Senate

Taxation Laws Amendment (Structured Settlements and Structured Orders) Bill 2002

Explanatory Memorandum

(Circulated by authority of the Treasurer, the Hon Peter Costello, MP)

Chapter 1 - Exemption for certain payments made under structured settlements

Outline of chapter

1.1 This bill inserts Division 54 of the ITAA 1997 to provide a tax exemption for certain annuities and deferred lump sums made under structured settlements in relation to persons who have suffered a serious personal injury. The tax exemption will only be available if certain eligibility criteria are met.

Context of amendments

1.2 In former Assistant Treasurer's Press Release No. 46 of 26 September 2001 the Government announced that it would introduce amendments designed to encourage the use of structured settlements for personal injury compensation by providing a tax exemption for structured settlement annuities.

1.3 The amendments are one of the steps agreed to at a meeting of Commonwealth, State and Territory Ministers and the President of the Local Government Association on 27 March 2002 to tackle the problem of rising premiums and reduced availability of public liability insurance.

1.4 The Commonwealth agreed to introduce legislation (contained in this bill) to make tax changes to encourage the use of structured settlements for personal injury compensation. The States and Territories also agreed to make such legislative changes as are necessary to remove the barriers to structured settlements as an alternative to lump sums.

1.5 A structured settlement is basically a settlement in which part or all of a damages award is paid in the form of an annuity or annuities and may include a deferred lump sum. It is only reached once all the parties agree and the defendant or defendant's insurer purchases the annuity or group of annuities out of the lump sum compensation payment.

1.6 Structured settlements can be advantageous for both an injured person and an insurer.

1.7 Some injured people may have difficulty in managing large lump sums. In such a case, the lump sum may not adequately provide for the long-term needs of the person. Where lump sums are dissipated early, injured people may be unable to meet on-going medical and other costs. The injured become dependent on the public health and welfare services.

1.8 For insurers, structured settlements can allow the damages awarded to be more closely aligned with an injured person's actual needs.

1.9 A settlement may also provide for the payment of certain deferred lump sums to be paid to the claimant, for example, a lump sum of $5,000 indexed to the CPI and payable every 5 years for life, to replace a wheelchair.

1.10 Under the existing law, compensation for personal injury received in the form of a lump sum is generally tax-free in the hands of the recipient. It is not liable to be assessed under subsection 25(1) of the ITAA 1936 or subsection 6-5(1) of the ITAA 1997 because the payment is of a capital nature. It is not subject to capital gains tax because of paragraph 118-37(1)(b) of the ITAA 1997 which provides an exemption for certain compensation or damages receipts. However, any component of a lump sum that is identifiable as compensation for loss of earnings is taxable.

1.11 Annuities are included as assessable income under section 27H of the ITAA 1936. However, the part of an annuity payment that represents the return of the capital that was used to purchase the annuity (the 'deductible amount') is excluded from assessable income. The amount of the annuity in excess of the deductible amount is included in assessable income on the basis that it represents earnings on the lump sum.

1.12 Deferred lump sums may be assessable under Division 16E of the ITAA 1936 provided they fall within the definition of a 'qualifying security'.

Tax exemption for life companies

1.13 Life insurance companies are exempt from income tax under Division 320 of the ITAA 1997 on income derived from assets that support exempt life insurance policy liabilities. The term exempt life insurance policy is defined in the ITAA 1997 to mean, among other things, life insurance policies that provide for immediate annuities.

1.14 Amounts paid under structured settlements will not only include immediate annuities but also deferred annuities and lump sums. It is intended that life companies be exempt from income tax on income derived from assets that support structured settlement annuities and lump sums.

Summary of new law

1.15 The income tax law will be amended to provide a tax exemption for certain annuities and deferred lump sums awarded as part of personal injury compensation under a structured settlement. The income tax exemption will only be available if certain eligibility criteria are met.

Comparison of key features of new law and current law
New law Current law
Certain annuities and lump sums which are paid to an injured person under a structured settlement are exempt from income tax. Annuities are subject to tax under section 27H of the ITAA 1936. Under this section, the part of an annuity payment that represents the return of the capital that was used to purchase the annuity is excluded from assessable income.

Deferred lump sums may be assessable under Division 16E of the ITAA 1936.

Life insurance companies are exempt from income tax under Division 320 of the ITAA 1997 on income derived from assets that fund tax-exempt structured settlement annuities and structured settlement lump sums. Life insurance companies are exempt from income tax under Division 320 of the ITAA 1997 on income derived from assets that support exempt life insurance policy liabilities. Exempt life insurance policies would include life policies that provide structured settlement annuities that are immediate annuities.

Detailed explanation of new law

Income tax exemption

1.16 Item 1 of this bill repeals the link which follows section 53-25 of the ITAA 1997 and inserts Division 54 which provides a tax exemption for certain payments made under structured settlements. [Schedule 1, item 1]

Structured settlements

Definitions

1.17 New section 54-5 contains definitions which are used in new Division 54. These definitions are set out in Table 1.1.

Table 1.1: Definitions
Definition Meaning
Date of the settlement. For a structured settlement means:

the date on which the structured settlement is entered into; or
if the approval of a court is required, the date on which the court order is made.

Structured settlement annuity. An annuity that is purchased under a structured settlement as described in paragraphs 1.18 to 1.39.
Structured settlement lump sum. A lump sum that is purchased under a structured settlement as described in paragraphs 1.18 to 1.39.

What is a structured settlement ?

1.18 To qualify for the tax exemption certain annuities or deferred lump sums must be paid under a structured settlement. A structured settlement is the settlement of a claim that meets the following 5 conditions.

Condition 1

1.19 The claim must be for compensation or damages for personal injury suffered by a person and the claim must be made by the injured person or by his or her legal personal representative. [Schedule 1, item 1, paragraph 54-10(1)(a)]

1.20 'Personal injury' is not a defined term and therefore has its ordinary meaning; that is, an injury suffered to a person as opposed to the person's property, character or reputation. It covers both physical injury (internal and/or external) and mental injury that is clearly discernible to a qualified medical practitioner (see Graham v Robinson
[1992] 1 VR 279 ). It also covers illness (either physical or mental). In interpreting the meaning of 'injury' the Court have included 'disease' (e.g. Innes or Grant v G & G Kynoch (1919) AC 765).

1.21 The term 'legal personal representative' is defined in subsection 995-1(1) of the ITAA 1997.

Condition 2

1.22 The claim must be based on the commission of a wrong, or on a right created by statute. [Schedule 1, item 1, paragraph 54-10(1)(b)]

1.23 The 'commission of a wrong' includes negligence of another party which gives rise to an action for compensation or damages under common law. Tort cases for personal injury may arise from medical negligence, sporting accidents, motor accidents, public liability, product liability or other similar claims for personal injury arising from negligence.

1.24 Compensation or damages may arise out of a 'right created by statute'. Statutory schemes often provide access to compensation by extending the common law, that is, create a statutory liability where there would not be one at common law.

Condition 3

1.25 The claim cannot be made against a person in his or her capacity as the injured person's employer or associate of the employer, or be a claim made under workers' compensation law or a claim that could instead be made under workers' compensation law [Schedule 1, item 1, paragraph 54-10(1)(c)] . This includes where a claimant opts out of workers' compensation law and pursues a common law claim.

1.26 This condition operates so that the tax exemption is available for structured settlements which relate to claims made by a person against their employer in a non-work-related context. For example, where a traffic accident occurs between an employee and their employer outside of the work place and the employee takes an action against their employer, any amounts paid under a resulting structured settlement would not be excluded from the tax exemption merely because the defendant is the injured person's employer.

1.27 'Workers' compensation law' and 'associate' are defined in subsection 995-1(1) of the ITAA 1997. 'Workers' compensation law' is defined to have the same meaning as that given in subsection 136(1) of the Fringe Benefits Tax Assessment Act 1986 . That is, a law of the Commonwealth, a State, a Territory or a foreign country that provides for compensation or other benefits for work-related trauma suffered by employees where there is no requirement to prove any breach by an employer or associates of an employer.

1.28 It is intended that the exemption would extend to work-related claims not made against the claimant's employer, such as motor vehicle accident and product liability claims, even where these arise in an employment context. The exemption would apply to compensation or damages received by the claimant outside that available under workers' compensation arrangements, that come within the exemption because actions for compensation do not come within the description 'actions against the annuitant's employer'. The actions can be made independently of the employer/employee relationship.

Condition 4

1.29 The settlement must be in a written agreement between the parties to the claim. This requirement applies whether or not the agreement is approved by an order of a court or is embodied in a consent order made by a court. [Schedule 1, item 1, paragraph 54-10(1)(d)]

1.30 The parties to a structured settlement may seek court approval for the structured settlement. This may be necessary in cases involving those with a legal incapacity, that is, persons who are minors or severely mentally disabled.

Example 1.1 Chris, aged 10, was in a car accident when the car driven by his father collided with another car. He suffered a serious head injury resulting in permanent brain damage. He was permanently confined to a wheelchair and would never be able to work.There was a dispute over liability that could not be resolved by the parties. The parties were in agreement on quantum. The court ruled that the defendants were wholly liable.Chris was 15 years old at the time of trial and had a relatively long life expectancy of another 45 years.The parties then reached agreement on quantum, and this agreement was approved by the court. Court approval on damages was necessary because Chris was still a minor at the time of the trial. The court approved the following settlement:

Interim payments of $380,000 which had already been paid. A contingency fund of $420,000 would be paid to the Court of Protection.
Three annuities were purchased from a life insurance company. The first paid $12,500 per year for life (in equal monthly payments) increasing at the greater of the All Groups CPI or 5% per annum compound, guaranteed for the first 10 years. The second paid $30,000 per year starting in 3 years time, increasing at 5% per annum compound, guaranteed for the first 7 years. The third paid $30,000 per year, starting in 10 years time, increasing at 5% per year.

The fact that quantum was decided by the court will not affect the availability of the exemption.

1.31 However, the above requirement does not refer to the situation where a court has the authority to make an order incorporating structured terms. At present, courts in Australia are not authorised to make such orders.

1.32The parties to the settlement agreement generally include:

the claimant - the person who has suffered the personal injury that is caused by the wrong of another person;
the defendant - the person who is liable to the claimant for damages and may be insured in respect of that liability;
the defendant's insurer - the party that insures the defendant against liability to pay damages to the claimant and pays the annuity premium to the life company; and
the life insurance company - the company that issues the annuities to the claimant.

1.33 The exemption is only available where the annuities are purchased by the defendant or their insurer under the terms of a structured settlement. It will not be available in respect of annuities purchased by a claimant out of a lump sum that is agreed to between the claimant and the defendant.

Example 1.2 David settles a claim against Anne for a personal injury he has sustained. Under the terms of the settlement Anne is obliged to pay David a lump sum amount. David uses the lump sum to purchase an annuity from a life insurance company. The annuity is not an annuity which is provided under a structured settlement and therefore will not qualify for tax exemption. If Anne or Anne's insurer had paid the lump sum to a life insurance company to purchase an annuity the arrangement would be a structured settlement.

Condition 5

1.34 The terms of the settlement must provide for some or all of a lump sum award of compensation or damages to be used by the defendant or the defendant's insurer to be paid to, or for the benefit of, the injured person (or to a trustee) in the form of:

an annuity or group of annuities purchased from a life insurance company or State insurers; or
an annuity or group of annuities combined with one or more deferred lump sums purchased from a life insurance company or State insurers.

[Schedule 1, item 1, paragraph 54-10(1)(e)]

1.35 'Annuity' is defined in subsection 995-1(1) of the ITAA 1997 to include an annuity as defined in the Superannuation Industry (Supervision) Act 1993 or a pension as defined in the Retirement Savings Accounts Act 1997 .

1.36 'Life insurance company' is defined in subsection 995-1(1) of the ITAA 1997 to mean a company registered under the LIA 1995.

1.37 The LIA 1995 operates as a regulatory mechanism to protect the interests of life insurance policy holders and to restrict the conduct of life insurance business to companies that are able to meet certain requirements. A company which is registered under this Act is supervised by the Australian Prudential Regulation Authority.

Example 1.3 Jane suffered an injury at birth through the negligent use of forceps. The Health Authority admitted liability and agreed to a structured settlement under which it would pay an annuity over Jane's lifetime.Because the Health Authority had decided to fund the annuity itself rather than purchase the annuity from a life insurance company, the annuity will not be exempt from tax.

1.38 A State insurer is a body that carries on State insurance within the meaning of paragraph 51(xiv) of the Constitution. [Schedule 1, item 1, subsection 54-10(2)]

1.39 A claim may consist of a claim for personal injury as well as another claim such as compensation or damages for loss of, or damage to, property. The only compensation or damages that can be used to purchase annuities or lump sums and be subject to the tax exemption is that part of the compensation or damages which relates to personal injury. [Schedule 1, item 1, subsection 54-10(3)]

Annuities eligible for income tax exemption

1.40 The following conditions must be met in order for a structured settlement annuity to be eligible for the tax exemption. [Schedule 1, item 1, section 54-15]

Condition 1 - lump sum would have not been taxable

1.41 The tax exemption will only be available if the compensation payment or damages, if paid in the form of a lump sum at the date of settlement, would not have to be included in the assessable income of the injured person. [Schedule 1, item 1, section 54-20]

1.42 This eligibility condition ensures that the tax exemption does not extend to annuities purchased from a lump sum (or part of a lump sum) which is a substitute for lost earnings and therefore would be included in the taxpayer's assessable income. Thus, if a lump sum can be dissected into assessable and non-assessable components only the non-assessable component can be used to purchase tax-exempt structured settlement annuities.

Condition 2 - identification of settlement and beneficiaries

1.43 The annuity instrument must:

identify the structured settlement under which the annuity is provided;
only allow for payments of the annuity to be made to:

-
the injured person;
-
a trustee of a trust of which the injured person is the beneficiary (see new section 54-70 for special provisions about trusts); or
-
a reversionary beneficiary (or the injured person's estate in accordance with new section 54-35); and

contain a statement to the effect that the annuity cannot be assigned and cannot be commuted except by a reversionary beneficiary as specified in new section 54-35.

[Schedule 1, item 1, section 54-25]

1.44 In relation to the first dot point in paragraph 1.43, it is not a requirement that all annuities relating to the same structured settlement be purchased under the same contract or from the same life insurance company. It is necessary to know which structured settlement annuities are part of the same settlement to ensure that the minimum monthly level of support requirement (see paragraphs 1.62 to 1.70) is met.

1.45 In relation to the third dot point in paragraph 1.43, amendments to the LIA 1995 provide that assignments or commutations of structured settlement annuities or deferred lump sums are ineffective. The exception is where the claimant dies within a guarantee period and annuities are commuted to a reversionary beneficiary or the injured person's deceased estate (see paragraphs 1.55 to 1.61).

Condition 3 - minimum period of annuity

1.46The annuity instrument must provide that the payments of the annuity are to be made at least annually:

over a period of at least 10 years during the life of the injured person; or
for the life of the injured person.

[Schedule 1, item 1, subsection 54-30(1)]

1.47 It is not necessary where there are a group of annuities that all of the annuities or one annuity be provided over the life of the annuitant. However, annuities under a structured settlement must be paid for at least a period of 10 years. This requirement ensures that the annuity is prudentially regulated under the LIA 1995 by the Australian Prudential Regulation Authority.

1.48 The effect is that the income stream provided by multiple annuities (possibly of different amounts and over different periods) can be paid over the life of the annuitant to reflect the financial needs of the annuitant at different stages of his or her life. Annuities can be for life, a fixed period, immediate or deferred.

1.49 However, as outlined in paragraph 1.62, an annuity or annuities which make up the minimum level of support must be paid at least monthly.

1.50 The annuity instrument must specify:

the date of the first payment of the annuity;
if the annuity specifies a fixed period of years - the date of the last payment in that period; and
the amount of each periodic payment of the annuity.

[Schedule 1, item 1, subsection 54-30(2)]

1.51 The annuities can only be increased as follows:

in a manner which preserves their real value, that is, indexation in accordance with the All Groups CPI number or full-time adult average weekly ordinary times earnings published by the Australian Statistician; or
by a percentage specified in the annuity instrument.

[Schedule 1, item 1, subsection 54-30(3)]

1.52 The annuity instrument may allow the amount of a particular payment to be varied by one of the methods specified in new subsection 54-30(3) or by reference to whichever of those methods would result in the biggest or smallest increase. [Schedule 1, item 1, subsection 54-30(4)]

1.53 A reference in this section to specifying a date requires an actual date to be specified and not merely an event from which a date may be determined. [Schedule 1, item 1, subsection 54-30(5)]

1.54 The rules contained in new subsections 54-30(3) and (4) precludes allocated pensions and 'with-profits' annuities being used in structured settlements.

Condition 4 - maximum guarantee period

1.55 This condition is relevant only to annuities provided under the structured settlement in the period ending 10 years after the date of settlement. [Schedule 1, item 1, subsection 54-35(1)]

1.56 An annuity instrument can provide for a guarantee period of up to 10 years after the date of settlement. If the injured person dies within this period, the payments that would otherwise have been paid during the remainder of the guarantee period to the injured person can be paid instead to either:

the injured person's estate; or
a reversionary beneficiary.

[Schedule 1, item 1, subsection 54-35(2)]

1.57 If the annuity instrument provides for the remaining payments to be made to a reversionary beneficiary, the annuity instrument must:

provide the name of the beneficiary; and
allow the beneficiary to choose either:

-
to be paid the amounts of the payments that the injured persons would have been paid during that period; or
-
commute those payments into one lump sum as calculated under new subsection 54-35(5).

[Schedule 1, item 1, subsection 54-35(3)]

1.58 This rule permits the annuitant to choose a product that has a residual value if he or she dies within a maximum of 10 years after purchasing the product.

Example 1.4 Nadia is paid the following annuities under a structured settlement:

an immediate annuity providing $1,000 per month indexed to the All Groups CPI over her lifetime;
a deferred annuity starting in 5 years time for a period of 10 years, paying $30,000 per year, increasing at 5% per year; and
a deferred annuity starting in 15 years time for a period of 10 years, paying $65,000 per year, increasing at 5% per year.

If the immediate annuity (which it is assumed satisfies the minimum monthly level of support condition - see paragraph 1.62) was subject to an 11 year guarantee period, then this annuity would not attract the exemption. Without this annuity, the remaining annuities would not together meet the minimum monthly level of support requirement. Consequently, none of the annuities would attract the exemption.Provided the minimum monthly level of support condition is satisfied, if the deferred annuity starting in 5 years time were subject to a guarantee period of up to 5 years, then it would continue to attract the exemption, as the guarantee would be wholly within the 10 year guarantee period. However, if the guarantee period were to extend beyond 5 years, this annuity would not attract the exemption.If the deferred annuity starting in 10 years time were subject to a guarantee period, then it would not attract the exemption, because the guarantee would operate outside the 10 year guarantee period.

1.59 An injured person's estate may only be paid a commuted lump sum (as calculated under new subsection 54-35(5)) and not the tax-exempt periodic payments. [Schedule 1, item 1, subsection 54-35(4)]

1.60 The commuted lumps sums paid to either a reversionary beneficiary or an estate of the injured person is calculated by totalling the remaining payments that would otherwise have been made to the injured person for the remainder of the guarantee period. The payments are those that would have been paid to the injured person without any further indexation or increases by a specified percentage as described in new subsection 54-30(3). [Schedule 1, item 1, subsection 54-35(5)]

1.61 In new section 54-35:

'pay to a person' includes pay to the trustee of a trust of which the person is the beneficiary; and
'pay to the injured person's estate' includes pay to the trustee of a trust established by the injured person's will.

[Schedule 1, item 1, subsection 54-35(6)]

Condition 5 - minimum monthly level of support

1.62 An annuity (or annuities paid under the structured settlement as a whole) must provide a minimum monthly level of support over the annuitant's life [Schedule 1, item 1, subsection 54-40(1)] . That is, the minimum monthly level of support can be provided by different annuities.

Example 1.5 Tony suffered an injury because of medical negligence to which the Health Authority admitted liability. The parties agreed to a settlement agreement under which the Health Authority agreed to pay an up-front lump sum and to purchase annuities from a life insurance company including the following annuities:

an immediate annuity paying $120,000 per year, payable monthly, increasing every year in accordance with the indexation rules described below until Tony reaches 65 years of age; and
a deferred annuity starting at the expiry of the previous annuity, with monthly payments for life. The payments for the first year will equal an amount calculated by indexing $10,000 (assumed to be the age pension (see paragraph 1.63) at the commencement of the annuity) by indexation rules described in paragraphs 1.63 to 1.68 from the commencement of the immediate annuity until the first payment of the deferred annuity is made.

These annuities together meet the minimum monthly level of support requirement.

1.63 The minimum monthly level of support is determined as follows:

for the year starting on the date of settlement, one-twelfth of the amount that is, on that date, the sum of:

-
the maximum basic rate of age pension payable to a person in accordance with item 1 of Table B in point 1064-B1 of Pension Rate Calculator A in section 1064 of the Social Security Act 1991 ; and
-
the amount of a person's pension supplement, worked out (using that maximum basic rate) in accordance with Module BA of that Pension Rate Calculator; and

for any subsequent year starting on an anniversary of the date of the settlement:

-
if the indexation factor for the year is greater than 1, the amount worked out under subsection (4) described in paragraph 1.66; or
-
otherwise - the minimum monthly level of support for the previous year.

[Schedule 1, item 1, subsection 54-40(2)]

1.64 In working out the rate and amount that need to be taken into account under new paragraph 54-40(2)(a), the effect of the indexation provisions in sections 1191 to 1195 of the Social Security Act 1991 must be taken into account. The indexed figures are available from Centrelink.

1.65 The indexation factor referred to in new subparagraph 54-40(2)(b)(i) for a year is to be worked out on the anniversary of the date of settlement in accordance with the following formula:

[most recently published All Groups CPI number for a quarter] / [All Groups CPI number for the same quarter in the previous year]

[Schedule 1, item 1, subsection 54-40(3)]

1.66 If the indexation factor for a year is greater than 1, then the minimum monthly level of support for the year is the amount worked out in accordance with the following formula:

indexation factor for the year * minimum monthly level of support for the previous year

[Schedule 1, item 1, subsection 54-40(4)]

1.67 The figures calculated under new subsections 54-40(3) and (4) must be rounded to 3 decimal places (rounding up if the fourth decimal place is 5 or more). [Schedule 1, item 1, subsection 54-40(5)]

1.68 The indexation factor for a year must be worked out by reference to figures for the same quarter as has been used in previous years (e.g. the March quarter) even if on the date of settlement the All Groups CPI number for that quarter has not yet been published. If this happens, the calculation must be made as soon as practicable after the number for that quarter has been published. [Schedule 1, item 1, subsection 54-40(6)]

1.69 Annuities above the minimum monthly level of support can be paid less frequently than monthly. However, as specified in new subsection 54-30(1), to qualify as an annuity the payments must be made at least annually.

Example 1.6 Raylee was involved in a serious car accident that rendered her a paraplegic. The structured settlement reached with the insurer of the driver at fault required an up-front lump sum of $300,000. Three annuities are also to be paid as follows:

an immediate annuity providing $1,000 per month indexed in accordance with the rules described in new subsections 54-40(2) to (6) over her lifetime;
a deferred annuity that commences after 10 years of $20,000 per annum indexed annually by 4%, paid quarterly; and
the third annuity is deferred to commence in 15 years and will provide an additional $30,000 per annum for life, paid annually.

Assuming that the immediate annuity meets the minimum monthly level of support requirement and all annuities meet the eligibility criteria, the annuities paid under the structured settlement will be exempt from income tax.

1.70 In new section 54-40 'pay to a person' includes pay to the trustee of a trust of which the person is the beneficiary. [Schedule 1, item 1, subsection 54-40(7)]

Tax exemption for structured settlement lump sums

1.71 An important feature of structured settlements is that they may include lump sum payments that are made to claimants at regular intervals to fund expected purchases. For example, a payment of $5,000 every 5 years to purchase a new wheelchair.

1.72 These payments will not be an annuity because they are made less frequently than annually.

1.73 The payments (described as structured settlement lump sums) will be exempt from income tax if:

there is at least one structured settlement annuity provided under the same structured settlement that satisfies the eligibility conditions described in paragraphs 1.41 to 1.70; and
the other conditions described in paragraphs 1.74 to 1.80 are satisfied.

[Schedule 1, item 1, section 54-45]

Condition 1 - lump sum would not have been taxable

1.74 The tax exemption will only be available if the payments, if paid in the form of a lump sum at the date of settlement, would not have to be included in the assessable income of the injured person. [Schedule 1, item 1, section 54-50]

1.75 A component of these deferred lump sums may otherwise be assessable under Division 16E of the ITAA 1936.

Condition 2 - identification of settlement and beneficiaries

1.76 The annuity instrument must:

identify the structured settlement under which the structured settlement lump sum is provided; and
only allow for payments of the annuity to be made to:

-
the injured person;
-
a trustee of a trust of which the injured person is the beneficiary (see section 54-70 for special provisions about trusts); or
-
contain a statement to the effect that the right to receive the lump sum cannot be assigned or commuted/cashed out.

[Schedule 1, item 1, section 54-55]

Condition 3 - payment amounts

1.77 The contract must specify the date and amount of the payment of the lump sum. [Schedule 1, item 1, subsection 54-60(1)]

1.78 The lump sums can only be increased as follows:

in a manner which preserves their real value, that is, indexation in accordance with the All Groups CPI number or full-time adult average weekly ordinary times earnings published by the Australian Statistician; or
by a percentage specified in the contract.

[Schedule 1, item 1, subsection 54-60(2)]

Example 1.7 Robert at the age of 32 was rendered a quadriplegic in a motor bike accident. Robert's bike was hit by a car driven by an individual who failed to stop at a red light. His pre-accident normal life expectancy was 75 years of age. As a result of his injuries his life expectancy is reduced to the age of 47 years.Robert made a claim against the driver for compensation for personal injury. The driver was insured and their insurance company defended the claim on their behalf.The parties reached the following settlement agreement. The insurer would pay Robert the up-front lump sum amount of $565,000. Robert would use this amount to pay his lawyers, pay off his debts and purchase some equipment.The insurer would also buy Robert an annuity that would provide him with monthly payments of $2,000 for life, compounding annually at the same rate as the All Groups CPI and guaranteed for the first 10 years. This monthly sum would cover his medical expenses and living costs for life.The insurer would also buy Robert a series of deferred lump sum payments (8 payments spaced out every 5 years). After 5 years he would receive $25,000, after a further 5 years he would receive $50,000, after a further 5 years he would receive $75,000 and then $100,000, $150,000, $250,000, $350,000 and $500,000. These sums would be used to replace his wheelchair every 5 years and also cover other expenses. These payments were all life contingent (i.e. only payable if Robert was still alive).These payments would be exempt if all the eligibility conditions are satisfied.

1.79 The instrument may allow the amount of a particular payment to be varied by one of the methods specified in new subsection 54-60(2) or by reference to whichever of those methods would result in the biggest or smallest increase. [Schedule 1, item 1, subsection 54-60(3)]

1.80 The reference to specifying a date or percentage requires an actual date or figure to be specified and not merely a method from which a date or figure may be determined. [Schedule 1, item 1, subsection 54-60(4)]

Example 1.8 Under a contract a series of deferred lump sums based on the initial sum of $10,000 are to be paid to the injured person at the end of every 5 years. The lump sum is to increase annually by either the greater of 4% or the annual increase in the All Groups CPI. These payments would be exempt if the relevant conditions are all satisfied including those that apply to structured settlement annuities.

Tax exemption for certain payments to reversionary beneficiaries

1.81 As described in new section 54-35, to qualify for the tax exemption, structured settlement annuities can only have a guarantee period which does not extend beyond 10 years after the date of settlement.

1.82 A reversionary beneficiary will be exempt from income tax on the periodic payments or the lump sum payment referred to in new subsection 54-35(3) if the periodic payments or payments which make up the lump sum would have been exempt from income tax in the hands of the injured person. [Schedule 1, item 1, section 54-65]

Example 1.9 Geoff is an injured person who is receiving a tax-free annuity under a structured settlement. The annuity has a guarantee period of 10 years. Geoff's sons Michael and Robin are specified in the annuity contract as the reversionary beneficiaries. Geoff dies 5 years from the date of settlement. Michael and Robin choose under paragraph 54-35(3)(b) to commute the payments that otherwise would have been payable to Geoff for the remainder of the guarantee period. Michael and Robin are exempt from income tax on the payments.

Special provisions about trusts

1.83 A trustee who receives a structured settlement annuity or structured settlement lump sum is exempt from income tax if:

the beneficiary of the trust is the injured person; and
the payment, if made directly to the injured person would have been exempt from income tax under the exemption rules contained in Subdivision 54-B or 54-C.

[Schedule 1, item 1, subsection 54-70(1)]

1.84 A trustee may include a Public Trustee, State or Territory protective office or other legal guardian.

1.85 A trust which makes payments or a commuted payment referred to in subsection 54-35(3)(b) to a reversionary beneficiary will also be exempt from income tax on payments if the payments would have been exempt from income tax if made directly to the reversionary beneficiary. [Schedule 1, item 1, subsection 54-70(2)]

1.86 A payment of a lump sum to an injured person's estate or testamentary trust (see new subsection 54-35(4)) will be exempt from income tax. [Schedule 1, item 1, subsection 54-70(3)]

1.87 If, under subsections 54-70(1) to (3) a payment is exempt from income tax to a trustee, the same payment will be exempt from income tax to the beneficiary even if the trustee pays those amounts or parts of those amounts to the beneficiary or applies them for their benefit. [Schedule 1, item 1, subsection 54-70(4)]

1.88 The tax exemption that applies to trustees and beneficiaries in relation to structured settlement annuities and structured settlement lump sums does not extend to investment income of the trust.

Example 1.10 Paul, at the age of 9, was struck by a car and as a consequence he sustained a serious injury.At the age of 15, Paul's legal personal representative made a claim for compensation against the driver of the car. The driver has insurance and the insurance company will be defending the claim.Paul is considered to be unable to manage money matters so the settlement involves the establishment of the trust and court approval.The settlement agreed to and approved by the court is as follows:

an up-front lump sum of $250,000 to be paid to the trustees for investment on Paul's behalf to meet medical costs and other expenses incurred up to the date of settlement; and
an annuity to be paid to the trustees of $23,000 per year indexed by the All Groups CPI payable for the life of Paul and guaranteed for the first 10 years.

If all the eligibility conditions are met, the annuity will be exempt from tax in the hands of the trustee and also when payments are made to, or applied for the benefit of Paul. The lump sum would already be tax-exempt. The exemption does not apply to investment income derived by the trustee from the investment of the lump sum of $250,000.

Statutory review

1.89 This bill includes a requirement that the operation of the new provisions be reviewed within 5 years of their commencement.

1.90 The Minister must cause a person to report in writing about:

the operation of Division 54 of the ITAA 1997; and
Division 2A of Part 10 of the LIA 1995.

[Schedule 1, item 1, subsection 54-75(1)]

1.91 The person selected to conduct the review must, in the Minister's opinion, be suitably qualified and appropriate to conduct the review. [Schedule 1, item 1, subsection 54-75(2)]

1.92 The review will relate to the period beginning when Division 54 of the ITAA 1997 commences and ending 4 years and 6 months after commencement. [Schedule 1, item 1, subsection 54-75(3)]

1.93 The reviewer must give the report to the Minister as soon as practicable or within 6 months after the end of that period. [Schedule 1, item 1, subsection 54-75(4)]

1.94 The report can include suggestions for changes to the provisions to address problems identified in the report. [Schedule 1, item 1, subsection 54-75(5)]

1.95 The person conducting the review must provide reasonable opportunity for members of the public to make submissions to him or her about matters to which the review relates. [Schedule 1, item 1, subsection 54-75(6)]

1.96 The Minister must arrange a copy of the report to be laid before each House of the Parliament within 15 sitting days of that House after the Minister receives the report. [Schedule 1, item 1, subsection 54-75(7)]

Tax exemption for life insurance companies

1.97 This bill amends the definition of exempt life insurance policy to provide that it includes policies that provide structured settlement annuities or structured settlement lump sums that are exempt from tax under Division 54 of the ITAA 1997 [Schedule 1, item 1A] . Life insurance companies are exempt from income tax under Division 320 of the ITAA 1997 on income derived from assets that support exempt life insurance policy liabilities. The amendment ensures that life companies are exempt from income tax on assets that fund tax-exempt structured settlement annuities and structured settlement lump sums.

Amendments to the Life Insurance Act 1995

1.98 This bill will insert Division 2A into Part 10 of the LIA 1995 which will operate to ensure that the assignment or commutation of annuities or lump sums under structured settlements that are exempt from income tax under Division 54 of the ITAA 1997,with one exception, will have no legal effect. The exception is where the claimant dies within a 10 year guarantee period and a reversionary beneficiary or injured person's deceased estate is paid a commuted payment in accordance with new section 54-35 of the ITAA 1997.

1.99 The amendments operate to prevent life companies entering into contracts which would allow tax-exempt annuities that are intended to provide life time support to injured persons from being assigned or commuted.

1.100 Section 203A of the LIA 1995 contains definitions which are used in new Division 2A of the same Act. The terms date of the settlement and structured settlement take on the same meanings as in Division 54 of the ITAA 1997. The terms tax-exempt annuity and tax-exempt lump sum have the meanings given by new section 203B.

Table 1.2: Definitions
Definition Meaning
Tax-exempt annuity An annuity that is payable by a life insurance company or a State insurer that satisfies at a particular time the requirements contained in sections 54-20 to 54-40 of the ITAA 1997 that means it is exempt from income tax under Division 54.
Tax-exempt lump sum A lump sum that is payable by a life insurance company or a State insurer that satisfies at a particular time the requirements contained in sections 54-50 to 54-60 of the ITAA 1997 that means it is exempt from income tax under Division 54.

[Schedule 1, item 2, sections 203A and 203B]

1.101 This Division as it applies to bodies that carry on State insurance is subject to section 5 of the LIA 1995.

1.102 A purported assignment or commutation of an annuity, that is a tax-exempt annuity, at the time of the purported assignment or commutation, is not effective at law. [Schedule 1, item 2, subsection 203C(1)]

1.103 An exception to the rule is where the annuity instrument provides for payments that would have been made to the injured person are instead paid to the annuitant's estate or a reversionary beneficiary, in the event of the injured person's death. [Schedule 1, item 2, subsection 203C(2)]

1.104 A purported assignment of the right to receive a lump sum that is, at the time of the purported assignment, a tax-exempt lump sum is not effective at law. [Schedule 1, item 2, subsection 203D(1)]

1.105 A purported commutation, or other early cashing out, of the right to receive a lump sum that is, at the time of the purported commutation or cashing-out, a tax-exempt lump sum is not effective at law. [Schedule 1, item 2, subsection 203D(2)]

1.106 Division 2 of the LIA 1995 is subject to Division 2A. [Schedule 1, item 2, section 203E]

Consequential amendments

1.107 The words "and Division 54 of the Income Tax Assessment Act 1997 " are inserted after "subsection (1A)" in subsection 27H(1) of the ITAA 1936 to ensure that annuities referred to in Division 54 of the ITAA 1997 are not included in the assessable income of a taxpayer under section 27H of the ITAA 1936. [Schedule 1, item 3]

1.108 A note is inserted after subsection 27H(1) of the ITAA 1936 to alert readers to the income tax exemption that is available to certain annuities paid under structured settlements. [Schedule 1, item 4]

1.109 A note is inserted at the end of subsection 95-1(1) of the ITAA 1936 to alert the reader to a tax exemption for trusts for certain payments under structured settlements. [Schedule 1, item 5]

1.110 Division 11 of the ITAA 1997 lists the classes of exempt income and then links each class to the relevant section in the ITAA 1936 and the ITAA 1997. Section 11-10 is amended by inserting structured settlement annuities in the table of exempt income with a reference to new sections of the ITAA 1997. [Schedule 1, item 6]

1.111 The note in section 118-1 is amended to refer to the exemption in Division 54. [Schedule 1, items 7 and 8]

1.112 Consequential amendments have been made to subsection 995-1(1) of the ITAA 1997 to include references to new dictionary terms. [Schedule 1, items 9, 10, 11, 12, 13, 14, 15]

1.113 An amendment is made to the definition of life insurance premium in subsection 995-1(1) of the ITAA 1997 so that it includes consideration received by a life insurance company in respect of structured settlement lump sums [Schedule 1, item 12A] . This amendment supports the amendment made to exempt life insurance policy in subsection 995-1(1) of the ITAA 1997 (see paragraph 1.97).

Application and transitional provisions

Income Tax (Transitional Provisions) Act 1997

Division 54

1.114 The link note in section 53-1 is repealed and an application provision for Division 54 is inserted. [Schedule 1, item 16]

1.115 Under the application provision:

Division 54 applies to assessments for the 2001-2002 income year and later income years; and
the date of settlement must be 26 September 2001 or a later date.

[Schedule 1, item 16]

1.116 The amendments will therefore apply to compensable injuries incurred before 26 September 2001 but which had not been settled at that time.

Definitions of exempt life insurance policy and life insurance premium

1.117 The amendments to the definitions of exempt life insurance policy and life insurance premium apply to assessments for life companies for the 2001-2002 income year and later years where the date of the settlement is 26 September 2001 or a later date. [Schedule 1, item 16A]

Life Insurance Act 1995

1.118 Division 2A of Part 10 of the LIA 1995 applies to structured settlement tax-exempt annuities or lump sums where the date of settlement is after the commencement date of this Division. [Schedule 1, item 17]


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