Edited version of your private ruling

Authorisation Number: 1012553433548

Ruling

Question 1

Will the value of Head Company's unearned premium reserve at the end of the previous income year be equal to the amount that would have been the value of the General Insurance Company's unearned premium reserve just before the joining time for the purpose of working out any assessable income under Section 321-50 of Schedule 2J of the Income Tax Assessment Act 1936 (ITAA 1936) or allowable deduction under Section 321-55 of Schedule 2J of the ITAA 1936?

Answer

Yes.

Question 2

Will the value of Head Company's liabilities under the net risk component of life insurance policies at the end of the previous income year be equal to the amount that would have been the value of these liabilities for Life Insurance Company just before the joining time for the purpose of working out any assessable income under Paragraph 320-15(1) (h) of the Income Tax Assessment Act 1997 (ITAA 1997) or allowable deduction under Section 320-85 of the ITAA 1997?

Answer

Yes.

Relevant facts and circumstances

Head Company (HC) applied for a private binding ruling regarding its acquisition of a general insurance company and a life insurance company.

In supporting documentation HC stated that it is:

· An Australian resident company listed on the Australian Securities Exchange (ASX)

· Widely held

· A tax consolidated group with 100% owned Australian subsidiaries and trusts

· Owner of all the shares in General Insurance Company (GIC) and Life Insurance Company (LIC), prior to which it did not carry on a business of general or life insurance

· Had a later balancing period than LIC and GIC.

HC provided the following information on GIC and LIC:

GIC

GIC carries on an insurance business within the meaning of the Insurance Act 1973

(refer section 6(1) of the ITAA 1936 and section 995-1 of the ITAA 1997)

GIC's primary activity is the provision of general insurance products

GIC receives premiums from writing these general insurance policies

For accounting purposes the premiums received are recognised as revenue in the Statement of Comprehensive Income over the lives of the insurance contracts

The premiums that have been received/receivable for accounting purposes but not yet recognised as revenue are recorded as a liability in the Balance Sheet referred to as 'unearned premium liability'

As part of writing these insurance policies and acquiring new business, GIC incurs various acquisition costs including commission, policy issuance costs, underwriting, advertising and other costs, referred to as 'deferred acquisition costs' or DAC

For accounting purposes, these costs are deferred and recognised as an asset (DAC asset) in the Balance Sheet of GIC

The deferred acquisition costs are amortised systematically in accordance with the expected pattern of risk under the general insurance policy to which the costs relate. The amortisation of deferred acquisition costs is recognised as an expense in the Statement of Comprehensive Income.

LIC

LIC carries on an insurance business within the meaning of the Insurance Act 1973

(refer section 6(1) of the ITAA 1936 and section 995-1 of the ITAA 1997)

LIC is registered as a life insurance company pursuant to sections 20 and 21 of the Life Insurance Act 1995

LIC's primary activity is the provision of life insurance products, including whole of life insurance, term, disability and accidental death insurance

LIC receives premiums from writing these insurance policies

For accounting purposes, under the accumulation approach adopted by LIC, premiums received are deferred or earned in accordance with the underlying incidence of risk

That is, the premiums received are recognised as a component of the life insurance policy liabilities balance on the Balance Sheet, referred to as the 'unearned premium component'. The premiums are then recognised as revenue of LIC from the date of attachment of risk (in accordance with certain actuarial principles and calculations)

As part of writing these life insurance policies and acquiring new business, LIC incurs various acquisition costs, including commission, policy issuance, underwriting, advertising and other sales costs, referred to as 'deferred acquisition costs' or DAC

For accounting purposes, under the accumulation approach, these costs are deferred to the extent that costs are deemed recoverable from future premiums or policy charges. This has the effect that acquisition costs are deferred within the life insurance policy liability balance and are amortised over the period that they will be recovered from premiums (that is effectively recognised in the Statement of Comprehensive Income through movements in the life insurance policy liabilities)

As noted above, under the accumulation approach, both the unearned premiums and deferred acquisition costs are recognised on the Balance Sheet of LIC as being components of the life insurance policy liabilities balance. The movement in value of life insurance policy liabilities from year to year is recognised in the Statement of Comprehensive Income (and thus the amortisation of the deferred acquisition costs is also recognised in the Statement of Comprehensive Income).

Relevant legislative provisions

Income Tax Assessment Act 1936 (ITAA 1936)

ITAA 1936 subsection 6(1)

ITAA 1936 Schedule 2J Division 321 (repealed)

ITAA 1936 Schedule 2J section 321-45 (repealed)

ITAA 1936 Schedule 2J section 321-50 (repealed)

ITAA 1936 Schedule 2J section 321-55 (repealed)

ITAA 1936 Schedule 2J section 321-60 (repealed)

ITAA 1936 Schedule 2J subsection 321-60(a) (repealed)

ITAA 1936 Schedule 2J subsection 321-60(b) (repealed)

ITAA 1936 Schedule 2J subsection 321-60(c) (repealed)

ITAA 1936 Schedule 2J subsection 321-60(d) (repealed)

ITAA 1936 Schedule 2J subsection 321-60(e) (repealed)

ITAA 1936 Schedule 2J subsection 321-60(f) (repealed)

ITAA 1936 Schedule 2J subsection 321-60(g) (repealed)

ITAA 1936 Schedule 2J paragraph 321-60(g)(a) (repealed)

ITAA 1936 Schedule 2J subparagraph 321-60(g)(a)(i) (repealed)

ITAA 1936 Schedule 2J subparagraph 321-60(g)(a)(ii) (repealed)

ITAA 1936 Schedule 2J paragraph 321-60(g)(b) (repealed)

ITAA 1936 Schedule 2J subparagraph 321-60(g)(a)(i) (repealed)

ITAA 1936 Schedule 2J subparagraph 321-60(g)(a)(ii) (repealed)

Income Tax Assessment Act 1997 (ITAA 1997)

ITAA 1997 section 8-1

ITAA 1997 Division 320

ITAA 1997 section 320-5

ITAA 1997 paragraph 320-15(1)(a)

ITAA 1997 paragraph 320-15(1) (h)

ITAA 1997 section 320-85

ITAA 1997 Subdivision 321-A

ITAA 1997 Subdivision 321-B

ITAA 1997 section 701-1

ITAA 1997 Subdivision 713-L

ITAA 1997 section 713-505

ITAA 1997 section 713-511

ITAA 1997 Subdivision 713-M

ITAA 1997 section 713-715

ITAA 1997 subsection 713-715(1)

ITAA 1997 subsection 713-715(2)

ITAA 1997 subsection 713-715(3)

ITAA 1997 section 995-1

Tax Laws Amendment (Transfer of Provisions) Act 2010 (No 79 of 2010)

Reasons for decision

Question 1

Detailed reasoning

The assessable income of a general insurance company

Schedule 2J of the ITAA 1936 (repealed) is applicable to the year of income of this ruling, 1 September 2009 to 31 August 2010. Schedule 2J was repealed by Tax Laws Amendment (Transfer of Provisions) Act 2010 (No 79 of 2010), with Subdivisions 321-A and 321-B of the ITAA 1997 applicable to the first year of income starting on or after 1 July 2010 and later years of income.

The operative provisions of Schedule 2J formerly read:

SECTION 321-45 ASSESSABLE INCOME TO INCLUDE GROSS PREMIUMS  


321-45 The assessable income of a general insurance company for a year of income includes the gross premiums received or receivable by the company during the year of income in respect of general insurance policies.

History S 321-45 inserted by No 97 of 2002.

SECTION 321-50 AMOUNT TO BE INCLUDED IN ASSESSABLE INCOME FOR REDUCTION IN VALUE OF UNEARNED PREMIUM RESERVE  


321-50 If the value, at the end of a year of income (the current year of income), of the unearned premium reserve of a general insurance company under general insurance policies is less than the value, at the end of the previous year of income, of that reserve, the company's assessable income of the current year of income includes an amount equal to the difference.

History S 321-50 inserted by No 97 of 2002.

SECTION 321-55 DEDUCTION FOR INCREASE IN VALUE OF UNEARNED PREMIUM RESERVE 

 
321-55 If the value, at the end of a year of income (the current year of income), of the unearned premium reserve of a general insurance company under general insurance policies exceeds the value, at the end of the previous year of income, of that reserve, the company can deduct for the current year of income an amount equal to the excess.

SECTION 321-60 HOW VALUE OF UNEARNED PREMIUM RESERVE IS WORKED OUT  

321-60 The value of the unearned premium reserve, at the end of a year of income (the current year of income), of a general insurance company under general insurance policies issued in the course of carrying on insurance business is so much of the sum of the net premiums received or receivable by the company in relation to those policies as the company determines, based on proper and reasonable estimates, to relate to risks covered by the policies in respect of later years of income where: apportionable issue costs means so much of the costs incurred by the company in connection with the issue of the relevant policies as relate to the gross premiums and, without limiting the generality of the above, includes the following:


(a) commission and brokerage fees;


(b) administration costs of processing insurance proposals and renewals;


(c) administration costs of collecting premiums;


(d) selling and underwriting costs;


(e) fire brigade charges;


(f) stamp duty;


(g) other charges, levies and contributions imposed by governments or governmental authorities that directly relate to general insurance policies.

"net premiums" means:


(a) the sum of:


(i) the gross premiums received or receivable by the company in relation to the relevant policies in the current year of income or an earlier year of income; and


(ii) any reinsurance commissions received or receivable by the company that relate to relevant reinsurance premiums;

less


(b) the sum of:


(i) the apportionable issue costs; and


(ii) any relevant reinsurance premiums ….

In summary, Schedule 2J adopts a methodology that results in a spread of the deductions for acquisition expenses over the terms of the policies' relevant periods of risk. This is achieved through a 'net premiums approach' (paragraph 4.37 of the Revised Explanatory Memorandum to the Taxation Laws Amendment Act (No. 3) 2002 (EM)) that spreads a net amount determined as being the sum of gross premiums received or receivable in a current or previous income year and any reinsurance premiums less apportionable costs pursuant to paragraphs 321-60(a) to (g).

The difference in value between a general insurer's unearned premium reserve at the commencement of a year of income (the closing value at the end of the previous year of income) and its value at the end of its current year of income results in either an amount of assessable income (where the amount at the end of the year is less than the amount at the commencement of the year) or a deduction (where the amount at the end of the year exceeds the amount at the commencement of the year).

Under section 701-1 of the ITAA 1997, subsidiary members of a consolidated group are taken, for entity core purposes (core purposes), to be part of the head company of the group, rather than separate entities for any period the subsidiaries are members of the group. The core purposes include the working out of the amount of the head company's and subsidiary member's liability for income tax and the amount of a loss for a relevant period.

Subdivision 713-M of the ITAA 1997 sets out special rules for a general insurance company becoming or ceasing to be a subsidiary member of a consolidated group. Where a consolidated group acquires a general insurance company, section 713-710 provides that section 713-715 affects how former sections 321-50 and 321-55 of the ITAA 1936 apply in relation to the value of the company's unearned premium reserve that is worked out under section 321-60. The value of the unearned premium reserve is referred to as the 'affected value' for the purpose of these provisions (see section 713-710).

In regard to the liabilities and reserves of general insurance companies joining consolidated groups, section 713-715 of the ITAA 1997 is the relevant provision which is as follows:

This section applies if a ^*general insurance company becomes a ^*subsidiary member of a ^*consolidated group at a time (the joining time).

The object of this section is to ensure that the ^*head company of the ^*consolidated group bears the income tax consequences relating to changes after the joining time in the affected values.

Note: The general insurance company bears the income tax consequences relating to a change in the affected values before the joining time, because section 701-30 ensures that the affected sections apply in relation to a part of the income year before that time when the company was not a subsidiary member of a consolidated group as if that part were an income year.
713-715(3)

The affected sections apply for the head company core purposes set out in section 701-1 (Single entity rule) as if each of the affected values at the end of the last income year ending before the joining time were the amount that would have been that value had that income year ended just before the joining time.

Application to the facts

GIC carries on an insurance business within the meaning of the Insurance Act 1973 (and within the meaning of section 6(1) of the ITAA 1936 and section 995-1 of the ITAA 1997).

HC became the owner of all the shares of GIC and LIC on 1 July 2010, before which time it did not carry on either a business of general or life insurance. As a result of the acquisitions, GIC, a general insurance company, and LIC, a life insurance company, became subsidiary members of the HC consolidated group at the joining time.

In regard to the acquisition of GIC, the value of the company's unearned premium reserve is a key aspect and the subject of Question 1. The '"value of the unearned premium reserve" of a general insurance company under general insurance policies, at the time of the acquisition, has the meaning given by former section 321-60 of Schedule 2J' (section 6(1) of the ITAA 1936).

As stated above, a 'net premiums approach' (being the sum of gross premiums received or receivable in a current or previous income year and any reinsurance premiums less apportionable costs pursuant to former paragraphs 321-60(a) to (g)) is adopted in Schedule 2J to determine the unearned premium reserve for income tax purposes for a general insurance company.

Former section 321-50 of the ITAA 1936 provides for an amount to be included in assessable income for a reduction of the value of unearned premium reserve and former section 321-55 of the ITAA 1936 provides for a deduction for an increase in value of unearned premium reserve.

GIC became a subsidiary member of the HC consolidated group at the joining time, therefore by virtue of section 701-30 GIC bears the income tax consequences relating to the change in unearned premium reserve ('the affected values') before the joining time (see the note to subsection 713-715(2)). For GIC, this is the period from the beginning of its year of income to just before the joining time.

From the joining time, HC consolidated group assumes the tax consequences of the changes in GIC's unearned premium reserve by virtue of the operation of subsection 713-715(2) and section 713-710. Under subsection 713-715(3) this would be the value of GIC's unearned premium reserve as at just before the joining time. Sections 321-50 and 321-55 will then apply to HC in relation to GIC as if just before the joining time was the end of the previous income year, and therefore for HC's income year, the value of its unearned premium at the end of the previous income year for the purposes of former sections 321-50 and 321-55 will be the value of GIC's unearned premium reserve as at the joining time.

Conclusion

For HC's income year, its opening value for unearned premium reserve will be the value of GIC's unearned premium reserve at the end of the period just before the joining time.

Question 2

Detailed reasoning

The assessable income of a life insurance company

As stated in ATO ID 2007/41 Income Tax Life insurance company: assessment of premiums 'paid' to the company:

the object of … Division [320 of the ITAA 1997] is given in section 320-5 of the ITAA 1997 as providing a basis for taxing life insurance companies in a way that is broadly comparable to the way that other entities that derive similar kinds of income are taxed. To achieve this object Division 320 identifies certain amounts that are included in the assessable income and certain amounts that a life insurance company can deduct.

The approach adopted in Division 320 of the ITAA 1997 to achieve this object includes matching cash flows with the corresponding changes in liabilities. The correct reflex of the year's activities for risk policies emerges from comparing premium income with the corresponding changes in policy liabilities, and policy benefits with the corresponding change in policy liabilities. Under the Division 320 model, paragraph 320-15(1)(a) of the ITAA 1997 operates to assess premiums, while movements in the net risk components of life insurance policies are assessable under paragraph 320-15(1)(h) of the ITAA 1997 or deductible under section 320-85 of the ITAA 1997.

This matching process was judicially recognised in RACV Insurance Pty Ltd v. Federal Commissioner of Taxation 74 ATC 4169; (1974) 4 ATR 610 as the appropriate basis for the taxation of insurance business prior to the enactment of specific rules for the taxation of insurance businesses. It is clear from the structure and scheme of Division 320 of the ITAA 1997 that these statutory rules were intended to preserve and reinforce, rather than vary or detract from, these principles.

Subsidiary members of consolidated groups

As stated in reply to Question 1, above, under section 701-1 of the ITAA 1997 subsidiary members of a consolidated group are taken, for entity core purposes (core purposes), to be part of the head company of the group, rather than separate entities for any period the subsidiaries are members of the group. The core purposes include the working out of the amount of the head company's and subsidiary member's liability for income tax and the amount of a loss for a relevant period.

Subdivision 713-L of the ITAA 1997 sets out special rules for life insurance companies that become or cease to be subsidiary members of consolidated groups and includes the consideration of the circumstances where the head company of a consolidated group acquires a subsidiary that is a life insurance company.

Where a consolidated group includes a subsidiary that is a life insurance company, the head company is treated as a life insurance company for income tax purposes (section 713-505 of the ITAA 1997). Furthermore, the provisions in the income tax law that apply to a life insurance company apply to the head company of the consolidated group.

Where a consolidated group acquires a life insurance company, section 713-511 of the ITAA 1997 applies to affect how paragraph 320-15(1)(h) and 320-85 apply to the head company in relation to changes in the net risk components of life insurance policies. Section 713-511 is as follows:

This section affects how paragraph 320-15(1) (h) and section 320-85 apply if:

(a) a ^*life insurance company becomes a ^*subsidiary member of a ^*consolidated group at a time (the joining time); and

(b) just before the joining time, the life insurance company had one or more liabilities under the ^*net risk components of life insurance policies.

Note: Paragraph 320-15(1)(h) and section 320-85 both operate on the basis of a comparison of the value of the company's liabilities under the net risk components of life insurance policies at the end of the current year with the value of those liabilities at the end of the previous year, so that: (a) that paragraph includes an amount in the company's assessable income for the current year if the value at the end of the current year is less than the value at the end of the previous income year; and (b) that section allows a deduction for the current year if the value at the end of the current year is more than the value at the end of the previous income year.

713-511(2)

The object of this section is to ensure that the ^*head company of the ^*consolidated group bears the income tax consequences relating to a change in ^*value of the liabilities only after the joining time.

Note: The life insurance company bears the income tax consequences relating to a change in value of the liabilities before the joining time, because section 701-30 ensures that paragraph 320-15(1) (h) and section 320-85 apply in relation to a part of the income year before that time when the company was not a subsidiary member of a consolidated group as if that part were an income year.
713-511(3)

Paragraph 320-15(1)(h) and section 320-85 apply for the head company core purposes set out in section 701-1 (Single entity rule) as if the ^*value of the liabilities at the end of the last income year ending before the joining time were the value of the liabilities (for the ^*life insurance company) just before the joining time.

Application to the facts

As already stated in answer to Question 1, HC became the owner of all the shares in GIC and LIC, prior to which it did not carry on a business of life insurance.

LIC, a life insurance company, became a subsidiary member of the HC consolidated group at the joining time. The tax consequences relating to a change in value of the liabilities under the net risk components of life insurance policies before the joining time, for the period from the beginning of that year of income to just before the joining time are borne by LIC (see Note to 713-511(2)).

From the joining time, HC consolidated group assumes the tax consequences of the changes in LIC's liabilities under the net risk components of the life insurance policies by virtue of the operation of subsection 713-511(2).

Under subsection 713-511(3), this would be the value of LIC's net risk components of life insurance policies determined under section 320-85 of the ITAA 1997 as at just before the joining time. Paragraph 320-15(1)(h) of the ITAA 1997 and section 320-85 will then apply to HC in relation to LIC as if just before the joining time was at the end of the previous income year, and therefore for HC's year end, the value of HC's net risk components of life insurance policies at the end of the previous income year for the purposes of paragraph 320-15(1)(h) and section 320-85 will include the value of LIC's net risk component of life insurance policies determined under section 320-85 as at the joining time.

Conclusion

HC's opening value of its liabilities under the net risk component of life insurance policies will be equal to the amount that was the value of these liabilities for LIC determined under section 320-85 of the ITAA 1997 just before the joining time.

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