Senate

Taxation Laws Amendment Bill (No. 6) 2001

Revised Explanatory Memorandum

(Circulated by authority of the Treasurer, the Hon Peter Costello, MP)
This Memorandum takes account of amndments made by the House of Representatives to the bill as introduced

Chapter 6 - HIH rescue package

Outline of chapter

6.1 Schedule 5 to this bill amends the ITAA 1997 to:

·
ensure that the income tax consequences of payments under the HIH rescue package are the same as if those payments had been made directly by HIH; and
·
exempt the HIH Trust from income tax.

6.2 Schedule 5 also amends the GST Act to ensure that:

·
the GST consequences of payments made under the HIH rescue package are the same as if those payments had been made directly by HIH; and
·
where an insurance portfolio transfer has occurred, the GST consequences of transactions made by the transferee insurer are the same as if those transactions had been undertaken by the original insurer.

Context of amendments

6.3 As a consequence of the financial collapse of the HIH group of companies, the Commonwealth has established a scheme to assist certain qualifying individuals and small businesses who experience financial hardship as a direct result of the collapse.

6.4 The Commonwealth HIH rescue package involves the establishment of the HIH Trust with HCS as its trustee. HCS will make payments from the HIH Trust to qualifying policyholders who have claims under general insurance policies issued by the various HIH insurance companies.

6.5 On 26 June 2001 the Government announced that it would legislate to ensure that Commonwealth payments from the HIH rescue entity to eligible policyholders do not attract additional income tax or GST.

PART 1 - Income tax consequences

Summary of new law

6.6 This bill will amend the ITAA 1997 to ensure that:

·
payments received from the HIH Trust in settlement of a claim under a general insurance policy held with an HIH company will be taxed as if those payments were made:

-
by the HIH company; and
-
under the terms and conditions of the original policy;

·
no CGT consequences arise as a result of the assignment of a policy to HCS; and
·
the HIH Trust is exempt from income tax.

Comparison of key features of new law and current law
New law Current law
Payments received from the HIH Trust for the assignment of rights under or in relation to a claim under a general insurance policy held with an HIH company will be taxed as if those payments were made:

·
by the HIH company; and
·
under the terms and conditions of the original policy.

The taxation treatment of payments received for the assignment of rights under or in relation to a claim under a general insurance policy depends on the circumstances and character of the payment. In particular, special CGT rules apply to payments under a general insurance policy from a general insurance company.

Payments received for the assignment of rights under or in relation to a claim under a general insurance policy from the HIH Trust may have a different outcome for taxation purposes.

No CGT consequences will arise as a consequence of the assignment of rights under or in relation to a general insurance policy to HCS. An assignment of rights under or in relation to a general insurance policy to HCS, as required under the terms of the HIH rescue package, may trigger a CGT event.
The HIH Trust will be exempt from income tax. The HIH Trust would be subject to income tax on any income derived.

Detailed explanation of new law

6.7 This bill inserts new Division 322 into the ITAA 1997. The new Division sets out special measures to assist in the rescue package provided in response to the collapse of the HIH Group. [Schedule 5, item 6, section 322-1]

6.8 Division 322 ensures that:

·
HIH rescue payments are treated as insurance payments by an HIH company;
·
no CGT consequences arise as a consequence of the assignment rights under or in relation to a general insurance policy to HCS; and
·
the HIH Trust is exempt from income tax.

HIH rescue payments treated as insurance payments by an HIH company

6.9 The amendments will ensure that a payment from the Commonwealth of Australia, the HIH Trust or a prescribed entity for the assignment of rights under or in relation to a claim under a general insurance policy held with an HIH company will be treated for income tax purposes as though:

·
the payment had been made by the HIH company; and
·
the payment had been made under the terms and conditions of the policy held with the HIH company.

[Schedule 5, item 6, subsection 322-5(1)]

6.10 The HIH Trust is the HIH Claims Support Trust which was established by deed of trust entered into between the Commonwealth and HCS on 6 July 2001. [Schedule 5, items 6 and 8, subsections 322-5(2) and 995-1(1)]

6.11 The State and Territory Governments may establish separate arrangements to assist HIH policyholders. If so, payments under those arrangements will receive identical income tax treatment to payments under the Commonwealth HIH rescue package arrangements by listing the relevant payer as a prescribed entity. A prescribed entity is an entity that is prescribed in the Income Tax Assessment Regulations 1997 (see section 17 of the Acts Interpretation Act 1901 ).

6.12 A general insurance policy is defined in subsection 995-1(1) to mean a policy of insurance that is not a life insurance policy or an annuity instrument.

6.13 An HIH company is defined to mean:

·
CIC Insurance Limited;
·
FAI General Insurance Company Limited;
·
FAI Reinsurances Pty Limited;
·
FAI Traders Insurance Company Pty Limited;
·
HIH Casualty and General Insurance Limited;
·
HIH Underwriting and Insurance (Australia) Pty Limited;
·
World Marine and General Insurances Pty Limited; or
·
any other related company specified in writing by the Commissioner.

[Schedule 5, items 6 and 7, subsections 322-5(3) and 995-1(1)]

6.14 As the amendments apply to payments received for the assignment of rights in relation to a claim under a general insurance policy, payments received from the HIH Trust as a result of rights of the policyholder that are pursued against third parties, for example, will be treated for income tax purposes as if those payments had been made directly by the HIH company under the terms of the policy.

Example 6.1 Levi receives a lump sum payment from the HIH Trust for the assignment of his rights under a general insurance policy with an HIH company to compensate him for the loss of a limb. No part of the payment represents compensation for loss of earnings or interest. Therefore, if the payment had been made directly by the HIH company:

·
no part of the payment would be included in Levis assessable income under ordinary principles; and
·
the payment would have no CGT consequences because of the operation of section 118-37.

Section 322-5 operates to ensure that the same outcome arises for the payment Levi receives from the HIH Trust.

Example 6.2 Babette, who operates a small business, receives a payment from the HIH Trust for the assignment of her rights under a general insurance policy with an HIH company to compensate her for the destruction of a building from which she runs her business and that was owned by Babette. The amount of compensation paid to Babette for the replacement cost of the building exceeds the cost base of the building. No part of the payment represents compensation for loss of earnings or interest. Therefore, if the payment had been made directly by the HIH company:

·
no part of the payment would be included in Babettes assessable income under ordinary principles;
·
the payment would represent capital proceeds and, to the extent that those capital proceeds exceed the buildings cost base, would be included in Babettes assessable income as the disposal of a CGT asset (CGT event C1); and
·
the discharge of Babettes rights under the policy (CGT event C2) would have no CGT consequences because of the operation of section 118-300.

Section 322-5 operates to ensure that the same outcome arises for the payment Babette receives from the HIH Trust.

Example 6.3 Maggie, who operates a small business, receives a payment from the HIH Trust for the assignment of her rights under a general insurance policy with an HIH company to compensate her for a loss of trading stock as the result of a fire. Therefore, if the payment had been made directly by the HIH company, the payment would be included in assessable income under section 70-115. Section 322-5 operates to ensure that the same outcome arises for the payment Maggie receives from the HIH Trust.

Certain capital gains and capital losses disregarded

6.15 A feature of the Commonwealths HIH rescue package is that the policyholder will assign their rights under or in relation to the general insurance policy with an HIH company to HCS (as trustee of the HIH Trust). Any capital gain or capital loss that a taxpayer makes as the result of such an assignment to the Commonwealth, HCS (as trustee of the HIH Trust) or a prescribed entity will be disregarded. This will ensure that the assignment is not the disposal of a CGT asset (CGT event A1). [Schedule 5, items 2, 3 and 6, subsection 104-10(5) and section 322-15]

6.16 The State and Territory Governments may establish separate arrangements to assist HIH policyholders. If so, assignments of policies under those arrangements will receive identical income tax treatment to assignments of policies under the Commonwealth HIH rescue package arrangements provided that the relevant assignee is listed as a prescribed entity in the Income Tax Assessment Regulations 1997.

HIH Trust exempt from tax

6.17 As the HIH Trust is funded from Commonwealth revenue, the Trust will be exempt from income tax. Similarly, any similar bodies established by the State or Territory Governments to assist HIH policyholders will be exempt from income tax provided they are prescribed in the Income Tax Assessment Regulations 1997. [Schedule 5, items 1 and 6, sections 11-5 and 322-10]

Application and transitional provisions

6.18 The measures will apply with effect from on or after 15 May 2001 (which is the date that the details of the Commonwealths HIH rescue package arrangements were announced). [Schedule 5, item 9]

Consequential amendments

6.19 The amendments to the ITAA 1997 are to be inserted in Part 3-35. Consequently, the heading for Part 3-35 will be changed from Life Insurance Business to Insurance Business and the link note at the end of section 320-255 will be repealed. [Schedule 5, items 4 and 5]

PART 2 - Goods and services tax

Summary of new law

6.20 This bill will amend the GST Act to ensure that a payment or supply made by an HIH rescue entity for:

·
the transfer or surrender of the HIH policyholders rights under an insurance policy held with an HIH company;
·
the transfer or surrender of an entitys rights against another entity that is insured under an insurance policy held with an HIH company; or
·
the transfer or surrender of an entitys rights against another entity in relation to a matter to which the entity also has or had rights under an insurance policy held with an HIH company,

is treated as relating to the settlement of an insurance claim under an insurance policy by an insurer.

6.21 This bill also amends the GST Act to ensure that the insurance provisions within the GST Act apply as if the transferee insurer were the insurer in relation to the insurance policy. In particular, the amendments ensure that, regardless of which insurer issued the policy:

·
decreasing adjustments may be available to an insurer that is settling a claim under an insurance policy that was a taxable policy; and
·
an insurer is not entitled to input tax credits on acquisitions made by the insurer to provide in settlement of a claim under an insurance policy that was a GST-free policy.

Comparison of key features of new law and current law
New law Current law
Division 78 of the GST Act applies where payments or supplies are made by an HIH rescue entity as consideration for:

·
the transfer or surrender of the HIH policyholders rights under an insurance policy held with an HIH company;
·
the transfer or surrender of an entitys rights against another entity that is insured under an insurance policy held with an HIH company; or
·
the transfer or surrender of an entitys rights against another entity in relation to a matter in relation to which the entity also has or had rights under an insurance policy held with an HIH company.

The transfer or surrender of the entitys rights may be a taxable supply under the GST Act.
Payments or supplies by an HIH rescue entity are excluded from the calculation of the recipients annual turnover. The consideration received for this supply would form part of the entitys annual turnover. This may cause the entity to exceed thresholds such as the GST registration threshold.
Division 78 of the GST Act applies to insurers who, because of an arrangement in the nature of a portfolio transfer, have undertaken to settle claims under insurance policies issued by another insurer.

In particular, the transferee insurer:

·
may be entitled to a decreasing adjustment when it makes a payment or supply in settlement of a claim under an insurance policy issued by another insurer; and
·
is not entitled to an input tax credit on the acquisition of things which are to be provided in settlement of a claim under a GST-free insurance policy issued by another insurer.

Many of the provisions in Division 78 of the GST Act would not apply to the transferee insurer. In particular, the transferee insurer would:

·
be denied a decreasing adjustment because it is not the insurer that issued the insurance policy; and
·
inappropriately be entitled to an input tax credit for the acquisition of something to provide in settlement of a claim under a GST-free insurance policy.

Detailed explanation of new law

Payments made under an HIH rescue scheme

6.22 Division 78 of the GST Act sets out the GST treatment for payments or supplies that relate to the settlement of a claim under an insurance policy. Except in limited circumstances, the supply of anything in settlement of a claim under an insurance policy is not treated as a taxable supply. In addition, a payment of money or a supply, made by an entity in settlement of a claim under an insurance policy is treated as not being consideration for a supply made by the recipient of the payment or supply.

6.23 When an HIH rescue entity makes a payment or supply to an entity pursuant to an HIH rescue scheme, it does not make a settlement of a claim under an insurance policy, but rather, it acquires that entitys rights under an HIH insurance policy. In addition, an HIH rescue entity is not an insurer. Therefore, Division 78 of the GST Act will not apply to any payment or supply made by an HIH rescue entity. Payments or supplies made by an HIH rescue entity to an entity in relation to a claim under an HIH insurance policy may be consideration for a taxable supply made by that entity.

Division 78 applies to certain non-insurance transactions

6.24 New section 78-120 is inserted into the GST Act so that Division 78 applies to a payment or a supply made by an HIH rescue entity. This section provides that a payment or supply made by an HIH rescue entity for:

·
the transfer or surrender of the HIH policyholders rights under an insurance policy held with an HIH company;
·
the transfer or surrender of an entitys rights against another entity that is insured under an insurance policy held with an HIH company; or
·
the transfer or surrender of an entitys rights against another entity in relation to a matter in relation to which the entity also has or had rights under an insurance policy held with an HIH company,

is treated as relating to the settlement of an insurance claim under an insurance policy by an insurer. [Schedule 5, item 10, section 78-120]

6.25 The section applies Division 78 to transactions made by an HIH rescue entity as though the HIH rescue entity is an insurer making settlements of claims under insurance policies. This will mean that HIH policyholders have the same GST treatment on transactions as would have occurred if the payment or supply was from HIH in settlement of a claim under an insurance policy.

6.26 In addition, section 78-100 of the GST Act applies as if references in that section to a claim for compensation under a statutory compensation scheme, were references to a claim made to the HIH rescue entity corresponding to a claim for compensation under the scheme. However, this will only be the case if section 78-100 would have normally applied to the settlement of a claim by HIH.

6.27 Sections 78-10, 78-15 and 78-40 of the GST Act, which relate to decreasing adjustments that an insurer is generally entitled to in relation to the settlement of a claim under an insurance policy, do not apply to any payments or supplies made by an HIH rescue entity. HIH, as the entity that issued the insurance policy, will be entitled to a decreasing adjustment when, and if, it makes a payment or supply to an HIH rescue entity in settlement of the rights the HIH rescue entity has acquired in respect of the original HIH insurance policy.

6.28 Pursuant to section 78-50 of the GST Act, a payment or supply made by an insurer in settlement of a claim under an insurance policy, will be treated as consideration for a supply by the entity insured, or any entity that was entitled to an input tax credit on the premium paid on the insurance policy, unless the entity informs the insurer of its entitlement to input tax credits on the insurance premium. The information is used by the insurer to determine its entitlement to a decreasing adjustment under section 78-10 of the GST Act. Therefore, for the purposes of subsection 78-50(1), the original HIH policyholder will still need to inform HIH of the policyholders entitlement to input tax credits on the insurance premium.

6.29 If the original HIH policyholder does not inform HIH of its entitlement to input tax credits on the insurance premium, section 78-50 will operate to treat any payment or supply received from an HIH rescue entity as being consideration for a supply made by the HIH policyholder. The resulting GST liability will be based upon the amount of the payment, or value of the supply, that the HIH policyholder has received from an HIH rescue entity.

Annual turnover

6.30 Under section 188-22 of the GST Act, when an entity works out its current annual turnover or projected annual turnover, it disregards any supply that the entity has made to the extent that the consideration for the supply is a payment or a supply by an insurer in settlement of a claim under an insurance policy. This is to avoid entities triggering thresholds, such as the registration threshold, because of the receipt of a payment or supply made in settlement of a claim under an insurance policy. This provision is amended so that payments or supplies by an HIH rescue entity will also be excluded from the calculation of the entitys turnover. [Schedule 5, item 11, section 188-22]

Definitions

6.31 The Dictionary within section 195-1 of the GST Act has been amended to include definitions of an HIH company and an HIH rescue entity. The definition of an HIH company has the meaning as given by section 322-5 of the ITAA 1997 (see paragraph 6.13). An HIH rescue entity means the Commonwealth, the HIH Trust or a prescribed entity for the purposes of subsection 322-5(1) of the ITAA 1997. [Schedule 5, items 12 and 13, section 195-1]

Application and transitional provisions

6.32 The amendments to the GST Act apply, and are taken to have applied:

·
in relation to GST returns and net amounts for tax periods starting, or that started, on or after 15 March 2001; and
·
in relation to payments and supplies, of a kind referred to in section 78-120 of the GST Act, that are, or have been, made on or after 15 March 2001 to an entity that is neither registered nor required to be registered.

[Schedule 5, item 14]

Insurance portfolio transfers

6.33 Division 78 of the GST Act sets out the GST treatment for payments or supplies made between insurers, insureds and certain third parties. Generally, the supply of anything in settlement of a claim under an insurance policy is not a taxable supply and a payment or supply made by an entity in settlement of a claim under an insurance policy is not consideration for a supply made by the recipient of the payment or supply. The GST legislation also provides insurers with various increasing and decreasing adjustments.

6.34 The insurance industry has advised that it is not unusual for one insurer to transfer a book of insurance to another insurer. These transfers are known within the industry as a portfolio transfer. Where a portfolio transfer has occurred, the provisions within Division 78 of the GST Act may not apply to give the appropriate GST outcome. For example, the decreasing adjustment available under section 78-10 of the GST Act and the denied input tax credit under section 78-30 of the GST Act, only apply to the insurer that issued the policy.

6.35 The inability of insurers to claim decreasing adjustments has been highlighted by the financial collapse of the HIH group of companies. As a result of various contractual arrangements with HIH companies, portfolio transfers have occurred so that some insurers have undertaken to make payments under insurance policies issued by an HIH company. There are a variety of other situations where such a portfolio transfer can arise.

6.36 New section 78-118 of the GST Act ensures that where a portfolio transfer has occurred, the insurance provisions within the GST Act apply as if the transferee insurer were the insurer in relation to the insurance policy. [Schedule 5, item 9A, section 78-118]

6.37 The new section only applies where a portfolio transfer has occurred. Generally, a portfolio transfer occurs where an arrangement is entered into by 2 insurers and under the arrangement the second insurer undertakes to meet the liabilities, such as the liability to pay claims, under insurance policies issued by the first insurer. A portfolio transfer is contractual in nature and does not include situations where statutory provisions may provide that an entity will assume liability for a claim without any contractual agreement between the 2 insurers. For example, legislation providing for compulsory third party schemes may also provide that where an insurer is declared to be insolvent, the Nominal Defendant is liable to meet claims under a compulsory third party insurance policy issued by the insolvent insurer. This assumption of liability by the Nominal Defendant would not be an arrangement in the nature of a portfolio transfer.

6.38 In particular, the amendments ensure that:

·
anything done by the transferee insurer is done under the insurance policy if it would have been done under the policy by the first insurer;
·
regardless of which insurer issued the policy:

-
decreasing adjustments may be available, under section 78-10 of the GST Act, to an insurer that is settling a claim under an insurance policy that was a taxable policy; and
-
an insurer is not entitled to input tax credits, under section 78-30 of the GST Act, on acquisitions made by the insurer to provide in settlement of a claim under an insurance policy that was a GST-free policy; and

·
where there is a payment of an excess to either the transferor or transferee insurer, the insurer that settles the claim under the insurance policy is the insurer that has an increasing adjustment under section 78-18 of the GST Act.

[Schedule 5, item 9A, section 78-118]

6.39 The decreasing adjustment available to the transferee insurer is calculated under section 78-15 of the GST Act and is limited to the amount to which the insurer that issued the policy would have been entitled, if it had made the settlement of the claim under the insurance policy. The first insurer will not be entitled to a decreasing adjustment under section 78-10 of the GST Act because it no longer settles a claim under the insurance policy.

Example 6.4 Ostrich Insurance Company (Ostrich) and Whyte Nite Insurance Company (Whyte Nite) enter into an arrangement where Ostrich transfers its home and contents insurance portfolio to Whyte Nite. The arrangement is in the nature of a portfolio transfer and Whyte Nite has undertaken to settle claims that may arise from those policies that had been issued by Ostrich. Section 78-118 provides that Division 78 of the GST Act applies to Whyte Nite as if Whyte Nite were an insurer in relation to the policies.If Ostrich had settled a claim under one of the insurance policies (and the insurance policy had not been transferred):

·
the supply of something by Ostrich in settlement of the claim would not be a taxable supply;
·
any payment or supply made by an entity in settlement of a claim under an insurance policy is not consideration for a supply made by the recipient of the payment or supply; and
·
a decreasing adjustment would be available to Ostrich (where section 78-10 of the GST Act is satisfied).

Section 78-118 of the GST Act operates to ensure that the same outcome arises for payments or supplies made by Whyte Nite in settlement of a claim under the transferred insurance policy.In particular, when Whyte Nite settles claims under an insurance policy issued by Ostrich, Whyte Nite would be entitled to a decreasing adjustment under section 78-10 of the GST Act to the same extent that Ostrich would have if the insurance policy had not been transferred.

Application and transitional provisions

6.40 These amendments apply, and are taken to have applied to GST returns and net amounts for tax periods starting, or that started, on or after 1 January 2001. As a result, insurers who have been transferred HIH insurance policies may be entitled to a decreasing adjustment when they settle a claim under an HIH insurance policy. [Schedule 5, item 14]


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