Edited version of private advice

Authorisation Number: 1052333913194

Date of advice: 12 December 2024

Ruling

Subject: Scholarships - life insurance bonus/policies

Question 1

Will any capital gain (or capital loss) made by you, resulting from Other Withdrawals (Any Purpose), made at any time and in any amount after 10 years from its Commencement Date, sourced from your Earnings Component of your Education Bond, be disregarded under section 118-300 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes.

Question 2

Will any capital gain (or capital loss) made by you, resulting from Other Withdrawals (Any Purpose), made at any time and in any amount before 10 years from its Commencement Date, sourced from your Earnings Component of your Education Bond, be disregarded under section 118-300 of the ITAA 1997?

Answer

Yes.

Question 3

Will any capital gain (or capital loss) made by you, resulting from Other Withdrawals (Any Purpose), made at any time and in all situations, sourced from your Capital Component of your Education Bond, be disregarded under section 118-300 of the ITAA 1997?

Answer

Yes.

Question 4

Will an amount you receive from Other Withdrawals (Any Purpose), at any time and in any amount after 10 years from its Commencement Date, sourced from your Earnings Component of your Education Bond, be included in your assessable income under section 26AH of the Income Tax Assessment Act 1936 (ITAA 1936)?

Answer

No.

Question 5

Will an amount you receive from Other Withdrawals (Any Purpose), at any time and in any amount before 10 years from its Commencement Date, sourced from your Earnings Component of your Education Bond, be included in your assessable income under section 26AH of the ITAA 1936?

Answer

Yes.

Question 6

Will an amount you receive from Other Withdrawals (Any Purpose), at any time and in all situations, sourced from your Capital Component of your Education Bond, be included in your assessable income under section 26AH of the ITAA 1936?

Answer

No.

This ruling applies for the following periods:

Year ending 30 June 2025

Year ending 30 June 2026

Year ending 30 June 2027

Year ending 30 June 2028

Year ending 30 June 2029

The scheme commenced on:

1 July 2024

Relevant facts and circumstances

You are a private company with a sole director/secretary and sole corporate shareholder.

You are a corporate beneficiary to a Trust.

The Trust operates a business.

You receive distributions from the Trust.

You provided an unsecured loan with a seven-year term to the Trust, through a loan agreement complying with Division 7A of the ITAA 1936 (Loan).

You intend to use the minimum yearly repayments received from the Trust to invest in an Education Bond issued and managed by a mutually structured, friendly society-based life insurance company (Life Insurance Company).

You received a combined Product Disclosure Statement (PDS) issued by the Life Insurance Company.

The PDS states that, 'Where a company or other legal entity type owns an Education Bond, an individual as Life Insured still needs to be specified'.

The following terms are defined in the PDS as:

•         'Education Bond' or 'Bond' means an investment-linked life insurance contract (sometimes also called a policy or bond) between you and the Life Insurance Company to provide Education Benefits.

•         'Education Benefit' means a benefit paid to or on behalf of Education Beneficiary(s) to meet Eligible Education Expenses.

•         'Commencement Date' means the date upon which the Life Insurance Company accepts your Application by disbursing your Initial Contribution into an Investment Option(s) as selected by you.

•         'Initial Contribution' means the total amount that you invest to establish your Bond, which amount may be reduced by any fees, duties or Initial Advice Fees (if agreed by you with a Financial Adviser).

•         'Bond Benefits' means at any time the total value of your Unit Holding in each of your selected Investment Options.

•         'Bond Capital Component' or 'Capital Component' means an account that the Life Insurance Company maintains for your Education Bond that records all of your net Contributions less that portion of all Other Withdrawals (Any Purpose).

•         'Bond Earnings Component' or 'Earnings Component' means an account that the Life Insurance Company maintains for your Education Bond that records all net earnings attributed to the investment performance of your selected Investment Options less Education Benefit Claims and Other Withdrawals (Any Purpose).

•         'Bond Death Maturity' is when your Bond matures and becomes due for distribution and payment to you and/or your Bond Estate Nominee(s) due to the death of the last surviving Life Insured and following Bond Estate Completion.

•         'Bond Maturity' is when your Bond matures and becomes due for payment because a Bond Term Maturity or a prior Bond Death Maturity occurs.

•         'Bond Owner' means you and can also include other persons as joint owners. A company, a trust or deceased estate or other legal entity(s) can also be a Bond Owner.

•         'Bond Term' means the duration of your Bond as set by you between 1 and 99 years, or alternatively it means a term that ends upon your death as Bond Owner (or joint Bond Owners) or a set period (e.g. 10 years) after such death. (Your set Bond Term may end earlier if a Bond Death Maturity occurs.)

•         'Bond Term Maturity' is the date when your Bond matures and becomes due for payment to you because your Bond Term ends.

•         'Investment Bond 10-Year Advantage' means the benefits of Tax-Free access to your Bond after 10 years from its Commencement Date.

•         'Life Insured' means the person(s) - being you and/or some other person(s) (including your Education Beneficiary(s)), whose death will trigger us paying your Bond Benefits as a Bond Death Maturity.

•         'MTR' is the Bond Owner's or relevant Education Beneficiary's personal marginal tax rate.

•         'Other Withdrawals (Any Purpose)' means withdrawals from your Bond which can be made at any time for unspecified personal use, including 'non-education' uses. These withdrawals can be sourced from your Capital Component or otherwise Investment Bond Tax Rules will apply.

•         'Tax-Free' means your Bond's Tax-Free elements when making Education Benefit Claims or Other Withdrawals (Any Purpose) from its Capital Component or as applies under Investment Bond Tax Treatment.

The PDS also states that:

Your Education Bond will mature and become payable, either:

•         at the end of your selected Bond Term; or

•         before this ends, if Bond Death Maturity occurs due to death of the Education Bond's last surviving Life Insured.

In both instances, the Bond Maturity payment is the full value of the Bond Benefits at that time.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 6-5

Income Tax Assessment Act 1997 section 15-75

Income Tax Assessment Act 1997 paragraph 104-25(1)(b)

Income Tax Assessment Act 1997 subsection 104-25(3)

Income Tax Assessment Act 1997 subsection 108-5(1)

Income Tax Assessment Act 1997 section 116-20

Income Tax Assessment Act 1997 section 118-300

Income Tax Assessment Act 1997 subsection 995-1(1)

Income Tax Assessment Act 1936 section 26AH

Income Tax Assessment Act 1936 section 160AAB

Does IVA apply to this private ruling?

Part IVA of the Income Tax Assessment Act 1936 contains anti-avoidance rules that can apply in certain circumstances where you or another taxpayer obtains a tax benefit, imputation benefit or diverted profits tax benefit in connection with an arrangement.

If Part IVA applies, the tax benefit or imputation benefit can be cancelled (for example, by disallowing a deduction that was otherwise allowable) or you or another taxpayer could be liable to the diverted profits tax.

We have not fully considered the application of Part IVA to the arrangement you asked us to rule on, or to an associated or wider arrangement of which that arrangement is part.

If you want us to rule on whether Part IVA applies, we will need to obtain and consider all the facts about the arrangement which are relevant to determining whether Part IVA may apply.

For more information on Part IVA, go to our website ato.gov.au and enter 'part iva general' in the search box on the top right of the page, then select 'Part IVA: the general anti-avoidancerule for income tax'.

Reasons for decision

Question 1

Summary

Any capital gain (or capital loss) made by you, resulting from Other Withdrawals (Any Purpose), made at any time and in any amount after 10 years from its Commencement Date, sourced from your Earnings Component of your Education Bond, will be disregarded under section 118-300 of the Income Tax Assessment Act 1997 (ITAA 1997).

Detailed reasoning

A capital gains tax (CGT) asset is defined as any kind of property, or a legal or equitable right that is not property under subsection 108-5(1) of the ITAA 1997. The contractual rights of a Bond Owner and, as applicable, a Bond Owner's nominated beneficiary under the Education Bond, are legally enforceable rights and therefore a CGT asset according to the definition in subsection 108-5(1) of the ITAA 1997.

Where the Bond Owner receives an amount of Other Withdrawals (Any Purpose), at any time and in any amount, in satisfaction of the Bond Owner's contractual rights under the Education Bond, their ownership of those rights is discharged or satisfied. This discharge or satisfaction of the contractual rights gives rise to CGT event C2 (paragraph 104-25(1)(b) of the ITAA 1997).

The Bond Owner or their nominated beneficiary, as applicable, makes a capital gain from this CGT event if their capital proceeds from the ending of the ownership of their asset are more than the asset's cost base or, alternatively, a capital loss if those capital proceeds are less than the asset's reduced cost base (subsection 104-25(3) of the ITAA 1997).

The capital proceeds from this CGT event C2 will be the amount of Other Withdrawals (Any Purpose), the Bond Owner or their nominated beneficiary, as applicable, receives or is entitled to receive from the Life Insurance Company under the Education Bond (section 116-20 of the ITAA 1997).

Section 118-300 of the ITAA 1997 exempts certain capital gains and losses made in respect of a 'policy of insurance on the life of an individual'. This expression is not defined in the ITAA 1997. The meaning to be given to the expression 'policy of insurance on the life of an individual' includes, but is not limited to, life insurance policies within the common law meaning of that term. It can apply to other life insurance policies as defined in subsection 995-1(1) of the ITAA 1997 but only to the extent that those policies provide for a sum of money to be paid if an event happens that results in the death of an individual (Taxation Determination TD 2007/4 Income tax: capital gains tax: is a 'policy of insurance on the life of an individual' in section 118-300 of the Income Tax Assessment Act 1997 limited to a life insurance policy within the common law meaning of that expression?).

Table item 3 of subsection 118-300(1) of the ITAA 1997 provides that a capital gain or capital loss made from a CGT event happening in relation to a CGT asset that is an interest in rights under a policy of insurance on the life of an individual is disregarded where that CGT event happens to the original owner of the policy (other than the trustee of a complying superannuation entity).

The Education Bond (as defined in the PDS) is an 'investment-linked life insurance contract (sometimes also called a policy or bond) between you and the Life Insurance Company to provide Education Benefits', which also has a death benefit component.

As an entity to which the Education Bond is first issued, you, as Bond Owner, are regarded as the original owner of a policy of insurance on the life of an individual, being the Life Insured. Accordingly, you, as Bond Owner (where you are not the trustee of a complying superannuation entity[1]) is entitled under table item 3 of subsection 118-300(1) of the ITAA 1997 to disregard any capital gain or capital loss you make under section 104-25 of the ITAA 1997, from the receipt of a payment by the Life Insurance Company of either:

•         Other Withdrawals (Any Purpose) made at any time and in any amount from your Education Bond, or

•         Where the Bond Owner is not the relevant Life Insured, a Bond Death Maturity occurring due to the death of your Life Insured.

Question 2

Summary

Any capital gain (or capital loss) made by you, resulting from Other Withdrawals (Any Purpose), made at any time and in any amount before 10 years from its Commencement Date, sourced from your Earnings Component of your Education Bond, will be disregarded under section 118-300 of the ITAA 1997.

Detailed reasoning

As per 'Detailed reasoning' for Question 1.

Question 3

Summary

Any capital gain (or capital loss) made by you, resulting from Other Withdrawals (Any Purpose), made at any time and in all situations, sourced from your Capital Component of your Education Bond, will be disregarded under section 118-300 of the ITAA 1997.

Detailed reasoning

As per 'Detailed reasoning' for Question 1.

Question 4

Summary

An amount you receive from Other Withdrawals (Any Purpose), at any time and in any amount after 10 years from its Commencement Date, sourced from your Earnings Component of your Education Bond, will not be included in your assessable income under section 26AH of the Income Tax Assessment Act 1936 (ITAA 1936).

Detailed reasoning

A scholarship plan is a life insurance policy issued by a friendly society for the sole purpose of providing benefits to help in the education of nominated beneficiaries. It must not be used as security for borrowing or raising money (subsection 995-1(1) of the ITAA 1997).

Capital and investment income in relation to scholarship plans can be divisible, i.e. the capital (Capital Component) may be returned to the Bond Owner and investment income (Earnings Component) paid to the nominated beneficiary/ies.

The Education Bond (as defined in the PDS) is an 'investment-linked life insurance contract (sometimes also called a policy or bond) between you and the Life Insurance Company to provide Education Benefits', which also has a death benefit component. If some or all of the investment benefits defined as Other Withdrawals (Any Purpose), are returned to the Bond Owner, the Education Bond will not qualify as a scholarship plan and the investment benefits will be taxed as ordinary life insurance investment policy bonuses under section 26AH of the ITAA 1936.

That is:

•         for plans held for 8 years or less, recipients will include bonuses in assessable income and receive a 30% rebate

•         for plans held for 9 years, recipients will include two-thirds of the bonuses in assessable income and receive a 30% rebate in respect of the two-thirds taxable portion

•         for plans held for 10 years, recipients will include one-third of the bonuses in assessable income and receive a 30% rebate in respect of the one-third taxable portion, and

•         for plans held for more than 10 years, recipients will be exempt from tax on bonuses paid on the policy.

Section 26AH of the ITAA 1936 provides that a taxpayer's assessable income shall include bonuses, and some other amounts in the nature of bonuses, received under a relevant life assurance policy ('an eligible policy') during a specified period ('the eligible period'). However, subsection 26AH(6) of the ITAA 1936 operates so that reversionary bonuses received more than 10 years from the date of commencement of a life assurance policy are excluded from assessable income. A reversionary bonus is one where the entitlement to the bonus only accrues upon the maturity, forfeiture or surrender of the policy. In a life insurance context, the proceeds of a policy that incorporates such a bonus would not be income according to ordinary concepts.

Additionally, section 26AH of the ITAA 1936 may apply to amounts received under any form of life assurance policy including those known as unbundled life assurance contracts (Unbundled Policies) and which may be categorised as either investment account or investment-linked policies (paragraphs 5 and 6 of Taxation Ruling IT 2346 Income tax: bonuses paid on certain life assurance policies - section 26AH - interpretation and operation (IT 2346)).

In your case, an amount you receive from Other Withdrawals (Any Purpose), at any time and in any amount after 10 years from its Commencement Date, sourced from your Earnings Component of your Education Bond (which by definition may be characterised as an unbundled policy), is regarded as a reversionary bonus payment for the purposes of section 26AH of the ITAA 1936, as it represents the profit or gain element passed onto you as the Bond Owner (paragraph 9 of IT 2346).

A partial surrender of the Education Bond has also occurred in these circumstances. These payments are then received by you, the Bond Owner, after the tenth year of the eligible period, being the period of 10 years commencing on the date of commencement of risk under the Education Bond. This means an amount you receive from Other Withdrawals (Any Purpose), at any time and in any amount after 10 years from its Commencement Date, sourced from your Earnings Component of your Education Bond, will not be included in your assessable income under section 26AH of the ITAA 1936.

Moreover, these payments will also not be assessable income as life insurance bonuses, as reversionary bonuses are specifically excluded under section 15-75 of the ITAA 1997. Further, as a bonus is typically not ordinary income, the bonus would not be included in your assessable income under subsection 6-5(2) of the ITAA 1997.

Question 5

Summary

An amount you receive from Other Withdrawals (Any Purpose), at any time and in any amount before 10 years from its Commencement Date, sourced from your Earnings Component of your Education Bond, will be included in your assessable income under section 26AH of the ITAA 1936.

Detailed reasoning

As per 'Detailed reasoning' for Question 4, if some or all of the investment benefits (Earnings Component) defined as Other Withdrawals (Any Purpose), are returned to the Bond Owner, the Education Bond will not qualify as a scholarship plan and the investment benefits will be taxed as ordinary life insurance investment policy bonuses under section 26AH of the ITAA 1936. That is:

•         for plans held for 8 years or less, recipients will include bonuses in assessable income and receive a 30% rebate

•         for plans held for 9 years, recipients will include two-thirds of the bonuses in assessable income and receive a 30% rebate in respect of the two-thirds taxable portion

•         for plans held for 10 years, recipients will include one-third of the bonuses in assessable income and receive a 30% rebate in respect of the one-third taxable portion, and

•         for plans held for more than 10 years, recipients will be exempt from tax on bonuses paid on the policy.

Where an amount is included in the assessable income of a taxpayer under section 26AH of the ITAA 1936, the taxpayer may be entitled to a rebate under section 160AAB of the ITAA 1936 to reflect the tax already paid by the life assurance company on the income from which the bonus is paid. The entitlement arises when the policy has been issued by a life assurance company or a friendly society that is itself subject to income tax or by a government insurance office that, while not paying income tax, makes a contribution to a State Treasury equal to the income tax that would be payable but for the exemption. The rebate is currently 30% of the amount assessable under section 26AH of the ITAA 1936.

A rebate under section 160AAB of the ITAA 1936 may be offset against tax payable on assessable income from other sources and not just against the amount payable on the bonus assessable under section 26AH of the ITAA 1936. However, the sum of the section 160AAB of the ITAA 1936 and other rebates is limited to the total tax liability for the year. Any excess rebate is not refundable and, furthermore, the excess cannot be carried forward or back to reduce the amount of tax payable in a future or past year of income (paragraphs 4 and 5 of Taxation Ruling IT 2499 Income tax: rebate of tax - bonuses paid on eligible policies of life assurance (IT 2499)).

In summary, an amount you receive from Other Withdrawals (Any Purpose), at any time and in any amount before 10 years from its Commencement Date, sourced from your Earnings Component, will be included in your assessable income calculated in accordance with the period you have held the Education Bond under section 26AH of the ITAA 1936 and taxed at your marginal tax rate as Bond Owner.

Additionally, you may be entitled to a 30% rebate under section 160AAB of the ITAA 1936 to reflect the tax already paid by the Life Insurance Company on the income from which the bonus is paid, limited to your total tax liability for the year.

Question 6

Summary

An amount you receive from Other Withdrawals (Any Purpose), at any time and in all situations, sourced from your Capital Component of your Education Bond, will not be included in your assessable income under section 26AH of the ITAA 1936.

Detailed reasoning

An amount you receive from Other Withdrawals (Any Purpose), at any time and in all situations, sourced from your Capital Component of your Education Bond, is considered as being capital in nature as it does not have the necessary characteristics to be considered ordinary income. Further, a bonus is typically not ordinary income. Therefore, amounts sourced from your Capital Component will not be assessable under section 6-5 of the ITAA 1997.

Moreover, these amounts will also not be assessable income as life insurance bonuses, as reversionary bonuses are specifically excluded under section 15-75 of the ITAA 1997 or under section 26AH of the ITAA 1936 which deals with reversionary bonuses received from life insurance policies.

[1] Any capital gain or capital loss a Bond Owner that is the trustee of a complying superannuation entity makes under section 104-25 of the ITAA 1997 from the receipt of a payment of either a Surrender Value, part surrender benefit or Death Benefit is disregarded pursuant to table item 5 of subsection 118-300(1) of the ITAA 1997.

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