Senate

Explanatory Memorandum

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

Chapter 8 - Eligible investment income of registered organisations

Overview

6.1 Part 7 of Schedule 1 of the Bill will amend Division 8A of the Income Tax Assessment Act 1936 (the Act) to include income derived from certain assets in the assessable income of a friendly society or other registered organisations.

Purpose of the amendments

6.2 The purpose of the amendment is to ensure that the provisions of Division 8A of the Act are not circumvented by the holding of assets separate from the eligible insurance business of the organisation (for instance by the establishment of a separate fund) as a result of the High Court decision in Independent Order of Odd Fellows of Victoria v FC of T (91 ATC 5032) ( 22 ATR 783) (the IOOF case).

Date of effect

6.3 The amendments apply to income derived from eligible investment assets derived or purchased on or after 1 July 1994 by a registered organisation.

Background to the legislation

6.4 'Registered organisation' is defined in subsection 116E(1) to mean a trade union, a friendly society or an employees' association, which is exempt from tax under either paragraph 23(f) (as a trade union or employees' association) or subparagraph 23(g)(i) (as a friendly society).

6.5 Section 116F states that Division 8A overrides all other provisions of the Act in determining the assessable income of a registered organisation. Accordingly, section 116G sets out classes of assessable income of registered organisations; assessable income of registered organisations is limited to income falling within these classes. The classes of assessable income are non-complying superannuation, complying superannuation/roll-over annuity and eligible insurance business.

6.6 The amount of assessable income of a registered organisation to be included in each class is determined by section 116GD. The amount of assessable income in the eligible insurance business (EIB) class comprises assessable income allocated under certain sections relating to the disposal of relevant assets and any other EIB assessable income (subsection 116GD(2)).

6.7 The terms 'EIB', 'EIB assessable income' and 'EIB asset' are defined in subsection 116E(1). 'EIB' means the business of, or relating to, the issuing of, or the undertaking of liability under, eligible insurance policies. 'EIB assessable income' means so much of the total income (other than premiums) of the organisation as is derived from EIB of the organisation. 'EIB asset' means an asset that relates to the EIB.

6.8 In the IOOF case, the High Court examined the definition of 'EIB' in subsection 116E(1). In that case, the taxpayer, a friendly society, had transferred monies from the 'benefit fund' into which premiums were paid, into a 'tax provision repository fund' to cover any tax liability arising from its EIB. The High Court held that investment income derived from the fund which was specifically established to meet income tax obligations was not income derived from EIB and, therefore, was exempt. This was because the investment of monies in the 'tax provision repository fund' was not relevantly related to the issuing of or the undertaking of liability under eligible insurance policies.

6.9 The Court said that although the EIB of the friendly society included all the activities relating to the issuing of and undertaking of liabilities under eligible insurance policies, including making provisions for tax liabilities and making investments in the course of carrying on EIB, it did not include the investment of moneys held in a separate fund and which could be applied for purposes other than EIB. It followed that the investment income derived from the 'tax provision repository fund' was not income from EIB.

6.10 As a result of the IOOF case , Division 8A could be circumvented by holding assets separate from the EIB of the organisation, for instance by establishing a separate investment fund the income from which, on the basis of that case, may not be derived from the business of or in relation to the issuing of or undertaking of liability under eligible insurance policies.

6.11 To overcome that result, the definition of EIB assessable income is to be broadened to include all income derived from certain specified assets.

6.12 Legislation for this purpose was originally included in Taxation Laws Amendment Bill (No 3) 1994. However, to allow for consultation with industry, the amendments were withdrawn from the Bill. The amendments now proposed have been prepared in consultation with industry.

Explanation of the amendments

6.13 These amendments are necessary to ensure that all income derived by a registered organisation relating to EIB, such as income derived by a friendly society from the investment of premiums held separately from its benefit fund, is subject to income tax.

6.14 The definition of 'EIB assessable income' includes the following amounts in the assessable income of registered organisations:

(a)

if the registered organisation is a friendly society - income derived from eligible investment assets not included in a benefit fund of the society and income derived from EIB; and

(b)

if the registered organisation is not a friendly society - income derived from eligible investment assets regardless of where they are held and income derived from EIB.

[Item 54 - new definition of EIB assessable income]

6.15 'Eligible investment asset' means:

(a)

premiums and other amounts derived in carrying on EIB (regardless of whether such premiums or amounts are transferred from one fund into another); for example, the earnings or surplus of a friendly society's benefit fund, whether held in that fund or not;

(b)

income or profits derived from eligible investment assets, for example, interest derived on premiums or on the surplus of a friendly society's benefit fund, whether held in such a fund or not; and

(c)

assets purchased with amounts included in (a), (b) above or in (c). For example, equities or real estate purchased with premiums or with interest derived on premiums whether held in a benefit fund or transferred from the benefit fund into another fund.

[Item 55 - definition of eligible investment asset]

6.16 The definition of eligible investment asset applies to assets whether held in the original fund into which they were paid or credited, or whether transferred out of that fund, including if they were transferred into another fund or into a series of funds. Therefore, transferring assets (such as premiums or assets acquired with those premiums, or income derived thereon) between funds does not exclude them from the definition of eligible investment assets.

6.17 However, the definition of EIB assessable income excludes income derived from eligible investment assets which are held in or transferred to a benefit fund of a friendly society. Transfers of assets between benefit funds are made on an arm's length basis or at market value because of the fiduciary duty that friendly societies have towards their members, both of the transferor and the transferee funds. Therefore, there would be no reduction in the overall assets of the insurance business which generate assessable income.

6.18 A benefit fund (or member fund) is a common term used by the friendly society industry and is also defined in most State legislation governing friendly societies. Essentially, a benefit fund is established for each class of benefit that a friendly society confers and contains all the premiums of that class or the assets that it represents, plus the income generated from those assets.

6.19 The effect of the amendment is that income derived from eligible investment assets not included in a benefit fund of the society is included in EIB assessable income regardless of how such income is used (eg whether the income is capitalised or reinvested, used to pay expenses relating to insurance business, used to pay bonuses to policyholders or members, etc). Thus investment income derived from a fund specifically established to meet tax obligations in circumstances similar to those examined by the High Court in the IOOF case will come within the new definition of 'EIB assessable income'.

6.20 That effect is achieved by the amendment regardless of the number of funds which may be interposed between the fund in which the premiums or other amounts derived in carrying on the EIB are initially placed and the fund in which the EIB assessable income is derived.

6.21 As a consequence of these amendments, the definition of 'EIB asset' has been changed. EIB assets are:

(a)

if the registered organisation is a friendly society - eligible investment assets not included in a benefit fund of the society and assets that relate to its eligible insurance business; and

(b)

if the registered organisation is not a friendly society - assets that relate to its eligible insurance business and eligible investment assets.

[Item 54, new definition of EIB asset]

6.22 Subsection 116GA(4) is also amended. The provision currently refers to the business of the classes of income. The reference to 'the business of' is being deleted because of the inclusion of eligible investment assets in the definitions. [Item 56]