Explanatory Memorandum
(Circulated by authority of the Treasurer, the Hon Ralph Willis, MP)Chapter 11 - Passive income of controlled foreign companies
Overview
11.1 The amendments contained in Part 11 of Schedule 1 of the Bill will amend the controlled foreign company (CFC) provisions of the income tax law relating to general insurance companies to replace the definitions of 'tainted calculated liabilities' and 'calculated liabilities' with definitions that reflect the concept of 'outstanding claims' - a concept used in the 'general' insurance industry as opposed to the 'life' insurance industry.
Summary of the amendments
11.2 The amendments propose to replace the definitions of 'Tainted calculated liabilities' and 'Calculated liabilities' in section 446 of the Income Tax Assessment Act 1936 (the Act) which currently apply to general insurance companies with definitions that reflect the concept of 'outstanding claims'. [Item 86]
11.3 The amendments will apply to statutory accounting periods of CFCs that commence on or after the date of introduction of the Bill into Parliament. [Item 89]
Background to the legislation
11.4 Special rules are contained in the CFC measures of the income tax law to provide concessional treatment to Australian taxpayers who are shareholders of offshore 'general' insurance companies and 'life' insurance companies which are CFCs. The concessional treatment reduces the amount of passive income that may be attributed to those shareholders under the CFC measures.
11.5 More specifically, in relation to a CFC which is a 'general' insurance company, these rules provide for the passive income to be reduced by a proportion of its 'calculated liabilities' which relate to policies owned by non-residents of Australia who are unrelated to the CFC. However, the expression 'calculated liabilities' is defined in terms of actuarial valuations which is very appropriate for 'life' insurance companies but inappropriate for 'general' insurance companies. Therefore the Government will replace the concept of 'calculated liabilities' with the concept of 'outstanding claims' because the latter concept specifically relates to the operations of general insurance companies.
Explanation of the amendments
11.6 The amendments will replace the definitions of 'Tainted calculated liabilities' and 'Calculated liabilities' with the definitions of 'Tainted outstanding claims' and 'Outstanding claims' in subsection 446(4) of the Act because the concept of outstanding claims is more appropriate for general insurance companies. [Item 87]
11.7 Also, the amendments will delete the definition of 'calculated liabilities' in subsection 446(5) because the concept of calculated liabilities will not now be used in subsection 446(4). The concept of calculated liabilities is appropriate for 'life' insurance companies but not 'general' insurance companies. [Item 88]
11.8 The 'amount' of outstanding claims is to be taken to mean the amount which is necessary to be set aside by a company at the end of its statutory accounting period, which, when invested by the company, will provide sufficient funds (i.e., the amount needed) to pay the outstanding claims of the statutory accounting period. Furthermore, in relation to a particular company, the 'amount' of outstanding claims is not to include the amount that will be subject to reinsurance recoveries. The following example demonstrates the concepts of outstanding claims and reinsurance recoveries. [Item 87]
Example
This example is based on a single case to demonstrate the concepts of outstanding claims and reinsurance recoveries.
Assume during a statutory accounting period (SAP) ending on Year 1, the insured had a motor vehicle accident and that, in 5 years time, the general insurance company is expected to pay out $20,000 to the insured for litigation and health claims. The $20,000 is Year 5 dollars, not Year 1 dollars.
Let us also assume that the general insurance company has covered $5,000 of that expected $20,000 and the remainder, i.e., the $15,000 coverage, has been taken out by the general insurance company with another company, i.e., a reinsurance company.
The $5,000 cover is expressed in Year 5 dollars, i.e., the expected pay out in Year 5. The outstanding claim in relation to that $5,000 pay out is the amount of Year 1 dollars which, when invested at the end of year 1, will accrue to an amount of $5,000 in Year 5. Let us assume in this example that that amount is $4,000. Thus, in relation to the general insurance company, the outstanding claim is $4,000. The amount of the outstanding claim, in relation to the general insurance company, is not to include the amount of Year 1 dollars which, when invested, by the reinsurance company would accrue to $15,000, i.e., the reinsurance coverage.
Of course, in this example, if the reinsurance company were also a CFC, in calculating its passive income for the purposes of subsection 446(4), its outstanding claims would include the amount of Year 1 dollars which, when invested by the reinsurance company, would accrue to $15,000 in Year 5.