Senate

Explanatory Memorandum

(Circulated by authority of the Treasurer, the Hon Ralph Willis, MP)

Chapter 5 - Demutualisation of insurance companies

Overview

5.1 The amendments contained in Schedule 3 of the Bill propose new Division 9AA of Part III of Income Tax Assessment Act 1936 (the Act) which provides a framework for the taxation consequences of certain transactions associated with the demutualisation of life and general insurance companies and affiliated companies. The provisions also address the taxation consequences of the disposal by members of their interests in the demutualising entity. Rules are provided for determining the deemed acquisition cost of shares in the demutualised entity (or in another entity) issued to former members of the mutual insurance company and other members of the policyholder/member group.

5.2 The amendments are described in the context of the taxation consequences for:

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members and deemed members of demutualising life or general insurance companies or of an affiliated company (policyholder/members);

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the trustee of any trust established for the purpose of:

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exercising voting rights on behalf of policyholder/members prior to the issue of shares (a voting trust); or

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selling or distributing shares on behalf of policyholder/members (a selling trust);

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any new holding company or other company interposed between the former mutual company and the new shareholders;

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the life or general insurance company which is demutualising.

5.3 This chapter also deals with the methods to be adopted when calculating the deemed acquisition cost of shares issued to policyholder/members as consideration for the disposal of their interests in the mutual company or an affiliated company.

Summary of amendments

Purpose of the amendments

5.4 The purpose of the amendments contained in Schedule 3 of the Bill is to provide a generic framework which specifies the taxation consequences of certain transactions likely to occur in the course of an arrangement for the demutualisation of a life or general insurance company or an affiliate company. [New sections 121AA and 121AD]

5.5 The basic requirements for a demutualisation are that the members of a mutual insurance company (or a mutual affiliate company) will agree to surrender their rights in the company (for example, the right to vote at meetings and/or the right to participate in the surplus of the company on winding up) in exchange for shares in the demutualised entity. The shares must generally be listed on the Australian Stock Exchange within 2 years from the commencement of the demutualisation arrangement. These requirements are reflected in demutualisation methods 1 to 7 [new sections 121AF to 121AL] which are discussed below.

5.6 Broadly, the amendments will:

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ensure that capital gains tax will not arise as a consequence of any disposal constituted by the surrender by a member of a mutual insurance company or a mutual affiliate company (or any other member of the policyholder/member group) of his or her membership interests [table 1;item 1] ;

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prescribe the date of acquisition and cost of acquisition of shares acquired by a policyholder/member as part of the demutualisation process [table 1; items 5 and 11] . In relation to equitable and legal assignments of interests in sale and voting trusts and rights to receive shares, similar deemed acquisition cost rules will also apply [table 1; items 3, 4 and 11] ;

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prescribe the date of acquisition and cost of acquisition of ordinary shares acquired by the trustee of a sale trust for distribution to policyholder/members or sale on their behalf [table 1; items 5 and 9] ;

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ensure that where a holding company or another interposed company acquires shares in a demutualising life or general insurance company, the deemed acquisition cost of those shares properly reflects the deemed acquisition cost of shares issued to policyholder/members. The deemed acquisition cost rules will apply to all shares in entities interposed between the holding company and a former mutual insurance company or mutual affiliate company [table 1; items 5, 6, and 7] ;

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ensure that no capital loss can be realised by a policyholder/member, the trustee of a sale trust or an interposed company on the disposal of a demutualisation share, a right to receive a demutualisation share, or other interests in a voting or sale trust [table 1; items 3, 4, 5, 6, 7, 9, 11 and 12] ;

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provide that where special shares representing the voting rights of policyholder/members are held by a trustee on behalf of the policyholder/members and the special shares are later converted to ordinary shares, no disposal will be taken to have occurred for capital gains tax purposes. Specifically, Division 19B of Part IIIA will not apply in relation to any value shift that may have taken place as a consequence of the conversion [table 1, item 8] ;

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insert parallel provisions to those relating to capital gains tax set out at table 1, which will operate in circumstances where, as a consequence of a demutualisation transaction, an amount would be included in the assessable income of a taxpayer under a provision of the Act other than Part IIIA [table 2] ;

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ensure that at the demutualisation resolution day the franking account balance of a demutualising general insurance company or mutual affiliate company and any wholly owned subsidiaries of the company or companies will be reduced to nil [table 2; item 12] ; and

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ensure that no franking credit will arise in the franking account of a demutualised life or general insurance company, a mutual affiliate company or any wholly owned subsidiaries of the company or companies in relation to any dividend declared before the demutualisation resolution day and paid on or after the demutualisation resolution day [table 2; item 13] .

Date of effect

5.7 The amendments, which were foreshadowed by the Treasurer in the 1995-96 Budget, apply to mutual insurance companies and mutual affiliate companies that existed at 7.30 pm AEST on 9 May 1995. [Item 3]

Background to the legislation

What is a demutualisation?

5.8 For the purposes of the proposed amendments a mutual insurance company demutualises if it ceases to be a mutual insurance company (or a mutual affiliate company ) other than by ceasing to be an insurance company, or under a scheme approved by the Federal Court. [New subsections 121AD(1) and 121AD(2)]

5.9 New section 121AB defines the terms 'mutual insurance company ', 'insurance company', 'life insurance company' and 'general insurance company '. New section 121AC defines a mutual affiliate company to be a mutual company, limited by guarantee, the members of which include all of the policyholders of a mutual insurance company. The profits of a mutual affiliate company must not be divisible amongst its members in their capacity as members.

5.10 The demutualisation process commences on the demutualisation resolution day [new subsection 121AD(3)] , which is generally when the members of a mutual life insurance company or general insurance company or mutual affiliate company (broadly, a mutual organisation where the liability of members is limited by guarantee) agree that the mutual entity will become a company limited by shares. Where a mutual life insurance company ceases to be a mutual company because the whole of the life insurance business is transferred to another company under a court endorsed scheme, the demutualisation resolution day will be the day on which the business is transferred. The demutualisation process ends with the listing of the ordinary shares issued to former members of the mutual entity and other members of the policyholder/member group on the demutualisation listing day. The demutualisation listing day will be the day on which ordinary shares that are issued to the policyholder/member group are listed for quotation on the Australian Stock Exchange. [Table 1; note 4; new section 121AQ]

5.11 A demutualisation may follow the steps set out in demutualisation methods 1 to 7 [new sections 121AF to 121AL] which are described below. If one of these methods is not followed, the taxation consequences will not apply to any of the transactions undertaken in the course of the demutualisation [new subsection 121AE] .

Who is a policyholder/member?

5.12 The interest of a member in a mutual life or general insurance company can generally be characterised as a right to vote at meetings and to participate in any surplus of the company on winding up. The Memorandum and Articles of Association of a mutual company will describe the persons who are members of the company (generally the holders of insurance policies). For the purposes of demutualisation, new subsections 121AE(4) and 121AE(5) define a policyholder/member group of a mutual insurance company or a mutual affiliate company as including other specified categories of persons (i.e. employees, lapsed policyholders, beneficiaries and legal personal representatives of deceased policyholders, members of single member superannuation funds of which the trustee is a policyholder, charities and members of an affiliated mutual company). All of the taxation consequences described in tables 1 and 2 in new sections 160AS and 160AT will apply to all policyholder/members.

Explanation of the amendments

Methods of demutualisation

5.13 Tables 1 and 2 which are contained in new sections 121AS and 121AT at Subdivision C set out the taxation consequences of certain transactions that will or may occur in the course of a demutualisation. In order for these taxation consequences to apply in a particular case, it is necessary that the demutualisation be carried out in accordance with one of the 7 methods set out in new sections 121AF to 121AL . The Bill includes diagrams of the transactions involved in each of the demutualisation methods.

5.14 Each demutualisation method assumes that the demutualisation of the mutual company has been approved by members of the company or takes place pursuant to an order of the Federal Court. The demutualisation process commences on the demutualisation resolution day, being the day on which the resolution to proceed with the demutualisation is passed by the members of the company (or the date on which an order of the court becomes effective) [new section 121AD] , and concludes on the demutualisation listing day. The listing period , which is the period between the demutualisation resolution day and the demutualisation listing day will be 2 years, unless the Commissioner of Taxation allows an extension [new subsection 121AE(6)] .

5.15 In determining whether to grant an extension of time, the Commissioner will have regard to all relevant considerations including the steps already taken in the listing process and to market conditions affecting listing.

5.16 Other events or transactions may also occur in conjunction with, or as a consequence of, a demutualisation process. These may include:

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the transfer of assets between companies related to the demutualising entity before or after the date of demutualisation;

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the issue of shares in the demutualising entity to outside investors; and

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restructuring to facilitate demutualisation.

5.17 Where these transactions (or other transactions which are not specifically included in the demutualisation methods set out in Schedule 3 of the Bill) take place, the specific tax treatment for the transactions which have been identified as being part of the demutualisation process will still apply. However, the related transactions will be subject to the existing general tax law.

5.18 Under each of the demutualisation methods, certain basic events or transactions must occur or happen. These transactions are listed in each of the demutualisation methods outlined in new sections 121AF to 121AL and are also represented as demutualisation method 1.

Demutualisation method 1

5.19 The transactions involved in demutualisation method 1 are:

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membership rights (i.e. rights held by all policyholder/members in the mutual company) are extinguished [new paragraph 121AF(1)(a)] . Paragraph 5.12 above discusses who will be a policyholder/member of a mutual life or general insurance company or a mutual affiliate company and the nature of their rights in the company;

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shares of only one class (ordinary shares) are issued to the members of the policyholder/member group (no shares of any other class may be issued to the policyholder/member group during the course of the demutualisation) [new paragraph 121AF(1)(b)] ; and

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the shares are listed for quotation on the official list of the Australian Stock Exchange within the listing period [new paragraph 121AF(1)(c)] .

Demutualisation method 2

5.20 New section 121AG describes the transactions which occur under this demutualisation method. In addition to the transactions described in demutualisation method 1 in new section 121AF , prior to the issue of the ordinary shares to policyholder/members, no more than 10 special shares in the former mutual insurance company are issued to the trustee of a voting trust who holds the shares for the benefit of policyholder/members. On the subsequent issue of ordinary shares [new paragraph 121AG(1)(c)] , the shares convert to, or are replaced by, ordinary shares [new paragraph 121AG(1)(b)] .

5.21 Policyholder/members may elect to receive ordinary shares either directly from the insurance company or to receive the shares or their cash equivalent from the trustee of a selling trust. The selling trust may or may not be the same trust as the voting trust. If a policyholder/member has elected to receive cash, the shares which issue to the trustee will be sold by the trustee on behalf of the policyholder/member. [New paragraph 121AG(1)(c)]

Demutualisation method 3

5.22 This method is a variation of demutualisation method 1 whereby shares in a demutualised insurance company are issued to a holding company [new paragraph 121AH(1)(b)] . Ordinary shares of only one class in either the holding company or another company which is the ultimate holding company of the wholly-owned company group are then issued to members of the policyholder/member group. If the issued shares are those of the ultimate holding company, the holding company must be a wholly-owned subsidiary of the ultimate holding company, either directly or through one or more other wholly-owned subsidiaries [new paragraph 121AH(1)(c)] . The term 'wholly-owned subsidiary' is defined at new subsection 121AP(3) .

Demutualisation method 4

5.23 This method combines methods 1 to 3 and, like method 3, provides for the interposition of a holding company, or chain of interposed companies, between the policyholder/members and the former mutual company [new paragraphs 121AI(1)(b) and (c)] . Method 4 also provides that prior to the issue of ordinary shares, special shares which later convert to ordinary shares [new paragraph 121AI(1)(d)] may be issued to the trustee of a voting trust [new paragraph 121AI(1)(c)] , and that policyholder/members may elect to receive shares directly from the holding company or to receive shares or their cash equivalent from the trustee of a sale trust. [New paragraph 121AI(1)(e)]

Demutualisation method 5

5.24 Method 5 is essentially the same as method 4 except that it does not provide for the issue of special shares to the trustee of a voting trust. [New section 121AJ]

Demutualisation method 6

5.25 This method relates to demutualisation arrangements entered into pursuant to an order of the Federal Court of Australia whereby, in the course of a demutualisation arrangement, the whole of the life insurance business of a mutual life insurance company is transferred to another company formed for that purpose [new paragraph 121AK(1)(b)] . For these purposes, the term 'life insurance business' has the same meaning as in the Life Insurance Act 1995 [new section 121AQ] .

5.26 Ordinary shares of only one class in the other company are issued. The policyholder/members will have elected to receive either the shares or their cash equivalent. If a policyholder/member has elected to receive cash, the shares will issue to the trustee of a sale trust to sell on his or her behalf [new paragraph 121AK(1)(d)] . Otherwise ordinary shares will issue directly to the policyholder/members or through the trustee [new paragraph 121AK(1)(c)] .

Demutualisation method 7

5.27 New section 121AL describes method 7 which applies where the demutualising entity comprises both an insurance company and a mutual affiliate company. A 'mutual affiliate company' is described at paragraph 5.9 above and is defined at new subsection 121AC(1).

5.28 Shares in the mutual insurance company and the mutual affiliate company are issued to a holding company [new paragraph 121AL(1)(b)] and ordinary shares of only one class are issued to former members of the mutual companies. The policyholder/members will have elected to receive the shares directly from the holding company or to receive the shares or their cash equivalent from the trustee of a sale trust. If a policyholder/member has elected to receive cash, the shares which issue to the trustee will be sold on his or her behalf [new paragraph 121AL(1)(c)] .

Taxation consequences of demutualisation

5.29 Subdivision C of Schedule 3 of the Bill sets out the taxation consequences for transactions which may occur in the course of demutualisation methods 1 to 7 which are described at paragraphs 5.19 to 5.28 above. The taxation consequences of each transaction in the demutualisation methods will generally arise under Part IIIA of the Act which deals with capital gains and losses. However, it is possible that for certain taxpayers, or in certain circumstances, as a consequence of a demutualisation transaction, an amount may be included in the assessable income of a taxpayer under another provision of the Act. Therefore, the Bill contains 2 tables which describe the taxation consequences of each transaction both under Part IIIA and other provisions of the Act.

Consequences for policyholder/members

Disposal of membership interests

5.30 All of the demutualisation methods described at new sections 121AF to 121AL (i.e. demutualisation methods 1 to 7) require the extinguishment of the interests of members (generally the right to vote at meetings and to participate in surplus on winding up) in the former mutual company. Some of these interests will have been acquired prior to 20 September 1985, and would therefore be pre CGT assets. However, in relation to membership interests acquired on or after 20 September 1985, CGT would otherwise apply on disposal. Membership interests will be extinguished in consideration for shares in the demutualised entity. These consequences are set out at tables 1 and 2 which are contained in new sections 121AS and 121AT respectively.

5.31 Table 1; item 1 provides that CGT will not apply on the disposal of membership interests. This applies both to rights held by policyholders in the mutual insurance company (or mutual affiliate company), as well as to those rights created by the company in favour of other members of the policyholder/member group.

5.32 Table 2; item 1 provides similar treatment where the extinguishment of membership rights would otherwise lead to an amount being included in the assessable income of a taxpayer under a provision of the Act other than Part IIIA, or allowed as a deduction from assessable income.

Acquisition by member/policyholders of shares in the demutualised entity

Deemed cost of acquisition of shares

5.33 All of the possible demutualisation methods (i.e. methods 1 to 7) require that shares in the demutualised entity will be issued to policyholder/members.

5.34 In relation to disposals of shares prior to the demutualisation listing day (the day on which ordinary shares, including shares issued to policyholder/members are listed for quotation on the Australian Stock Exchange [table 1; note 4] ), the cost of acquisition of the demutualisation shares will be taken to be an amount determined by reference to the embedded value of a life insurance company and the value of the net tangible assets of a general insurance company. This amount is the pre-listing day company valuation amount [table 1; note 2] .

5.35 The methods for determining the embedded value or value of the net tangible assets of a mutual insurance company are discussed in detail at paragraphs 5.78 and 5.107 below.

5.36 The pre-listing day company valuation amount will be allocated across all of the demutualisation shares issued to policyholder/members, and the amount relating to each share is taken to be the cost of acquisition of the share. [Table 1; items 5 and 11]

5.37 Prior to the demutualisation listing day, no capital loss will be available in relation to the disposal of a demutualisation share [table 1; subitem 5(1)] . This is a general rule applicable to all demutualisation shares and interests in demutualisation shares or in trusts that hold demutualisation shares.

5.38 For disposals of shares after the demutualisation listing day , the amount to be applied in determining the deemed cost of acquisition of demutualisation shares (the applicable company valuation amount [table 1; note 1] ) will be the lesser of the pre listing day company valuation amount (described above) and an amount determined by reference to the published price at which a demutualisation share was last traded on the listing day, multiplied by the number of demutualisation shares issued to policyholder/members (the listing day company valuation amount [table 1; note 3] ). This will be taken to be the total cost of acquisition of all of the demutualisation shares.

5.39 The total amount of the applicable company valuation amount is apportioned between all of the shares in the demutualised entity issued to policyholder/members in the course of the demutualisation arrangement and, in relation to any subsequent disposals of the shares, is taken to be the cost of acquisition of the shares.

Bonus shares

5.40 Division 8 of Part IIIA of the Act provides that, where bonus shares are issued to a taxpayer by a company and no part of the paid up value of the bonus shares is a dividend, the cost base of the original shares to which the bonus shares relate is to be apportioned between the bonus shares and the original shares.

5.41 Table 1; items 5 and 11 provide that where bonus shares ( non demutualisation bonus shares ) are issued to policyholder/members, the deemed acquisition cost of the demutualisation shares already issued to the policyholder/members to which the bonus shares relate (the demutualisation original shares ) will be apportioned between the demutualisation original shares and the non-demutualisation bonus shares in accordance with Division 8 of Part IIIA.

5.42 Where a disposal of the demutualisation original shares and/or the non-demutualisation bonus shares takes place prior to the demutualisation listing day, the amount apportioned between the shares to determine their deemed cost of acquisition will be the pre listing day company valuation amount (that is, the amount determined by reference to the embedded value of a life insurance company and the net tangible assets of a general insurance company).

5.43 If a disposal of the demutualisation original shares and/or the non demutualisation bonus shares occurs after the listing day, the amount apportioned between the shares to determine the deemed cost of acquisition will be the listing day company valuation amount (being the lesser of the pre listing day company valuation amount and an amount determined by reference to the price at which an ordinary share in the demutualised entity was last traded on the first day of listing). [Table 1;item 5(3)]

Actual consideration is also included

5.44 In any case, any amount that would be taken to be consideration for the acquisition of a share or an interest in a share for the purposes of section 160ZH of Part IIIA and which is actually given by a policyholder/member for the acquisition of a demutualisation share, will be included in the deemed acquisition costs of the share.

Date of acquisition of shares by policyholder/members

5.45 Policyholder/members will be taken to have acquired shares in the demutualised entity on the demutualisation resolution day. Indexation of the deemed cost of acquisition of the shares will therefore apply from this date. Demutualisation original shares and, by virtue of the operation of Division 8 of Part IIIA, any non demutualisation bonus shares will also be taken to have been acquired on the demutualisation resolution day. [Table 1;item 5]

Application of provisions other than Part IIIA

5.46 Table 2, items 3 and 8 contain parallel provisions to items 5 and 11 of table 1. They provide that where, as a consequence of a disposal of a demutualisation share by a policyholder/member, an amount would be included in the assessable income of the policyholder/member, an amount equal to the deemed net profit on the sale of the share should be included in assessable income. The profit included in assessable income will be the consideration for the disposal of the share reduced by the deemed acquisition cost of the share calculated in accordance with the formula for determining the acquisition cost of the share for capital gains tax purposes and described at paragraphs 5.33 to 5.44 above.

5.47 Table 2, items 3 and 8 also apply if, as a consequence of the disposal of a demutualisation original share or a non-demutualisation bonus share an amount would be included in the assessable income of a taxpayer. In determining the net profit to be included in the assessable income of the taxpayer, the applicable company valuation amount will be apportioned between the original and bonus shares in accordance with section 6BA of the Act.

Application to employees

5.48 The definition policyholder/member includes employees of the demututalising company. Generally, no amount will be included in the assessable income of an employee as a consequence of the distribution of a demutualisation share. However, where a share is issued as consideration for services provided, or to be provided, by the recipient, the general rules relating to employee share schemes will apply. [Table 2; item 10]

Disposals by policyholder/members of rights to receive shares and interests in trusts

5.49 All demutualisation methods require that shares in the demutualised company group must be listed for quotation on the Australian Stock Exchange within the listing period. New subsection 121AE(6) defines the listing period to be the period within 2 years of the date of demutualisation or such further time as the Commissioner allows.

5.50 In the listing period, a number of other events may occur. For example, the trustee of a voting trust may exercise the voting rights of members on their behalf (demutualisation methods 2 and 4) and/or shares may be issued to the trustee of a sale trust to sell on behalf of members or to transfer to members (demutualisation methods 2, 4, 5, 6, and 7).

5.51 At the time of the extinguishment of a members interest, the policyholder/member acquires enforceable rights (i.e. a right to receive shares in the demutualised company) and may also acquire interests in the property of a voting and/or sale trust. It is possible that in some circumstances a policyholder/member may assign these rights to a third person prior to the issue of shares in the demutualised entity.

5.52 By table 1; items 3 and 4 , if a policyholder/member assigns a right to receive shares, or an interest in the property of a sale or voting trust, Part IIIA of the Act will apply as if the member/policyholder had disposed of a share in the demutualised entity. Therefore, the deemed acquisition cost of the assigned asset will be determined by reference to the applicable company valuation amount and will apply in the same way as for the deemed acquisition cost of shares as described at paragraphs 5.33 to 5.44 above. Prior to the listing day, no capital loss can be realised on any disposal of a right to receive a share or an interest in the property of a sale or voting trust.

5.53 Table 2; item 2 proposes parallel rules where, as a consequence of the disposal of a right to receive shares or an interest in trust property, a provision of the Act other than Part IIIA would require that an amount be included in the assessable income of a taxpayer.

Distribution of shares by a trustee

5.54 Under demutualisation methods 2, 4, 5, 6 and 7 shares may be issued to the trustee of a sale trust to sell on behalf of policyholder/members or distribute directly to policyholder/members. Paragraphs 5.60 to 5.64 below discuss the taxation consequences of the sale of shares by a trustee. Where, as a consequence of the distribution by a sale trustee of ordinary shares to a policyholder/member, the policyholder/member has disposed of his or her interest in the trust, table 1;item 10 specifies that Part IIIA will not apply to that disposal. Part IIIA will also not apply to the disposal of the share by the trustee that occurs as a consequence of the distribution.

5.55 Table 2; item 10 provides that no amount will be included in, or allowed as a deduction from, the assessable income of a taxpayer in respect of the distribution of a demutualisation share by the trustee of a sale trust.

5.56 By table 1; items 5, 9, 10 and 11 , the date of acquisition of the share by the policyholder/member will be taken to be the demutualisation resolution day, regardless of whether the share is distributed directly to the policyholder/member or is sold on his or her behalf.

Application of rollover provisions

5.57 Table 1; note 5 defines a rollover provision to be section 160X or any provision of Division 17 of Part IIIA. Section 160X applies to assets forming part of a deceased estate. In relation to an asset acquired by the deceased on or after 20 September 1985, on a subsequent disposal of the asset, the beneficiary of the estate (or the legal personal representative of the deceased) will be taken to have acquired the asset for an amount equal to its cost base, indexed cost base or reduced cost base at the date of death. Other rollover provisions (eg. section 160ZZO which relates to transfers of assets between wholly-owned group companies) also deem the transferee of an asset to have acquired the asset for an amount equal to the cost base, the indexed cost base or the reduced cost base at the time of the transfer.

5.58 Table 1;item 12 provides that where a taxpayer has acquired an asset under a rollover provision, and the transferee disposes of the asset prior to the listing day, no capital loss will be available in relation to the disposal. For disposals after the listing day, for the purposes of applying the relevant rollover provision, the amount that will be taken to have been the cost base of the asset at the time of the rollover will be determined by reference to the deemed cost of acquisition rules set out at [table 1;item 5] and described at paragraphs 5.33 to 5.44 above. Therefore, if after listing it is determined that the listing day company valuation amount of shares is to be determined by reference to the published last traded price of a demutualisation share on the first day of listing of ordinary shares, then, for the purposes of calculating the capital gain or loss on a subsequent disposal of the shares, it is this amount that is taken to have been the cost base of the share to the transferor at the time of the rollover.

Application to trustees

What is the role of the trustee?

5.59 The trustee of a voting trust is issued special shares in the life or general insurance company (or a holding company or other company) to hold for the benefit of policyholder/members pending the issue of ordinary shares. The trustee will exercise voting rights on behalf of policyholder/members in that period. The trustee of a selling trust will be issued shares in the life or general insurance company (or a holding or other company) to distribute in specie to policyholder/members or to deal with for the benefit of the policyholder/members who have elected (or have been deemed to have elected) to receive cash rather than shares.

Sale of shares by a trustee on behalf of policyholder/members.

Date and cost of acquisition of shares by a sale trustee

5.60 The deemed cost of acquisition of shares, sold by the trustee of a sale trust on behalf of policyholder/members, will be determined as if the share were disposed of the by policyholder/member. Therefore, if the shares are sold prior to the listing date, the deemed cost of acquisition will be determined by reference to the pre-listing day company valuation amount. [Table 1; items 5 and 9]

5.61 Where bonus shares have also been issued to a sale trustee, the acquisition cost of the demutualisation original shares and the non-demutualisation bonus shares will be determined in accordance with Division 8 of Part IIIA. Therefore the deemed acquisition cost of the demutualisation original shares and the non demutualisation bonus shares will be determined by reference to the pre listing day company valuation amount or the listing day company valuation amount as the case may be. [Table 1; items 5 and 9]

5.62 Shares will be taken to have been acquired by the policyholder/member in the demutualisation resolution day or the date on which a court order in respect of the demutualisation becomes effective. [Table 1;item 9]

5.63 Table 2, item 7 proposes parallel provisions where an amount would be included in the assessable income of a policyholder/member as a consequence of a disposal by a sale trustee.

5.64 Table 1, item 10 ensures that no CGT consequences will apply to the trustee on the distribution by the trustee of a share to a policyholder/member.

Other taxation consequences for the trustee of a voting trust

5.65 Under demutualisation methods 2 or 4 the trustee of a voting trust may hold a small number of special shares (10 or less) for the benefit of the policyholder/member group. Once ordinary shares are issued, the special shares may be replaced by ordinary shares or the rights attaching to the special shares may be modified and become the same as those attaching to the ordinary shares. Table 1, item 8 ensures that Part IIIA will not apply in relation to any disposal (for example a notional disposal under Division 19B of Part IIIA of the Act) constituted by the disposal and replacement of the special shares or a change in rights attaching to the special shares. The deemed acquisition cost of ordinary shares issued to the trustee of a voting trust will be calculated in accordance with the rules described at paragraphs 5.33 to 5.44 above.

Application to trustees of superannuation funds

5.66 It is possible that the policyholder/member group may include the trustee of a superannuation fund where the fund holds policies in the demutualising company on behalf of its members. Where in the course of a demutualisation, ordinary shares are distributed to the trustee of a superannuation fund as a member of the policyholder/member group, the trustee may hold the shares on behalf of a beneficiary of the fund.

5.67 In order for such shares to benefit from the deemed acquisition cost calculated by reference to the applicable company valuation amount, table 2; item 11 provides that, on payment by the trustee of an ETP or a superannuation pension or annuity to a member of the fund, the undeducted contribution amount in relation to the payment will be increased to reflect the deemed acquisition cost of the shares.

Application to holding and other companies interposed between member/policyholders and the insurance company

5.68 Demutualisation methods 3, 4 and 5 propose that companies may be interposed between the policyholder/member group and the demutualising insurance company. Table 1, items 5 and 7 set out the method for determining the consideration for the acquisition of shares in the mutual insurance company or another interposed company where these demutualisation methods apply.

5.69 The deemed cost of acquisition of the shares is calculated in the same way that the deemed cost of acquisition of shares by policyholder/members is determined and which is described at paragraphs 5.33 to 5.44 above. Prior to the listing date, the applicable company valuation amount (being the pre-listing day company valuation amount) is determined by reference to the embedded value of a life insurance company or the net tangible asset value of a general insurance company. Following the listing day the lesser of the pre-listing day company valuation amount and an amount calculated by reference to the last published traded price of ordinary shares on the first day of trading is the applicable company valuation amount.

5.70 No capital loss is available where a share is disposed of by a holding company or other interposed company prior to the listing date. [Table 1; items 5 and 7] .

5.71 Table 1;item 6 proposes parallel rules for shares issued to holding companies where demutualisation method 7 applies and the demutualising entities comprise a mutual insurance company and a mutual affiliate company.

Bonus shares

5.72 The modifications proposed by [table 1, items 5, 6 and 7] operate so that the rules relating to bonus shares in Division 8 of Part IIIA will apply appropriately. The applicable company valuation amount will be spread across the original demutualisation shares as well as any subsequent non demutualisation bonus shares.

The demutualising company

Imputation credits

5.73 Section 160APKA of the Act provides that, from 22 August 1990, mutual life insurance companies cannot maintain dividend franking accounts. Following demutualisation, franking accounts can be maintained by former mutual life insurance companies.

5.74 In relation to general insurance companies, table 2; item 12 provides that any existing class A, B or C franking account balance held by the general insurance company, a wholly-owned subsidiary of a general insurance company, or (where demutualisation method 7 applies), mutual affiliate companies and their subsidiaries, will be reduced to nil at the demutualisation resolution day. The same rule will apply to companies whose shares are beneficially owned by the general insurance company and the mutual affiliate company.

Application in relation to dividends declared prior to the demutualisation resolution day

5.75 In relation to dividends declared before the demutualisation resolution day, to be paid to:

•

a life insurance company;

•

a general insurance company;

•

a wholly-owned subsidiary of a life or general insurance company;

•

a mutual affiliate company; or

•

a company all of whose shares are owned by the mutual affiliate company and the general insurance company

and which are paid on or after the demutualisation resolution day, no franking account credit arises in relation to the dividend in the accounts of the company. [Table 2; item 13]

Transfer of life insurance business

5.76 A demutualisation may proceed under demutualisation method 6 whereby all of the life insurance business of a company is transferred to another company under a scheme confirmed by the Federal Court of Australia. Table 1;item 2 deems the second company to be related to the insurance company for the purposes of the application of section 160ZZO of the Act to the transfer of the assets. Section 160ZZO generally provides a capital gains tax rollover for assets transferred between related companies.

5.77 Following the transfer of the life insurance business, the second company, will be deemed to carry on the same business (i.e. the transferred life insurance business) as the mutual life insurance company. [Table 2, item 9]

Calculating the embedded value or net tangible assets value

5.78 The Commissioner of Taxation and the Australian Government Actuary were asked by the Government to consult with the Institute of Actuaries of Australia on the details of the appropriate method of calculating the 'embedded value' of life insurance companies in the case of demutualisations. Following those discussions the following method of calculating the 'embedded value' of a life insurance company is to be adopted in cases of demutualisations.

5.79 In calculating the 'embedded value' of a life insurance company an actuary is to apply normal actuarial practice to the calculation, having regard to the Institute of Actuaries of Australia Professional Standard PS 201 - Determination of Life Insurance Policy Liabilities and Guidance Note GN 252 - Actuarial Appraisals of Life Insurance Business. The 'embedded value' should relate to existing business only, calculated on a going concern basis and assuming no major changes in the company circumstances. No value is to be placed on future new business and no value is to be placed on transactions occurring in association with the demutualisation.

5.80 The calculation of 'embedded value' is to be the sum of the life insurance company's existing business value and its adjusted net worth (see paragraphs 5.84 to 5.86 below) on the applicable accounting day. The calculation is to be performed by a Fellow or Accredited Member of the Institute of Actuaries of Australia according to Australian actuarial practice. Such an actuary is not to be an employee of the life insurance company, a mutual affiliate company or a subsidiary of either the mutual insurance or mutual affiliate companies. [New subsections 121AM(1), (2), (5) and 121 AP]

5.81 The calculation of the 'embedded value' or the 'net tangible assets value' is to use the most recent financial accounts applicable to the demutualisation resolution day. The particular day is referred to as the 'applicable accounting day'. [New subsections 121AM(3) and 121AN(4)]

5.82 Where a significant change has occurred in values between the applicable accounting day and the demutualisation resolution day such a change is to be incorporated into the calculation of the 'embedded value' or the 'net tangible assets value'. [New subsections 121AM(4) and 121AN(5)]

5.83 The above formulae for 'embedded value' consists of 2 of the 3 components of an actuarial calculation known as the appraisal value of a life company. Guidance Note GN 252 (issued by the Institute of Actuaries of Australia) is concerned with all three components. The third component (value of future new business) is specifically excluded from the 'embedded value' calculation for the purposes of calculating the cost base of shares obtained as a result of demutualisation.

Adjusted net worth and existing business value

5.84 The terms 'adjusted net worth' and 'existing business value' are specific Australian actuarial terms and form the basic concepts for an actuarial calculation of 'embedded value'. Both terms are explained in detail in Guidance Note GN 252.

5.85 Generally, 'adjusted net worth' can be explained as the sum of the following:

(a)

the net balance of shareholders' funds;

(b)

the proprietors' share of any unappropriated surplus that is disclosed in the statutory funds; and

(c)

the proprietors' share of any market value excess.

5.86 Generally, 'existing business value' can be explained as the present value of distributable profits expected to emerge from existing business in the future.

Assumptions in calculating embedded value

Continued business

5.87 In calculating the 'embedded value' of a life insurance company it will be assumed that the organisation will continue to carry on the same business after demutualisation as it did before demutualisation. It is also assumed that the organisation will not conduct any new business after demutualisation. These assumptions are based on the 'going concern' concept and are used to value the organisation as at the date of demutualisation as if the demutualisation were not to occur. [New subsections 121AM(5)]

5.88 The concept of a 'going concern' business includes the following assumptions:

(a)

the valuation should not take account of changes to the company's business plans which are contingent on the demutualisation proceeding;

(b)

the valuation should not take into account changes in experience that might be expected as a result of the demutualisation (an example would be a reduction in the policy surrender rates of the company due to increased consumer confidence in the company); and

(c)

the valuation should not take into account any expected major business changes (eg, the sale of assets) as a consequence of the demutualisation not proceeding.

Distributable profits

5.89 It is assumed that capital just sufficient to meet statutory capital adequacy standards is maintained at all times, and all remaining profits are distributed. The capital adequacy standards are about to be strengthened following the passage of the Life Insurance Act 1995. The phase-in arrangements have not been determined. [New subsection 121AM(10)]

5.90 To the extent that a company does not meet the standards at the present time, it is to be assumed that the phase-in arrangement is such that a company can continue to operate, but that it cannot distribute any profits until it meets the new final capital adequacy standard. This will require the use of a higher discount rate during any period when the new capital adequacy standard is not met. The new capital adequacy standard will be published by the Life Insurance Actuarial Standards Board. The capital reserve adequacy standard is to be the standard published after 1 July 1995. Until those standards are published the capital reserve adequacy level will be the level of reserves necessary to provide adequate capital for the conduct of the life insurance business and other activities of the company. This level will be calculated by the eligible actuary according to Australian actuarial practice. [New subsection 121AO(2)]

Treasury bond rate

5.91 The Treasury bond rate is to be the yield on the 10 year Treasury bond as published by the Reserve Bank of Australia in the monthly Reserve Bank of Australia Bulletin. The rate published in the August 1995 Bulletin for the July 10 year Treasury bond yield was 9.42%. The Treasury bond is the Treasury bond issued by the Commonwealth of Australia. [New subsection 121AO(1)]

Discount rate

5.92 The discount rate is to be set at the 10 year Treasury bond rate plus 4.5 per cent. Where a company does not meet the capital adequacy standard, the discount rate should be increased by 0.2 per cent for each full 1 per cent by which the reserves available fall below the capital adequacy standard. The discount rate would, in these circumstances, be expected to fall each year into the future, as the company moves closer to the capital adequacy standard. [New subsection 121AM(6)]

5.93 The capital adequacy shortfall is to be calculated having regard to the average of the capital adequacy position of the company over the year rather than at any particular time during the year. The use of an average will smooth any fluctuations that may occur during the year.

5.94 For example, assume company ABC has an average capital adequacy shortfall of 10% and that the Treasury bond rate is the rate for July 1995 as published in the Reserve Bank of Australia's Bulletin (i.e. 9.42%). In this circumstance the discount rate to be used in the calculation of ABC company's embedded value would be as follows:

Discount Rate = 9.42% + 4.5% + 2% = 15.92%


5.95 The 'embedded value' of a life office represents the present value of the future distributable earnings calculated on an after-tax basis. The usual actuarial approach would apply an after-tax discount rate to the net of tax earning stream. For the purposes of the actuarial calculations the discount rate is to be an after-tax discount rate.

Inflation rate

5.96 The inflation rate is to be set at the 10 year Treasury bond rate less 4 per cent. This rate is to be used for all purposes where inflation is an assumption, for example, inflation in expenses, CPI growth etc. [New subsection 121AM(7)]

5.97 In the above example (at paragraph 94) ABC's inflation rate would be 5.42%.

Expenditure assumption

5.98 In calculating the 'embedded value' of a life assurance organisation actual maintenance and investment management expenses of the preceding accounting period excluding clearly identifiable non-recurring items (eg, redundancy costs) are to be assumed. The preceding accounting period's expenses of the same kind and amounts (increased by the inflation rate) are to be used in this calculation. Anticipated future improvements in expenses are not to be included in any calculations. [New subsection 121AM(8)]

5.99 In applying the expenditure assumption to the embedded value calculation it is anticipated that the eligible actuary should exclude non-recurring expenditure and divide the company's total expenditure between acquisition and maintenance (recurring) and then express the maintenance expenditure as some combination of rates per unit of assets, rates per unit of premium income and dollar amounts per policy. Those rates are then to be held constant into the future and the dollar amounts are to be inflated at the prescribed inflation rate.

Investment return

5.100 In calculating the existing business value or adjusted net worth, it is to be assumed that future investment distribution will remain in line with the company's investment policy and returns on investments are to be as follows:

5.101 The term of a security will be ascertained with reference to the period from the applicable accounting day to the date of maturity of the security. For example, a 10 year bond that from the applicable accounting day only has 14 months to maturity will be treated as a short term security.

5.102 The term 'securities' is to have the meaning as contained in subsection 159GP(1), Division 16E, of the Act with the exception that it does not refer to stock and as if paragraph (d) of subsection 159GP(1) had not been enacted.

5.103 The term 'security' then for the purpose of these provisions will mean:

(a)

a bond, debenture, certificate of entitlement, bill of exchange, promissory note or other security;

(b)

a deposit with a bank, building society or other financial institution; or

(c)

a secured or unsecured creditor. [New subsection 121AO(4)]

Assumptions in calculating net tangible assets value

5.104 The 'net tangible asset value' of a general insurance company or mutual affiliate company is to be the amount of its assets as at the 'demutualisation resolution day' reduced by the amount of its liabilities including its future liabilities arising from business conducted by the company before the 'demutualisation resolution day'. [New subsection 121AN(1)]

5.105 The value of a company's assets and liabilities (excluding future liabilities) is to be calculated in accordance with Australian accounting practice. [New subsection 121AN(2)]

5.106 An eligible actuary will be required to calculate the amount of future liabilities (the outstanding claims) in relation to business conducted before the demutualisation. The other components of the 'net tangible asset value' will normally be ascertained by the company in conjunction with the actuary's calculations and its external auditors. The calculation of net tangible assets is to be made at the applicable accounting day and adjusted for any significant changes between the applicable accounting day and the demutualisation resolution day. [New subsections 121AN(3), (4) and (5)]

5.107 When calculating the 'net tangible assets' of a general insurance company the requirement that the calculation be performed on the basis of the continued business assumption is to apply. The continued business assumption is discussed in paragraphs 5.87 and 5.88 above. [New subsections 121AN(6)]