House of Representatives

Tax Laws Amendment (2004 Measures No. 2) Bill 2004

Explanatory Memorandum

(Circulated by authority of the Treasurer, the Hon Peter Costello, MP)

Chapter 1 - Life insurance companies

Outline of chapter

1.1 Schedule 1 to this bill modifies the operation of the income tax law affecting life insurance companies to:

·
overcome a range of technical difficulties that the life insurance industry has raised about the practical operation of the income tax law affecting them;
·
clarify how the two classes of taxable income and/or tax losses of life insurance companies are calculated;
·
ensure that the provisions in the Income Tax Assessment Act 1936 (ITAA 1936) relating to reinsurance with non-residents apply only to their accident and disability business;
·
ensure that certain aspects of the ITAA 1936 are effectively replicated in the Income Tax Assessment Act 1997 (ITAA 1997); and
·
ensure that the interactions with other provisions in the income tax law work as intended.

Context of amendments

1.2 The taxation treatment of life insurance companies was reformed with effect from 1 July 2000. Those reforms reflected recommendations made by the Review of Business Taxation. Legislation to implement those reforms (Division 320 of the ITAA 1997) was developed in consultation with industry and enacted by the New Business Tax System (Miscellaneous) Act (No. 2) 2000.

1.3 These amendments respond to concerns raised by the life insurance industry and will improve the practical operation of the taxation regime for life insurance companies and its interaction with other aspects of the income tax law.

Summary of new law

1.4 The income of life insurance companies is divided into different types for income tax purposes. The three main types of income, which reflect the different types of business of life insurance companies, are:

·
the ordinary class of taxable income that is taxed at the company tax rate;
·
income derived in relation to risk business and ordinary investment business is included in this class;
·
the complying superannuation class of taxable income that is taxed at a rate of 15%;
·
income derived in relation to complying superannuation business is included in this class; and
·
non-assessable non-exempt income derived in relation to immediate annuity business.

1.5 The amendments ensure that:

·
the taxable income of the complying superannuation class and the ordinary class are worked out separately; and
·
tax losses of one class can only be applied to reduce future income of the same class.

1.6 The amendments also modify the taxation treatment of each type of business.

1.7 In relation to risk business, the amendments ensure that:

·
for life insurance companies, the provisions in the ITAA 1936 relating to reinsurance with non-residents only apply to accident and disability risk covered by the relevant reinsurance contracts;
·
certain reinsurance commissions are included in assessable income; and
·
the basis for determining the amount of the decrease in the value of policy liabilities that is included in assessable income is the same as the basis for determining the amount of the increase in the value of policy liabilities that is deductible.

1.8 In relation to ordinary investment business, the amendments:

·
clarify that the deduction for the capital component of ordinary investment policies does not apply to other types of policies;
·
ensure that funeral policies issued by friendly societies are taxed as ordinary investment policies;
·
ensure that the amount of the reduction in exit fees over the term of a life insurance policy is deductible; and
·
ensure that risk rider premiums are included in assessable income.

1.9 In relation to complying superannuation business, the amendments:

·
clarify the scope of the deduction for the capital component of premiums received in respect of virtual pooled superannuation trust policies;
·
clarify the scope of the liabilities that can be supported by virtual pooled superannuation trust assets;
·
allow up to 30 days after the time that the transfer value of virtual pooled superannuation trust assets is determined or the time that the value of the virtual pooled superannuation trust policy liabilities is determined, whichever is latter, to transfer excess assets out of the virtual pooled superannuation trust; and
·
impose administrative penalties for the failure to undertake the required valuations of assets and liabilities, or to transfer excess assets out of the virtual pooled superannuation trust, within the specified time periods.

1.10 In relation to immediate annuity business, the amendments:

·
modify the types of policies that are exempt life insurance policies;
·
clarify the scope of the liabilities that can be supported by segregated exempt assets;
·
allow up to 30 days after the time that the transfer value of segregated exempt assets is determined or the time that the value of the exempt life insurance policy liabilities is determined, whichever is latter, to transfer excess assets out of the segregated exempt assets; and
·
impose administrative penalties for the failure to undertake the required valuations of assets and liabilities, or to transfer excess assets out of the segregated exempt assets, within the specified time periods.

1.11 There are also a range of technical amendments that:

·
clarify the scope of the transitional measure for certain management fees that are non-assessable non-exempt income;
·
clarify the interactions between Division 320 and the uniform capital allowances system;
·
modify the operation of the transitional measures relating to the establishment of a virtual pooled superannuation trust and the segregated exempt assets;
·
ensure that the current Actuarial Standards are used for income tax purposes;
·
ensure that the non-resident proportion of foreign establishment amounts that is non-assessable non-exempt income is worked out consistently with the equivalent amount that was exempt income prior to 1 July 2000;
·
ensure that income derived by friendly societies in respect of sickness policies issued before 1 January 2003 is non-assessable non-exempt income; and
·
ensure that various provisions in the ITAA 1936 that apply to policies of life insurance are limited to policies issued by an Australian life insurance company.

Comparison of key features of new law and current law

New law Current law
Tax losses of the complying superannuation class can be applied only to reduce future complying superannuation class income.
Tax losses of the ordinary class can be applied only to reduce future ordinary class income.
Tax losses of the complying superannuation class can be applied only to reduce future complying superannuation class income.
Tax losses of the ordinary class must be applied to reduce both future ordinary class income and future complying superannuation class income.
In relation to risk business:

·
the provisions in the ITAA 1936 relating to reinsurance with non-residents apply only to accident and disability risk covered by the relevant reinsurance contracts entered into by life insurance companies;
·
reinsurance commissions are specifically included in assessable income; and
·
the basis for determining the amount of the decrease in the value of policy liabilities that is included in assessable income is the same as the basis for determining the amount of the increase in the value of policy liabilities that is deductible.

In relation to risk business:

·
the provisions in the ITAA 1936 relating to reinsurance with non-residents apply to the whole of the risk covered by the relevant reinsurance contracts entered into by life insurance companies;
·
reinsurance commissions may not be included in assessable income; and
·
the basis for determining the amount of the decrease in the value of policy liabilities that is included in assessable income may be different to the basis for determining the amount of the increase in the value of policy liabilities that is deductible.

In relation to ordinary investment business:

·
the deduction for the capital component of ordinary investment policies does not apply to other types of policies;
·
funeral policies issued by friendly societies are taxed as ordinary investment policies;
·
the amount of the reduction in exit fees over the term of a life insurance policy is deductible; and
·
risk rider premiums are included in assessable income.

In relation to ordinary investment business:

·
the deduction for the capital component of ordinary investment policies may apply to other types of policies;
·
funeral policies issued by friendly societies may be taxed as risk policies;
·
the amount of the reduction in exit fees over the term of a life insurance policy may not be deductible; and
·
risk rider premiums may not be included in assessable income.

In relation to complying superannuation business:

·
the deduction for the capital component of premiums received in respect of virtual pooled superannuation trust policies is not reduced by the risk component of participating policies;
·
liabilities relating to virtual pooled superannuation trust policies and all relevant provisions for income tax can be supported by virtual pooled superannuation trust assets;
·
life insurance companies must transfer excess assets out of the virtual pooled superannuation trust within 30 days of the later of:

·
the time that the transfer value of virtual pooled superannuation trust assets is determined; and
·
the time that the value of the virtual pooled superannuation trust policy liabilities is determined; and

·
administrative penalties will be imposed if a life insurance company does not undertake the required valuations of assets and liabilities, or transfer excess assets out of the virtual pooled superannuation trust, within the specified time periods.

In relation to complying superannuation business:

·
the deduction for the capital component of premiums received in respect of virtual pooled superannuation trust policies is reduced by the risk component of participating policies;
·
liabilities relating to virtual pooled superannuation trust policies and relevant provisions for tax in respect of unrealised gains and for unpaid pay as you go instalments can be supported by virtual pooled superannuation trust assets;
·
life insurance companies must transfer excess assets out of the virtual pooled superannuation trust within 30 days of the time that the transfer value of virtual pooled superannuation trust assets is determined; and
·
no administrative penalties are imposed if a life insurance company does not undertake the required valuations of assets and liabilities, or transfer excess assets out of the virtual pooled superannuation trust, within the specified time periods.

In relation to immediate annuity business:

·
exempt life insurance policies include, among other things:

·
immediate annuity policies that satisfy certain conditions; and
·
part of a policy held by a complying superannuation fund or pooled superannuation trust where the relevant part satisfies certain conditions;

·
liabilities relating to exempt life insurance policies can be supported by segregated exempt assets;
·
life insurance companies must transfer excess assets out of the segregated exempt assets within 30 days of the later of:

·
the time that the transfer value of segregated exempt assets is determined; and
·
the time that the value of the exempt life insurance policy liabilities is determined; and

·
administrative penalties will be imposed if a life insurance company does not undertake the required valuations of assets and liabilities, or transfer excess assets out of the segregated exempt assets, within the specified time periods.

In relation to immediate annuity business:

·
exempt life insurance policies include, among other things:

·
all immediate annuity policies; and
·
policies held by a complying superannuation fund or pooled superannuation trust only where the whole of the policy satisfies certain conditions;

·
liabilities relating to exempt life insurance policies and relevant provisions for tax in respect of unrealised gains can be supported by segregated exempt assets;
·
life insurance companies must transfer excess assets out of the segregated exempt assets within 30 days of the time that the transfer value of segregated exempt assets is determined; and
·
no administrative penalties are imposed if a life insurance company does not undertake the required valuations of assets and liabilities, or transfer excess assets out of the segregated exempt assets, within the specified time periods.

Detailed explanation of new law

1.12 The amendments affect a broad range of issues relating to the operation of the income tax law for life insurance companies. In particular, the amendments affect:

·
the basis of working out the ordinary class and complying superannuation class of taxable income or tax losses;
·
the taxation treatment of risk business;
·
the taxation treatment of ordinary investment business;
·
the operation of the virtual pooled superannuation trust; and
·
the operation of the segregated exempt assets.

1.13 There are also a range of technical amendments.

Taxable income or tax losses of the ordinary class and the complying superannuation class

1.14 The amount of income tax that is payable by a taxpayer is generally worked out by applying the method statement in subsection 4-10(3). Step 2 in the method statement requires taxpayers to work out their basic income tax liability on their taxable income using the income tax rates that apply to them for the income year.

1.15 The basic income tax liability for a life insurance company depends on how much of the company's taxable income relates to:

·
the complying superannuation class which is taxed at a rate of 15%; and
·
the ordinary class which is taxed at the company tax rate.

1.16 To enable a life insurance company to calculate its basic income tax liability and the amount of income tax that it has to pay, new Subdivision 320-D allows the company to have taxable incomes or tax losses for each of these classes. [Schedule 1, item 33, sections 320-130 and 320-131]

Working out the taxable income and tax loss of each class

1.17 Subdivision 320-D ensures that:

·
the taxable income of the complying superannuation class and the ordinary class are worked out separately; and
·
tax losses of one class can only be applied to reduce future income of the same class.

[Schedule 1, items 33 and 66, section 320-133 and the definition of 'class' in subsection 995-1(1)]

1.18 For these purposes, Subdivision 320-D allocates a life insurance company's assessable income and deductions to the complying superannuation class and the ordinary class. The taxable income and tax losses of each class are then worked out under the ordinary provisions of the income tax law. A life insurance company can have:

·
taxable incomes of both classes for the same income year;
·
tax losses of both classes for the same income year; or
·
a taxable income of one class and a tax loss of the other class for the same income year.

[Schedule 1, item 33, section 320-135]

1.19 In addition, in certain circumstances other provisions in the income tax law (such as Subdivision 165-B) can apply so that a life insurance company can have a taxable income and a tax loss of the same class.

Complying superannuation class taxable income and tax losses

1.20 For the purpose of working out the taxable income or tax loss of the complying superannuation class under the ordinary provisions of the income tax law, sections 320-137 and 320-141 specify the assessable income, net exempt income, deductions and tax losses of the company that relate to the complying superannuation class.

1.21 The assessable income of a life insurance company that is allocated under subsection 320-137(2) to the complying superannuation class (complying superannuation assessable income) is:

·
assessable income derived from the investment of virtual pooled superannuation trust assets (this includes gains on the disposal of virtual pooled superannuation trust assets);
·
life insurance premiums transferred to the virtual pooled superannuation trust;
·
the amount that is included in assessable income because of section 320-200 as a result of an asset (other than money) being transferred from a virtual pooled superannuation trust where the transfer is made:

·
to reduce excess virtual pooled superannuation trust assets;
·
in exchange for money; or
·
in respect of fees or charges;

·
the transfer values of assets transferred to the virtual pooled superannuation trust to make up a shortfall in virtual pooled superannuation trust assets;
·
taxable contributions transferred from complying superannuation funds (section 275 transfers) in respect of virtual pooled superannuation trust policies;
·
specified roll-over amounts;
·
amounts received relating to dividends paid by listed investment companies to trusts or partnerships in respect of virtual pooled superannuation trust assets that are included in the company's assessable income under subsection 115-280(4); and
·
the excess of relevant amounts credited to retirement savings accounts over relevant amounts debited from those retirement savings accounts;

·
as a consequence of changing the methodology for working out the complying superannuation class of taxable income, the provisions for working out the net amount credited to retirement savings accounts that is included in the complying superannuation class have been relocated and specific provisions relating to preventing losses from being applied against retirement savings accounts income have been removed.

[Schedule 1, item 33, section 320-137]

1.22 The deductions (other than tax losses) of a life insurance company that are allocated under subsection 320-137(4) to the complying superannuation class (complying superannuation deductions) are:

·
the component of life insurance premiums transferred to the virtual pooled superannuation trust that the company can deduct under section 320-55;
·
amounts the company can deduct (other than any tax losses) that relate to the investment of virtual pooled superannuation trust assets. These amounts include expenses incurred directly in respect of virtual pooled superannuation trust assets and amounts that the company can deduct under the capital allowances regime in respect of virtual pooled superannuation trust assets;
·
the amount that is allowed as a deduction because of section 320-200 as a result of an asset (other than money) being transferred from a virtual pooled superannuation trust where the transfer is made to:

·
reduce excess virtual pooled superannuation trust assets;
·
in exchange for money; or
·
in respect of fees or charges;

·
the transfer values of assets transferred from the virtual pooled superannuation trust to reduce excess virtual pooled superannuation trust assets;
·
amounts that the company can deduct under subsection 115-280(1) relating to dividends paid by listed investment companies in respect of virtual pooled superannuation trust assets; and
·
amounts that the company can deduct under subsection 115-215(6) in respect of net capital gains of trust estates that are attributable to virtual pooled superannuation trust assets.

[Schedule 1, item 33, section 320-137]

1.23 The taxable income of the complying superannuation class is worked out under section 4-15. Generally, as a result of applying section 4-15, a life insurance company will have a taxable income of the complying superannuation class for an income year if the company's complying superannuation assessable income for that income year exceeds the sum of:

·
the complying superannuation deductions for that income year; and
·
tax losses of the complying superannuation class that the company can deduct in that income year.

[Schedule 1, items 33 and 67, subsection 320-137(1) and the definition of 'complying superannuation class for a taxable income of a life insurance company' in subsection 995-1(1)]

1.24 A tax loss of the complying superannuation class for an income year is worked out under section 36-10. Generally, as a result of applying section 36-10, a life insurance company will have a tax loss of the complying superannuation class for an income year if the company's complying superannuation deductions for that income year exceed the sum of:

·
the complying superannuation assessable income for that income year; and
·
net exempt income for that income year that is attributable to the virtual pooled superannuation trust assets.

[Schedule 1, items 33 and 68, subsection 320-141(1) and the definition of 'complying superannuation class for a tax loss of a life insurance company' in subsection 995-1(1)]

1.25 A tax loss of the complying superannuation class is deducted on the same basis as other tax losses. However, a tax loss of the complying superannuation class for an income year can only be deducted in a later income year from:

·
net exempt income that is attributable to the virtual pooled superannuation trust assets for that later income year; and
·
that part of the complying superannuation assessable income that exceeds the complying superannuation deductions for that later income year.

[Schedule 1, item 33, subsection 320-141(2)]

Ordinary class taxable income and tax losses

1.26 For the purpose of working out the taxable income or tax loss of the ordinary class under the ordinary provisions of the income tax law, sections 320-139 and 320-143 specify the assessable income, net exempt income, deductions and tax losses of the company that relate to the ordinary class.

1.27 The assessable income of the company that is allocated to the ordinary class (ordinary assessable income) is the amount of the company's assessable income that is not complying superannuation assessable income.

1.28 The deductions (other than tax losses) that are allocated to the ordinary class (ordinary deductions) is the amount of the company's deductions (other than tax losses) that are not complying superannuation deductions.

1.29 The taxable income of the ordinary class is worked out under section 4-15. Generally, as a result of applying section 4-15, a life insurance company will have a taxable income of the ordinary class for an income year if the company's ordinary assessable income for that income year exceeds the sum of:

·
the company's ordinary deductions for that income year; and
·
tax losses of the ordinary class that the company can deduct in that income year.

[Schedule 1, items 33 and 71, section 320-139 and the definition of 'ordinary class for a taxable income of a life insurance company' in subsection 995-1(1)]

1.30 A tax loss of the ordinary class for an income year is worked out under section 36-10. Generally, as a result of applying section 36-10, a life insurance company will have a tax loss of the ordinary class for an income year if the company's ordinary deductions for that income year exceed the sum of:

·
the company's ordinary assessable income for that income year; and
·
the company's net exempt income (other than net exempt income that is attributable to the virtual pooled superannuation trust assets) for that income year.

[Schedule 1, items 33 and 72, subsection 320-143(1) and the definition of 'ordinary class for a tax loss of a life insurance company' in subsection 995-1(1)]

1.31 A tax loss of the ordinary class is deducted on the same basis as other tax losses. However, a tax loss of the ordinary class for an income year can only be deducted in a later income year from:

·
net exempt income (other than net exempt income that is attributable to the virtual pooled superannuation trust assets) for that later income year; and
·
that part of the ordinary assessable income that exceeds the ordinary deductions for that later income year.

[Schedule 1, item 33, subsection 320-143(2)]

Tax losses held as at 1 July 2000

1.32 Prior to 1 July 2000, tax losses of life insurance companies that were carried forward from a previous income year were applied, in the first instance, to reduce the equivalent of the ordinary class of taxable income.

1.33 Consistent with this approach, as a transitional rule, tax losses that arose before 1 July 2000 and are carried forward will be tax losses of the ordinary class and can be deducted only from future ordinary class income. [Schedule 1, item 80, section 320-100 of the Income Tax (Transitional Provisions) Act 1997]

Working out the amount of income tax payable by a life insurance company

1.34 The amount of income tax payable by a taxpayer is generally worked out by applying the method statement in subsection 4-10(3). That method statement is modified for a life insurance company so that:

·
steps 1 and 2 in the method statement are applied to work out separately:

·
the amount of the company's basic income tax liability for its taxable income of the complying superannuation class; and
·
the amount of the company's basic income tax liability for its taxable income of the ordinary class; and

·
for the purposes of step 4 in the method statement, the amount of income tax payable by the company is the sum of its basic income tax liabilities for each class reduced by its tax offsets.

[Schedule 1, item 33, subsection 320-134(1)]

1.35 The amount worked out under step 4 in the method statement is taken to be the company's income tax on its taxable income for the income year. In addition, except for the purposes of working out the company's income tax liability for an income year, the company's taxable income for a year is taken to be equal to the sum of the taxable incomes of the two classes for that year. This will ensure that the company is issued with only one notice of assessment for the income year and will have only one debt payable to the Commonwealth. [Schedule 1, item 33, subsection 320-134(2)]

1.36 In addition, subsection 320-134(1) applies in working out the amount of the company's income tax if certain assumptions were made. It applies in the same way in working out the company's income tax under section 4-10 (except in regard to those assumptions). This means that the modifications to section 4-10 will be recognised, for example, in applying the assumptions made in section 67-30 (which determines when a taxpayer can get a refund of a tax offset). [Schedule 1, item 33, subsection 320-134(3)]

Example 1.1 MB Life has the following income and expenses for the year ending 30 June 2004:

Complying superannuation class
premiums received $10,000
investment income $900
deductible expenses $1,200
net exempt income $80
Ordinary class
premiums received $15,000
investment income $2,000
deductible expenses $700
net exempt income $300
In relation to the premiums received, MB Life can deduct:
virtual pooled superannuation
trust premiums $10,000
ordinary premiums $13,000
MB Life made the following transfers in cash to the virtual pooled superannuation trust during the income year:
premiums (subsection 320-185(3)) $10,000
transfers subsection 320-180(3) $270
MB Life also transferred $150 in cash from the virtual pooled superannuation trust in respect of fees imposed during the income year.The assessable income allocated to the complying superannuation class and the ordinary class is as follows:
  Complying superannuation class
($)
Ordinary class
($)
Investment income 900 [F1] 2,000 [F2]
Premiums 10,000 [F3] 15,000 [F4]
Subsection 320-180(3) transfers to the virtual pooled superannuation trust 270 [F5] n/a
Fees transferred from the virtual pooled superannuation trust n/a 150 [F6]
Total Assessable Income 11,170 17,150
The deductions (other than tax losses) allocated to the complying superannuation class and the ordinary class are as follows:
  Complying superannuation class
($)
Ordinary class
($)
Premiums 10,000 [F7] 13,000 [F8]
Expenses 1,200 [F9] 700 [F10]
Assets transferred to the virtual pooled superannuation trust under subsection 320-180(3) n/a 270 [F11]
Fees transferred from the virtual pooled superannuation trust 150 [F12] n/a
Total deductions (other than tax losses) 11,350 13,970
MB Life's complying superannuation deductions exceed its complying superannuation assessable income. Therefore, MB Life does not have a taxable income of the complying superannuation class for the income year.Instead, MB Life has a tax loss of the complying superannuation class. The tax loss of the complying superannuation class is calculated under Division 36 as follows:
Complying superannuation deductions $11,350
Less complying superannuation assessable income $11,170
Less total net exempt income that relates to the complying superannuation class $80
Tax loss of the complying superannuation class $100
MB Life's ordinary class assessable income exceeds its ordinary class deductions. Therefore, MB Life has a taxable income of the ordinary class for the income year. The company's taxable income of the ordinary class for the income year is calculated under section 4-15 as follows:
Ordinary assessable income $17,150
Less ordinary deductions $13,970
Taxable income of the ordinary class $3,180
MB Life did not have any tax offsets for the income year. Therefore, the amount of income tax payable by MB Life is $954 (i.e. taxable income of the ordinary class ($3,180) multiplied by the company tax rate (30%)).No income tax is payable in relation to the complying superannuation class because MB Life has a complying superannuation class tax loss for the income year. That tax loss can be deducted in a later income year only from complying superannuation class income.

Provisions in the Income Assessment Act 1997 that apply only to the ordinary class

1.37 Most provisions in the income tax law that affect the amount worked out for taxable income or tax losses also apply to the taxable income and tax loss that are worked out for both the complying superannuation class and the ordinary class.

1.38 The only exceptions to this principle are section 36-55 and Division 165 (other than Subdivision 165-CD). These provisions will not affect the taxable income or tax loss of the complying superannuation class. [Schedule 1, item 33, section 320-149]

1.39 Section 36-55 allows an entity that has excess franking tax offsets because it has insufficient tax payable on taxable income to convert the excess into an equivalent amount of tax loss. This tax loss is then aggregated with any other tax loss for the year and the aggregated amount becomes the tax loss for the income year. Section 36-55 can apply only to the ordinary class because excess franking tax offsets relating to the complying superannuation class are refundable tax offsets.

1.40 Division 165 essentially prevents a company from deducting prior year tax losses unless it satisfies the continuity of ownership test. If the company does not pass this test, it can still claim a deduction if it passes the same business test.

1.41 In some circumstances Division 165 (other than Subdivision 165-CD) modifies the way in which net capital gains and net capital losses are calculated. As net capital gains and net capital losses are elements that are used to work out the amount of taxable income or tax loss, section 320-149 ensures that the provisions in Division 165 (other than Subdivision 165-CD) do not apply to capital gains and capital losses on virtual pooled superannuation trust assets.

1.42 Subdivision 165-CD applies to prevent multiple recognition of losses when significant equity and debt interests that entities have in a loss company are realised. Subdivision 165-CD is not covered by section 320-149 and therefore will continue to apply to the taxable income or tax losses of both the complying superannuation class and the ordinary class.

Consequential amendments

1.43 As a result of modifying the way in which the ordinary class and complying superannuation class of taxable income and tax losses are calculated, a number of consequential amendments are made to the ITAA 1997 and to the Taxation Administration Act 1953 (TAA 1953).

1.44 Consequential amendments to the ITAA 1997:

·
include the transfer values of assets transferred to and from the virtual pooled superannuation trust in the company's assessable income;
·
allow the company to deduct the transfer values of assets transferred to and from the virtual pooled superannuation trust; and
·
insert various notes to guide readers, modify the checklist of deductions, modify guide material and various headings in Division 320, and repeal obsolete provisions and definitions.

[Schedule 1, items 2 to 6, 9, 10, 28, 31, 32, 34, 35, 48, 49, 74, 76, 77, 79, 81, 98, 99, 101, 105 and 106, sections 4-15, 12-5, 36-25, 320-1, 320-5, 320-15, 320-35, 320-87, 320-120, 320-125, 320-165 and 713-530 and subsection 995-1(1)]

1.45 Consequential amendments to the TAA 1953 modify the method statement for working out the adjusted taxable income of a life insurance company for pay as you go instalment purposes. [Schedule 1, items 84 and 107, subsection 45-330(3) in Schedule 1 to the TAA 1953]

Risk business

Reinsurance with non-residents

1.46 Section 148 of the ITAA 1936 deals with reinsurance with non-resident insurers. Subsection 148(1) broadly ensures that, where an Australian insurer reinsures the whole or part of any risk out of Australia with a non-resident:

·
the reinsurance premiums paid or credited are not allowable deductions to the Australian insurer; and
·
the reinsurance premiums paid or credited are not included in the assessable income of the non-resident reinsurer.

1.47 In addition, any amount recovered by the Australian insurer from the non-resident reinsurer in respect of a loss on any risk reinsured does not form part of the assessable income of the Australian insurer.

1.48 Subsection 148(2) allows an Australian insurer to make an election so that subsection 148(1) does not apply to reinsurance contracts it enters into during an income year and all subsequent income years. If an Australian insurer makes a subsection 148(2) election:

·
the Australian insurer is required to furnish returns and to pay tax as agent for all non-resident insurers with whom it has reinsurance contracts; and
·
the Australian insurer is assessed on, and is liable to pay tax on, an amount equal to 10% of the gross premiums paid or credited to non-resident reinsurers in an income year.

1.49 The effect of making an election is that the Australian insurer is essentially taxed on the non-resident reinsurance on the same basis as resident reinsurance. That is, the Australian insurer can deduct the reinsurance premiums paid to non-resident reinsurers and includes reinsurance recoveries in its assessable income.

1.50 Prior to the introduction of Division 320, section 148 applied only to the accident and disability business of life insurance companies. The Division 320 amendments unintentionally broadened the scope of section 148.

1.51 Section 148 is amended so that, in relation to a life insurance company, it applies only to the whole or part of a risk that:

·
is covered by a disability policy (as defined in subsection 995-1(1) of the ITAA 1997); and
·
relates to a disability benefit.

[Schedule 1, item 1, subsection 148(10) of the ITAA 1936]

1.52 Consequential amendments to various provisions in Division 320 relating to reinsurance exclude amounts received or recovered under a contract of reinsurance that relate to a risk to which subsection 148(1) of the ITAA 1936 applies. [Schedule 1, items 7, 8, 29 and 70, paragraphs 320-15(1)(b) and (c), section 320-100 and the definition of 'net risk component' in subsection 995-1(1)]

1.53 As a consequence of the amendment to modify the definition of 'net risk component', the transitional provisions relating to the change in value of liabilities in respect of continuous disability policies in section 320-30 will operate as intended.

Reinsurance commissions

1.54 Amounts received or recovered by a life insurance company that are a refund, or in the nature of a refund, of a life insurance premium paid under a contract of reinsurance (other than amounts that relate to a risk to which subsection 148(1) of the ITAA 1936 applies) are included in assessable income under paragraph 320-15(1)(c). Reinsurance commissions are intended to be specifically included in assessable income under this paragraph. Alternatively, they would be included in assessable income under section 6-5 as income according to ordinary concepts.

1.55 The amendments will remove any doubt about this outcome by specifically including all reinsurance commissions (other than reinsurance commissions that relate to a risk to which subsection 148(1) applies) in a life insurance company's assessable income. [Schedule 1, item 116, paragraph 320-15(1)(ca)]

1.56 New paragraph 320-15(1)(ca) may have the effect of broadening the scope of the current law if it can be established that reinsurance commissions are not included in assessable income under either paragraph 320-15(1)(c) or under section 6-5. Therefore, this amendment will apply to reinsurance commissions received or recovered by a life insurance company after the date of Royal Assent. [Schedule 1, subitem 126(8)]

Decrease in the value of risk liabilities

1.57 Section 320-85 allows a deduction for increases in the value of risk liabilities relating to certain life insurance policies. Decreases in the value of risk liabilities are included in assessable income under paragraph 320-15(1)(h).

1.58 The amendments clarify that paragraph 320-15(1)(h) and section 320-85 both apply to risk liabilities relating to life insurance policies other than:

·
policies that provide for participating benefits or discretionary benefits;
·
exempt life insurance policies; or
·
funeral policies.

[Schedule 1, items 13, 16 and 27, paragraph 320-15(1)(h) and subsections 320-15(2) and 320-85(2)]

Ordinary investment business

Scope of section 320-75

1.59 Currently, section 320-75 allows a deduction for, in essence, the capital component of premiums received in respect of ordinary investment policies. The amount of that deduction is, broadly, the sum of premiums received in respect of ordinary investment policies reduced by the amount of those premiums that an actuary determines to be attributable to fees and charges. The actuary's determination must have regard to changes in the net current termination value of relevant policies over the income year. The net current termination value of a policy at a particular time is, broadly, the amount that the company would pay to the policyholder if the policy was terminated at that time.

1.60 The amendments clarify that section 320-75 can apply only to ordinary investment policies (including funeral policies). An ordinary investment policy is a life insurance policy that is not:

·
a virtual pooled superannuation trust life insurance policy;
·
an exempt life insurance policy;
·
a policy that provides for participating or discretionary benefits; or
·
a policy (other than a funeral policy) under which benefits are paid only on the death or disability of a person.

[Schedule 1, items 24 and 73, subsection 320-75(1) and the definition of 'ordinary investment policy' in subsection 995-1(1)]

Funeral policies

1.61 Funeral policies are investment products primarily issued by friendly societies. Funeral policy benefits can only be paid on the death of a person to pay for the person's funeral. The amendments clarify that funeral policies are appropriately treated as ordinary investment policies rather than as risk policies. [Schedule 1, items 16, 23 to 27 and 73, subsections 320-15(2), 320-70(2), 320-80(2) and 320-85(2) and the definition of 'ordinary investment policy' in subsection 995-1(1)]

Exit fees

1.62 Many life insurance companies charge exit fees. Exit fees are typically levied if a policyholder terminates a policy within, for example, the first four or five years. However, an exit fee diminishes over time. That is, the exit fee that applies to a policy that is terminated after one year is substantially greater than the exit fee that applies to a policy that is terminated after three or four years. In most cases, no exit fee is payable if the policy has been held for more than four or five years.

1.63 Exit fees (however described under the terms of a policy) levied on ordinary investment policies are included in assessable income in the year a policy is taken out. This arises because:

·
premiums paid to the company are included in assessable income under paragraph 320-15(1)(a); and
·
a deduction is allowed under section 320-75 for the sum of the net premiums received less the amount of those net premiums that an actuary determines to be attributable to fees and charges.

1.64 Therefore, in the absence of any other fees, the amount deductible under section 320-75 would be the premium received reduced by the exit fees.

1.65 The section 320-75 mechanism effectively allows a deduction to reflect reductions in exit fees on ordinary investment policies over time. However, the mechanism is ineffective if the life insurance company does not receive any premiums in respect of an ordinary investment policy in a particular income year.

1.66 To overcome this anomaly, a life insurance company will be allowed a deduction for a reduction in exit fees if an actuary determines that:

·
there has been a reduction in the income year of exit fees that were imposed in respect of ordinary investment policies in a previous income year; and
·
that reduction has not been taken into account in a determination made by the actuary under subsection 320-75(2).

[Schedule 1, item 24, subsection 320-75(4)]

Example 1.2 On 14 December 2001, Natasha takes out an ordinary life insurance investment policy with MB Life and paid a premium of $10,000. The premium included fees (other than exit fees) of $150. In addition, an exit fee is payable if Natasha terminates the policy within three years.

·
The exit fee payable if the policy is terminated in the first year is $420.
·
The exit fee payable if the policy is terminated in the second year is $370.
·
The exit fee payable if the policy is terminated in the third year is $130.

In the 2001-2002 income year, MB Life will:

·
include the premiums of $10,000 in assessable income (paragraph 320-15(1)(a)); and
·
claim a deduction under subsection 320-75(2) for $9,430 - that is, the premiums ($10,000) reduced by the amount of the premium that relates to fees and charges ($150 + $420).

Natasha pays additional premiums of $1,000 on 14 December 2002. No fees or charges are included in the premium. Therefore, in the 2002-2003 income year, MB Life will:

·
include the premiums of $1,000 in assessable income; and
·
claim a deduction under subsection 320-75(2) for $1,050 - that is, the premiums paid ($1,000) plus the increase in net current termination value of Natasha's policy caused by the reduction in the exit fees ($50).

Natasha does not pay any further premiums but continues to hold the policy. MB Life will be entitled to deductions under subsection 320-75(4) as a consequence of the reduction in exit fees on the policy of:

·
$240 in the 2003-2004 income year; and
·
$130 in the 2004-2005 income year.

Risk riders

1.67 Ordinary investment policies can have risk riders attached. Risk riders confer risk benefits in return for the payment of additional premiums.

1.68 Risk rider premiums levied on ordinary investment policies are usually included in assessable income because:

·
premiums paid to the company are included in assessable income under paragraph 320-15(1)(a); and
·
a deduction is allowed under section 320-75 for the sum of the net premiums received less the amount of those net premiums that an actuary determines to be attributable to fees and charges.

1.69 Therefore, in the absence of any other fees and charges, the amount deductible under section 320-75 would be the premium received reduced by the risk rider premiums.

1.70 However, the section 320-75 mechanism is ineffective if:

·
the life insurance company does not receive any premiums in respect of ordinary investment policies in a particular income year; and
·
risk rider premiums are charged on those policies.

1.71 To overcome this anomaly, amounts imposed by a life insurance company in respect of risk riders for ordinary investment policies in an income year during which the company did not receive any premiums for those policies will be included in the company's assessable income. [Schedule 1, item 14, paragraph 320-15(1)(ja)]

Operation of the virtual pooled superannuation trust

1.72 Section 320-170 allows a life insurance company to establish a virtual pooled superannuation trust by segregating assets to support liabilities in relation to complying superannuation business. The virtual pooled superannuation trust is taxed in broadly the same way as a complying superannuation fund. Income generated on virtual pooled superannuation trust assets is included in the company's taxable income of the complying superannuation class and taxed at a rate of 15%.

Deduction for premiums in respect of virtual pooled superannuation trust policies

1.73 Section 320-55 allows a deduction for premiums received by a life insurance company in respect of virtual pooled superannuation trust life insurance policies. The amount allowed as a deduction is the premiums received reduced by the death and disability component of those premiums.

1.74 Where a risk rider attaches to an investment policy, and that policy provides for participating or discretionary benefits, a life insurance company can classify the rider as a participating or discretionary policy. As they are attached as a rider, the premium is often separately identified.

1.75 Currently section 320-55(2) denies a deduction for the risk rider premium because it is separately identified. This inappropriately results in premiums being assessable to the virtual pooled superannuation trust but the claims not being deductible.

1.76 The amendments modify section 320-55 to ensure that the deduction allowed in respect of premiums received on virtual pooled superannuation trust life insurance policies is not reduced by risk riders on policies that provide for participating or discretionary benefits. [Schedule 1, item 22, subsection 320-55(3)]

Value of assets that can be held in the virtual pooled superannuation trust

1.77 The amendments clarify that the transfer value of assets held in the virtual pooled superannuation trust at a particular time must not exceed the sum of:

·
the company's virtual pooled superannuation trust liabilities at that time; and
·
any reasonable provision made by the company at that time in its accounts for liability for income tax in respect of the assets segregated.

·
A reasonable provision made by the company in its accounts for liability for income tax includes provisions for current tax and for tax on unrealised gains in respect of the virtual pooled superannuation trust assets.

[Schedule 1, items 36, 39, 40 and 42 to 44, subsections 320-170(3) and 320-185(1), paragraph 320-195(3)(c) and subsection 320-195(4)]

Annual valuation of virtual pooled superannuation trust assets and liabilities

1.78 If a life insurance company has established a virtual pooled superannuation trust, the company is required to undertake an annual valuation of virtual pooled superannuation trust assets and of virtual pooled superannuation trust policy liabilities within 60 days of the end of each income year (section 320-175). If the transfer value of virtual pooled superannuation trust assets exceeds the value of relevant liabilities, the company must transfer excess assets out of the virtual pooled superannuation trust within 30 days of valuing the assets (section 320-180).

1.79 In practice, the transfer value of virtual pooled superannuation trust assets may be determined earlier than the value of virtual pooled superannuation trust liabilities. Therefore, the amendments ensure that the 30 day time limit for transferring assets starts from the later of:

·
the time that the transfer value of virtual pooled superannuation trust assets is determined; and
·
the time that the value of virtual pooled superannuation trust liabilities is determined.

[Schedule 1, items 37, 38, 41, 45, 78, 95 and 97, sections 320-175 and 320-180, subsections 320-185(4 ) and 320-200(1), section 713-525 and the definition of 'valuation time' in subsection 995-1(1)]

Administrative penalties for failure to undertake a valuation or to transfer assets

1.80 An administrative penalty will be imposed if a life insurance company does not undertake the required valuations or transfer excess assets out of the virtual pooled superannuation trust within the specified time periods.

1.81 The administrative penalty is equal to five penalty units (one penalty unit is currently $110) for each period of 28 days or part of a period of 28 days:

·
starting immediately after the end of the relevant 60 day or 30 day period; and
·
ending at the end of the day on which the valuation or transfer of assets is made.

[Schedule 1, item 125, section 288-70 in Schedule 1 to the TAA 1953]

1.82 The maximum penalty that can be imposed for each failure to make a valuation or to transfer excess assets is 25 penalty units (currently $2,750). [Schedule 1, item 125, subsection 288-70(5) in Schedule 1 to the TAA 1953]

1.83 The administrative penalty will apply in relation to a valuation time that occurs after the date of Royal Assent. [Schedule 1, subitem 126(11)]

Operation of the segregated exempt assets

1.84 Section 320-225 allows a life insurance company to establish a pool of segregated assets (segregated exempt assets) that are used to support liabilities in relation to exempt life insurance policies (i.e. broadly, immediate annuity policies). Income generated on the segregated exempt assets is non-assessable non-exempt income.

Exempt life insurance policies

1.85 Currently, a life insurance policy (other than a retirement saving account) is an exempt life insurance policy if, broadly:

·
the policy is held by the trustee of a complying superannuation fund and provides solely for the discharge of current pension liabilities of the fund;
·
the policy is held by the trustee of a pooled superannuation trust and provides solely for the discharge of current pension liabilities of the complying superannuation funds that are unit holders of the pooled superannuation trust;
·
the policy is held by another life insurance company and is a segregated exempt asset of that other company;
·
the policy is held by the trustee of a constitutionally protected superannuation fund;
·
the policy is an immediate annuity policy; or
·
the policy is a policy that provides for either an exempt personal injury annuity or an exempt personal injury lump sum.

1.86 The amendments:

·
ensure that an immediate annuity policy will be an exempt life insurance policy only if it satisfies certain conditions; and
·
allow part of a life insurance policy to be an exempt life insurance policy.

[Schedule 1, items 56, 57, 69 and 100, sections 320-246 and 320-247 and the definition of 'exempt life insurance policy' in subsection 995-1(1)]

Conditions for an immediate annuity policy to qualify as an exempt life insurance policy

1.87 When Division 320 was introduced, it was intended that the types of policy liabilities that could be supported by the segregated exempt assets would be broadly equivalent to the types of policies that qualified for exemption under the pre-July 2000 arrangements for taxing life insurance companies.

1.88 Under those pre-July 2000 arrangements, income in relation to most immediate annuity policies was exempt from tax only if those policies satisfied certain conditions.

1.89 The amendments essentially replicate those conditions. The conditions only apply to an immediate annuity policy where:

·
the purchase price of the policy consists wholly or partly of a rolled-over eligible termination payment; or
·
the policy was purchased after 9 December 1987.

[Schedule 1, item 57, paragraph 320-246(1)(e)]

1.90 These immediate annuity policies need to satisfy three conditions to qualify as an exempt life insurance policy.

1.91 First, the annuity must be payable until the later of:

·
the death of a person (or the last to die of two or more persons); or
·
the end of a fixed term.

[Schedule 1, item 57, subsection 320-246(3)]

1.92 Second, the annuity contract must not permit:

·
the total amount payable on the commutation of the annuity to exceed the reduced purchase price of the annuity;

·
the reduced purchase price of the annuity is the purchase price of the annuity reduced by the accumulated amount of the annual undeducted purchase price that has been excluded from assessable income under section 27H of the ITAA 1936; or

·
the residual capital value of the annuity to be greater than its purchase price.

[Schedule 1, item 57, subsection 320-246(4)]

1.93 Finally, there must be no unreasonable deferral of the payment of the annuity having regard to:

·
to the extent to which the annuity payments depend on investment returns of the life insurance company - when the payments are made and when those returns are derived;
·
to the extent to which the annuity payments do not depend on those investment returns - the relative sizes of the annuity payments from year to year; and
·
any other relevant factors - the Commissioner of Taxation can determine these other relevant factors.

[Schedule 1, item 57, subsection 320-246(5)]

An exempt life insurance policy includes part of a policy

1.94 Complying superannuation funds are exempt from tax on income relating to their current pension liabilities. Broadly, the amount that is exempt from tax is either the amount of income derived on segregated current pension assets or a proportion of income that is attributable to the current pension liabilities. Taxable income that is attributable to members in the accrual phase is taxed at a rate of 15%.

1.95 If a complying superannuation fund purchases a life insurance investment policy, the policy may be held to support liabilities of the fund in respect of both fund members who are accruing benefits and fund members who are being paid pensions.

1.96 Similarly, a pooled superannuation trust is exempt from tax on the proportion of its income that relates to the discharge of current pension liabilities of the complying superannuation funds that are unit holders of the pooled superannuation trust.

1.97 If a complying superannuation fund or a pooled superannuation trust purchases a life insurance policy that supports both members who are in the pension phase and members who are in the accrual phase, the amendments ensure that the policy is split into two policies.

1.98 The part of the policy that is taken to be an exempt life insurance policy is:

·
that part of the policy held by the trustee of a complying superannuation fund that provides solely for the discharge of current pension liabilities of the fund; or
·
that part of the policy held by the trustee of a pooled superannuation trust that provides solely for the discharge of current pension liabilities of the complying superannuation funds that are unit holders of the pooled superannuation trust.

[Schedule 1, item 57, section 320-247]

1.99 Where part of a policy is taken to be an exempt life insurance policy, the remainder of the policy is treated as a separate policy. That separate policy will usually be a virtual pooled superannuation trust policy. [Schedule 1, item 57, subsection 320-247(3)]

1.100 The extent to which a policy is taken to be an exempt life insurance policy can vary from time to time. For example, if a member of a complying superannuation fund that holds a life insurance policy commences to receive a pension, the life insurance company can transfer assets from the virtual pooled superannuation trust to the segregated exempt assets (subsection 320-195(1)). In these circumstances, the proportion of the policy that is taken to be an exempt life insurance policy will increase.

1.101 Similarly, as the proportion of the complying superannuation fund's current pension liabilities changes because, for example, the fund commences new pension payments or because members join or leave the fund, there will be a corresponding change in the proportion of the policy that is taken to be an exempt life insurance policy.

Value of assets that can be held in the segregated exempt assets

1.102 The amendments clarify that the transfer value of assets held in the segregated exempt assets at a particular time must not exceed the amount of the company's exempt life insurance policy liabilities at that time. [Schedule 1, items 50, 53, 54 and 59, subsections 320-225(3) and 320-240(1) and paragraph 320-250(2)(c)]

Annual valuation of segregated exempt assets and exempt life insurance policy liabilities

1.103 If a life insurance company has established a pool of segregated exempt assets, the company is required to undertake an annual valuation of those assets and of exempt life insurance policy liabilities within 60 days of the end of each income year (section 320-230). If the transfer value of segregated exempt assets exceeds the value of the exempt life insurance policy liabilities, the company must transfer excess assets out of the segregated exempt assets within 30 days of valuing the assets (section 320-235).

1.104 In practice, the transfer value of segregated exempt assets may be determined earlier than the value of exempt life insurance policy liabilities. Therefore, the amendments ensure that the 30 day time limit for transferring assets starts from the later of:

·
the time that the transfer value of segregated exempt assets is determined; and
·
the time that the value of exempt life insurance policy liabilities is determined.

[Schedule 1, items 30, 51, 52, 55, 58, 61, 78, 96 and 97, sections 320-105, 320-230, and 320-235, subsections 320-240(4) and 320-255(1), section 713-525 and the definition of 'valuation time' in subsection 995-1(1)]

Administrative penalties for failure to undertake a valuation or to transfer assets

1.105 An administrative penalty will be imposed if a life insurance company does not undertake the required valuations or transfer excess assets out of the segregated exempt assets within the specified time periods.

1.106 The administrative penalty is equal to five penalty units (one penalty unit is currently $110) for each period of 28 days or part of a period of 28 days:

·
starting immediately after the end of the relevant 60 day or 30 day period; and
·
ending at the end of the day on which the valuation or transfer of assets is made.

[Schedule 1, item 125, section 288-70 in Schedule 1 to the TAA 1953]

1.107 The maximum penalty that can be imposed for each failure to make a valuation or to transfer excess assets is 25 penalty units (currently $2,750). [Schedule 1, item 125, subsection 288-70(5) in Schedule 1 to the TAA 1953]

1.108 The administrative penalty will apply in relation to a valuation time that occurs after the date of Royal Assent. [Schedule 1, subitem 126(11)]

Miscellaneous technical amendments

Transitional exemption of certain management fees

1.109 As a transitional measure, one-third of certain management fees derived by life insurance companies is treated as non-assessable non-exempt income (section 320-40). The transitional measure ceases to apply from 1 July 2005.

1.110 The transitional measure applies to specified management fees received on certain types of life insurance policies that were in force as at 30 June 2000.

1.111 The amendments clarify the types of management fees that qualify for transitional relief.

1.112 Management fees on virtual pooled superannuation trust policies are identified by transfers from the virtual pooled superannuation trust. The amendments ensure that specified management fees that qualify for transitional relief do not include:

·
amounts transferred from the virtual pooled superannuation trust that relate to expenses incurred by the company in respect of policies that provide for participating or discretionary benefits; and
·
amounts transferred from the virtual pooled superannuation trust that represent the recovery of expenses that should have been paid directly from the virtual pooled superannuation trust under subsection 320-195(4).

[Schedule 1, items 17 and 18, paragraph 320-40(5)(b) and subsection 320-40(5A)]

1.113 Similarly, management fees on exempt life insurance policies are identified by transfers from the segregated exempt assets. The amendments ensure that specified management fees that qualify for transitional relief do not include:

·
amounts transferred from the segregated exempt assets that relate to expenses incurred by the company in respect of policies that provide for participating benefits or discretionary benefits; and
·
amounts transferred from the segregated exempt assets that represent the recovery of expenses that should have been paid directly from the segregated exempt assets under subsection 320-250(3).

[Schedule 1, items 19 and 20, subsections 320-40(6) and 320-40(6A)]

1.114 Currently, management fees on ordinary investment policies are identified, broadly, by the difference between the premiums received in respect of those policies and the sum of:

·
the amount that can be deducted under section 320-75; and
·
the risk component of claims paid.

1.115 The amendments ensure that specified management fees that qualify for transitional relief include management fees that are included in assessable income under paragraph 320-15(1)(k). They also clarify that paragraph 320-15(1)(k) does not apply to amounts that are included in assessable income as a consequence of a transfer from a life insurance company's virtual pooled superannuation trust or segregated exempt assets. [Schedule 1, items 15 and 21, paragraph 320-15(1)(k) and subsection 320-40(7)]

Interaction with the uniform capital allowance system

1.116 When a life company transfers an asset to or from its virtual pooled superannuation trust or segregated exempt assets, the company is taken to have sold and repurchased the asset at that time. Section 320-200 and section 320-255 specify the consideration that the company is taken to have sold and repurchased the asset for.

1.117 Where the asset transferred to or from the virtual pooled superannuation trust or segregated exempt assets is a unit of plant or a depreciating asset, the deemed sale of the asset triggers the taxation consequences that arise under the capital allowances system.

1.118 The amendments clarify the interaction between Division 320 and the capital allowances system to ensure that the intended outcome is achieved. That is, the amendments clarify that, for the purposes of former Division 42 (which, broadly, applies to a unit of plant that the life insurance company started to hold before 1 July 2001):

·
in relation to the deemed sale of a unit of plant:

·
the sale is a balancing adjustment event;
·
the consideration that the company is taken to have sold the asset for is the termination value of the asset for that event; and
·
the company ceases to be the owner or quasi-owner of the asset at the time of sale; and

·
in relation to the deemed purchase of the unit of plant:

·
the company only became the owner or quasi-owner of the unit of plant at the time of the purchase;
·
the consideration that the company is taken to have purchased the asset for is the asset's cost; and
·
the company acquires the asset from an associate of the company.

[Schedule 1, items 46 and 65, subsections 320-200(2A) and 320-255(9)]

1.119 Similarly, the amendments clarify that, for the purposes of Division 40 (which, broadly, applies to depreciating assets that the life insurance company started to hold after 30 June 2001):

·
in relation to the deemed sale of a depreciating asset:

·
the sale is a balancing adjustment event;
·
the consideration that the company is taken to have sold the asset for is the termination value of the asset for that event; and
·
the company stopped holding the asset at the time of sale; and

·
in relation to the deemed purchase of the depreciating asset:

·
the company only began to hold the asset at the time of the purchase - consequently, the start time of the asset is the time that the company first uses the asset or has it installed ready for use for any purpose after the time of the deemed purchase;
·
the consideration that the company is taken to have purchased the asset for is the first element of the asset's cost; and
·
the company acquires the asset from an associate of the company.

[Schedule 1, items 87 and 93, subsections 320-200(2A) and 320-255(9)]

1.120 The amendments also:

·
insert notes to guide the reader in Division 40;
·
clarify that the company can claim deductions that are allowed in relation to an asset under the former Division 42 or under Division 40 at the time the life insurance company transfers the asset to or from its virtual pooled superannuation trust or to its segregated exempt assets;
·
modify terminology used in section 320-255 to reflect terminology used in the former Division 42 and in Division 40; and
·
remove redundant provisions in section 320-255 and a redundant definition.

[Schedule 1, items 47, 62, 63, 64, 85, 86, 88 and 89 to 94, section 40-15, subsections 320-200(4), 320-255(3A), 320-255(5) and 320-255(7) and the definition of 'notional adjustable value' in subsection 995-1(1)]

Example 1.3 On 14 September 2004, MB Life transfers a depreciating asset to its segregated exempt assets. The asset was purchased for $100,000 and, prior to the transfer, had only been used for the purposes of producing assessable income. At the time of the transfer:

·
the market value of the asset is $65,000; and
·
the adjustable value of the asset is $40,000.

The assets decline in value for the income year for the period up to the time of the transfer is $2,500.As the asset is a depreciating asset, MB Life is deemed to have sold and repurchased the asset at the time of the transfer for a consideration equal to its market value at that time - that is, $65,000 (subsection 320-255(6)).In relation to the deemed sale:

·
the transfer of the asset to the segregated exempt assets is a balancing adjustment event (subparagraph 320-255(9)(a)(i));
·
the termination value of the asset for the purposes of working out the balancing adjustment under Division 40 is $65,000 (subparagraph 320-255(9)(a)(ii));
·
as the termination value is more that the adjustable value, MB Life will include the difference ($25,000) in its ordinary assessable income for the 2004-2005 income year (subsections 40-285(1), 320-255(6) and 320-255(9) and paragraph 320-139(a)); and
·
as MB Life stops holding the asset at the time of the deemed sale (subparagraph 320-255(9)(a)(iii)), MB Life can claim a deduction of $2,500 for the asset's decline in value during the income year up to the time of the transfer (section 40-25 and paragraph 320-139(b)).

In relation to the deemed purchase:

·
MB Life is taken to have held the asset from the time of the transfer - that is, from 14 September 2004 (subparagraph 320-255(9)(b)(i));
·
the first element of the cost of the asset is $65,000 (subparagraph 320-255(9)(b)(ii)); and
·
MB Life cannot claim a deduction for the assets decline in value during the period the asset is held in the segregated exempt assets as the asset is used to produce non-assessable non-exempt income (section 40-25).

On 1 December 2006, MB Life transfers the depreciating asset from the segregated exempt assets. At that time:

·
the market value of the asset is $50,000; and
·
the adjustable value of the asset is $45,000.

As the asset is a depreciating asset and the asset's market value at the time of the transfer ($50,000) is less than its market value at the time it was transferred to the segregated exempt assets ($65,000), MB Life is deemed to have sold and repurchased the asset at the time of the transfer for a consideration equal to its market value at the time the asset was transferred from the segregated exempt assets - that is, $50,000 (paragraph 320-255(8)(b)).In relation to the deemed sale:

·
although a balancing adjustment event occurs as a result of the transfer (paragraph 320-255(9)(a)), a balancing adjustment is not made because the asset was used to produce non-assessable non-exempt income (sections 40-285 and 40-290); and
·
MB Life cannot claim a deduction for the asset's decline in value for the income year for the period up to the time of the transfer period because the asset was used to produce non-assessable non-exempt income (section 40-25).

In relation to the deemed purchase:

·
MB Life is taken to have held the asset from the time of the transfer - that is, from 1 December 2006 (subparagraph 320-255(9)(b)(ii));
·
the first element of the cost of the asset is $50,000 (paragraphs 320-255(8)(b) and 320-255(9)(b));
·
if MB Life started to use the asset immediately after it was transferred, the assets start date is 1 December 2006. Therefore, MB Life can claim a deduction for the asset's decline in value from 1 December 2006 (section 40-25 and paragraph 320-139(a)); and
·
as the asset is deemed to be acquired from an associate, MB Life must use the same method to work out the decline in value that was used when the asset was originally purchased (subparagraph 320-255(9)(b)(iii) and sections 40-65 and 40-95).

Transitional rules relating to pre-July 2000 virtual pooled superannuation trust and exempt life insurance policy liabilities

1.121 As a transitional rule, a life insurance company that segregated assets before 1 October 2000 was taken to have established the virtual pooled superannuation trust or segregated exempt assets on 1 July 2000.

1.122 In addition, subsections 320-175(1) and 320-230(1) of the Income Tax (Transitional Provisions) Act 1997 ensured that no tax consequences would arise in respect of assets transferred to meet pre-July 2000 virtual pooled superannuation trust and exempt life insurance policy liabilities.

1.123 The amendments clarify that life insurance companies cannot obtain an advantage by delaying the transfer of assets to the virtual pooled superannuation trust or segregated exempt assets to meet pre-July 2000 policy liabilities. That is, the amendments ensure that:

·
if assets are transferred to the virtual pooled superannuation trust on or after 1 October 2000 to meet pre-July 2000 virtual pooled superannuation trust liabilities, then the assets will be deemed to be sold and repurchased in accordance with section 320-200; and
·
if assets are transferred to the segregated exempt assets on or after 1 October 2000 to meet pre-July 2000 exempt life insurance policy liabilities, then the assets will be deemed to be sold and repurchased in accordance with section 320-255.

[Schedule 1, items 82 and 83, paragraphs 320-175(1)(e) and 320-230(1)(e) of the Income Tax (Transitional Provisions) Act 1997]

1.124 The amendments will ensure that, if assets are transferred to the virtual pooled superannuation trust or segregated exempt assets on or after 1 October 2000 to meet relevant pre-July 2000 liabilities, then, for example:

·
the company will have a capital gain tax event in relation to the assets transferred;
·
the company will include in its assessable income the amount that is assessable because of section 320-200;
·
the company can deduct the amount that is deductible because of section 320-200;
·
the company will not include the transfer value of assets transferred in assessable income; and
·
the company will not be able to claim a deduction for the transfer value of assets transferred.

1.125 In addition, currently the transitional provisions can inappropriately disadvantage a life insurance company in circumstances where, for example:

·
the company correctly transferred assets having a transfer value equal to its pre-July 2000 virtual pooled superannuation trust liabilities to the virtual pooled superannuation trust before 1 October 2000;
·
subsequent increases in the transfer value of assets (due to market fluctuations) caused the company to transfer excess assets out of the virtual pooled superannuation trust; and
·
assets need to be transferred back to the virtual pooled superannuation trust as a result of further market fluctuations which caused a subsequent decrease in the transfer value of assets.

1.126 The amendments ensure that the transitional provisions do not apply to:

·
assets transferred to support pre-July 2000 virtual pooled superannuation trust liabilities if, at any point in time prior to the transfer, the company had transferred assets to meet the whole of its pre-July 2000 virtual pooled superannuation trust liabilities; or
·
assets transferred to support pre-July 2000 exempt life insurance policy liabilities if, at any point in time prior to the transfer, the company had transferred assets to meet the whole of its pre-July 2000 exempt life insurance policy liabilities.

[Schedule 1, items 82 and 83, subsections 320-175(1A) and 320-230(1A) of the Income Tax (Transitional Provisions) Act 1997]

Example 1.4 At 30 June 2000, MB Life had a liability of $10,000 under a life insurance policy. The liability relates to a virtual pooled superannuation trust life insurance policy that, from 1 July 2000, is to be discharged out of virtual pooled superannuation trust assets.MB Life transfers assets to its virtual pooled superannuation trust to meet half of the policy liability on 14 September 2000. Assets to meet the balance of the liabilities are transferred to the virtual pooled superannuation trust on 30 November 2000. In both cases, the transfer value of the assets transferred is $5,000 and the amount that could be included in the company's assessable income because of section 320-200 is $300.No tax consequences will arise for MB Life as a result of the transfer made on 14 September 2000 as the assets are transferred before 1 October 2000 to meet part of a virtual pooled superannuation trust liability that existed before 1 July 2000.In relation to the transfer made on 30 November 2000:

·
MB Life will include $300 in its ordinary assessable income (i.e. the amount that is included in assessable income because of section 320-200); and
·
the transfer values of the assets transferred will not be included in MB Life's complying superannuation assessable income or in its ordinary deductions.

In the 2001-2002 income year, the transfer values of the assets that relate to the liabilities fall by $1,500. To make up the shortfall, MB Life transfers $1,500 in cash to the virtual pooled superannuation trust. As MB Life had previously transferred assets to meet all of its virtual pooled superannuation trust policy liabilities as at 1 July 2000, the transfer values of the assets transferred is included in MB Life's complying superannuation assessable income and ordinary deductions.

Actuarial standards

1.127 Division 320 requires life insurance companies to value life insurance policy liabilities for various purposes. Depending on the circumstances, actuaries are required to determine the appropriate value of policy liabilities using either the Solvency Standard or the Valuation Standard.

1.128 Currently, the Solvency Standard is defined to mean:

·
for a life insurance company other than a friendly society, Actuarial Standard 2.02; and
·
for a life insurance company that is a friendly society, Actuarial Standard (Friendly Societies) 2.01.

1.129 Similarly, the Valuation Standard is defined to mean:

·
for a life insurance company other than a friendly society, Actuarial Standard 1.02; and
·
for a life insurance company that is a friendly society, Actuarial Standard (Friendly Societies) 1.01.

1.130 Both the Solvency Standard and the Valuation Standard have been revised since the introduction of Division 320. Therefore, the amendments modify the definitions of 'Solvency Standard' and 'Valuation Standard' to ensure that the relevant Standard as currently in force under the Life Insurance Act 1995 is used for the purposes of determining the value of the relevant policy liabilities in Division 320. [Schedule 1, items 123 and 124, definitions of 'Solvency Standard' and 'Valuation Standard' in subsection 995-1(1)]

·
The current Solvency Standard for life insurance companies (including friendly societies) is Actuarial Standard 2.03.
·
The current Valuation Standard is:

·
for a life insurance company other than a friendly society, Actuarial Standard 1.03; and
·
for a life insurance company that is a friendly society, Actuarial Standard (Friendly Societies) 1.02.

1.131 The new Actuarial Standards apply for all valuations made in respect of periods ending on or after 30 June 2002. Therefore, the amendments apply with effect from the income year in which 30 June 2002 occurs. [Schedule 1, subitem 126(10)]

Amounts received in respect of foreign life insurance policies

1.132 Prior to 1 July 2000, life insurance companies were exempt from tax on certain income attributable to policies issued by foreign permanent establishments (former section 112C of the ITAA 1936).

1.133 That exemption was intended to be replicated under Division 320 by treating the non-resident proportion of foreign establishment amounts as non-assessable non-exempt income (paragraph 320-37(1)(c)).

1.134 The former section 112C:

·
limited the exemption to income that was derived from assets belonging to a permanent establishment that were held to cover liabilities referable to policies issued by the permanent establishment; and
·
worked out the amount that was exempt from tax on the basis of the average value of relevant policy liabilities.

1.135 Those conditions were not effectively replicated on the transfer of the provisions to Division 320.

1.136 Therefore, the amendments ensure that the non-resident proportion of foreign establishment amounts that is treated as non-assessable non-exempt income under paragraph 320-37(1)(c) is consistent with the amount attributable to policies issued by foreign permanent establishments that was formerly exempt from tax under the former section 112C. [Schedule 1, items 117 to 122, paragraph 320-37(1)(c) and subsections 320-37(1A) and 320-37(2)]

1.137 The amendments may potentially result in an increase in the tax liability of a life insurance company and therefore apply to the 2003-2004 income year and later income years. [Schedule 1, subitem 126(9)]

Friendly society sickness policies

1.138 Prior to 1 July 2000, friendly societies were exempt from tax on, among other things, income attributable to funeral policies and sickness policies.

1.139 Under Division 320, income derived by friendly societies that is attributable to funeral policies issued before 1 January 2003 is non-assessable non-exempt income (paragraph 320-37(1)(d)).

1.140 Therefore, for consistency, the amendments ensure that income derived by friendly societies that is attributable to sickness policies issued before 1 January 2003 is also non-assessable non-exempt income. [Schedule 1, items 102 and 103, paragraph 320-37(1)(d)]

1.141 A sickness policy is defined to mean a life insurance policy issued by a friendly society for the sole purpose of providing:

·
sickness benefits; or
·
sickness and funeral benefits.

[Schedule 1, item 75, definition of 'sickness policy' in subsection 995-1(1)]

1.142 A friendly society's sickness policy business does not include registered health insurance business that is exempt from tax under section 50-30.

References to a policy of life assurance in the Income Tax Assessment Act 1936

1.143 In some cases, the ITAA 1936 refers to 'a policy of life assurance'. Under the common law, a policy of life assurance may include a policy issued by a non-resident life insurance company.

1.144 The amendments change these references to a 'life assurance policy' to ensure that the relevant provisions apply only to policies issued by Australian resident life insurance companies. [Schedule 1, items 108 to 115, paragraph (f) of the definition of 'dividend' in subsection 6(1), paragraph 26(i), section 26AH, subparagraph 102AE(2)(b)(iv), sections 282A, 291A and 297A of the ITAA 1936]

1.145 To ensure that no taxpayers are disadvantaged, the amendments apply to amounts received or derived after the date of Royal Assent. [Schedule 1, subitem 126(7)]

Application and transitional provisions

1.146 Most of the amendments apply from 1 July 2000 because:

·
the new regime for taxing life insurance companies (Division 320) commenced on 1 July 2000; and
·
the amendments have generally been sought by the life insurance industry to clarify the operation of the income tax law and ensure that it operates as intended.

1.147 However, some amendments that affect Division 320 have been made after 1 July 2000. Consequently, the amendments to these provisions apply from the date of application of the original amendments.

1.148 Other amendments apply prospectively as they potentially have an adverse impact on life insurance companies.

·
The amendments to remove any doubt that reinsurance commissions are included in assessable income apply to reinsurance commissions received or recovered by a life insurance company after the date of Royal Assent [Schedule 1, subitem 126(8)].
·
The amendments to impose administrative penalties on life insurance companies that do not undertake required valuations of assets and liabilities relating to the virtual pooled superannuation trust and the segregated exempt assets or fail to transfer excess assets from the virtual pooled superannuation trust or the segregated exempt assets apply to a valuation time that occurs after the date of Royal Assent [Schedule 1, subitem 126(11)].
·
The amendments to narrow the scope of foreign establishment amounts that are included in non-assessable non-exempt income apply to the 2003-2004 and later income years [Schedule 1, subitem 126(10)].
·
The amendments to change various references to a 'policy of life assurance' to a 'life assurance policy' in the ITAA 1936 apply to amounts received after the date of Royal Assent [Schedule 1, subitem 126(7)].


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