.35/49.76%)*49.76% = 7.16%.
Second, we design the tax system of participating in-
surance designed by this paper. The viewpoint in this
paper is that the tax-deferred withholding taxing method
should be adopted to levy personal income tax on the
policyholder dividends. The tax scope includes the extra
policyholder dividends more than the insurance cost and
the accumulated interest of policyholder dividends.
Therefore, at the expiry time of insurance policy, the
policyholder dividends and interest amounts to 400*5%*
10
(11.05 )
11.05
=251.56
billion Yuan, of which the policyholder dividends is 20
billion Yuan, and the accumulated interest is 5.156 bil-
lion Yuan. Taxable personal income tax totals 200 *
80% * 10% +51.56 * 10% = 2.116 billion Yuan, an in-
crease of 116 million Yuan more than the original. Af-
ter the taxation, the total policyholder dividends is
251.56-21.56 = 23 billion Yuan, the policyholder divi-
dends rate is 5.75%the proportion of participating in-
surance premium income in the total homochronous life
insurance premium income refers to
49.76%-5.8*(5-5.75)/5*12.35 = 60.50%,
increasing by 10.74%. After the taxation, the premium
income of the life insurance industry increases by
10.74%*49.76% = 5.35%.
5. Conclusions and Suggestions
This paper has made theoretical and empirical analysis
on the question whether personal income tax should be
levied on the policyholder dividends of participating in-
surance. By contrast, we conclude that if levying 10%
personal income tax on the policyholder dividends of the
participating insurance in accordance with the claims of
the tax authorities, the market share of the participating
insurance will drop by 14.39%, as well as the premium
income of the participating insurance will decreases by
7.16%. Following the recommendations in this paper,
whether to levy personal income tax depends on the dif-
ferent sources of policyholder dividends. On one hand,
the market share and premium income of the participat-
ing insurance will increase; on the other hand, the tax
revenue of tax authorities also increases. The viewpoint
in this paper is that the tax-deferred withholding taxing
method should be adopted to levy personal income tax on
the policyholder dividends, compared with the claim of
the tax authorities. This taxing method has a strong ad-
vantage both on policy benefit of policyholders and on
the total tax revenue of tax authorities.
In short, there will be a greater negative impact on the
development of life insurance industry undoubtedly to
levy personal income tax on the policyholder dividends
of the participating insurance. However we can minimize
the negative impact through designing reasonable tax
system, even the negative impact can be transformed into
a positive impact, and make the participating insurance
business develop healthily.
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