House of Representatives

Explanatory Memorandum

(Circulated by authority of the Assistant Treasurer and Minister for Financial Services, the Hon Stephen Jones MP)

Chapter 6 Income tax amendments for updates to the accounting standard for general insurance contracts

Outline of chapter

6.1 Schedule 6 to the Bill amends the income tax law with respect to general insurance to provide broad alignment with the new accounting standard, AASB 17. The amendments reduce the income tax compliance burden on the general insurance industry caused by the misalignment between the income tax law and the adoption of the new AASB 17.

Context of amendments

6.2 Division 321 of the ITAA 1997 sets out requirements for calculating insurance liabilities for tax purposes that arise from general insurance policies. Prior to the amendments, the methodologies in Division 321 broadly aligned with the requirements of the accounting standard that applied prior to the adoption of AASB 17, being AASB 1023. From 1 January 2023, AASB 17 replaced AASB 1023 as the mandatory accounting standard for insurance contracts for financial reporting purposes.

6.3 The amendments seek to minimise the regulatory burden facing general insurers following the introduction of AASB 17, which fundamentally differs from AASB 1023. This will allow general insurers to continue using audited financial reporting information as the basis for their tax returns.

6.4 Legislative references in this Chapter are made to the ITAA 1997 unless otherwise specified.

Comparison of key features of new law and current law

Table 6.1 Comparison of new law and current law

Detailed explanation of new law

Subdivisions 321-A and 321-B – General insurance

6.5 Schedule 6 to the Bill amends the income tax law with respect to general insurance to provide broad alignment with the new accounting standard, AASB 17. This reduces the income tax compliance burden on the general insurance industry caused by the misalignment between the income tax law and the adoption of the new AASB 17.

6.6 The main changes under the amendments include:

•

Subdivision 321-A – 'outstanding claims liabilities' is updated to 'adjusted liability for incurred claims';

•

Subdivision 321-B – 'unearned premium reserve' is updated to 'adjusted liability for remaining coverage'; and

•

The respective method statements are updated to broadly align with AASB 17.

AASB 17 Insurance Contracts

6.7 The amendments introduce the following definitions:

•

applicable insurance contracts accounting standard;

•

asset for insurance acquisition cash flows;

•

liability for incurred claims; and

•

liability for remaining coverage.

[Schedule 6, item 14, subsection 995-1(1)]

6.8 To broadly align the income tax law with AASB 17, AASB 17 must be used in working out assessable income and deductions. The policy intention is to reduce compliance costs for relevant taxpayers by broadly aligning requirements under the tax law with the taxpayer's audited financial statements.

6.9 For the purposes of the amendments, the applicable insurance contracts accounting standard is the compiled version of AASB 17 in force on 31 December 2022, and this can be accessed on the Federal Register of Legislation: https://www.legislation.gov.au/Details/F2023C00382. [Schedule 6, item 14, definition of applicable insurance contracts accounting standard in subsection 995-1(1)]

6.10 The amendments also include a regulation-making power to prescribe another accounting standard. The scope of the power is limited and ensures that any future updates to AASB 17 can be incorporated in the ITAA 1997 once they are determined to be suitable for tax law purposes.

6.11 Requiring such modifications to be prescribed by regulations provides the opportunity to separately consider any tax and revenue impacts caused by future changes to the accounting standard with respect to general insurers. The regulation-making power is therefore necessary for the effective operation of tax legislation and to deliver the policy intention.

6.12 Further, to provide certainty and clarity to taxpayers, the primary legislation broadly specifies for the way assessable income and deductions are calculated with reference to terminology used in the accounting standards to the extent they are necessary for tax legislation, particularly in the relevant method statements. The combination of a point-in-time reference and the regulation-making power ensures that future updates to AASB 17 do not cause a disconnect between the primary and subordinate legislation in a manner that would adversely impact the effective operation of tax legislation.

6.13 The terms 'asset for insurance acquisition cash flows', 'liability for incurred claims', and 'liability for remaining coverage' have the same meaning as in AASB 17. [Schedule 6, item 14, subsection 995-1(1)]

6.14 Under the amendments, AASB 17 is used for the purposes of calculating the 'adjusted liability for incurred claims' and the 'adjusted liability for remaining coverage'. These adjustments refer to the adjustments for tax purposes required under the amendments.

6.15 The policy intention is to minimise compliance costs for the industry, and to align tax and accounting with respect to general insurers. Where applicable, general insurance companies must use the measurement approach they have adopted in their audited financial statements prepared according to AASB 17 or in the information provided to APRA prepared according to AASB 17.

Subdivision 321-A: Provision for, and payment of, claims by general insurance companies

Liability for incurred claims

6.16 The concept of liability for incurred claims comprises of the fulfilment cash flows related to past services allocated to the relevant group of contracts at that date.

6.17 To align the income tax provisions with AASB 17, the concept of 'outstanding claims liability' is replaced with the 'adjusted liability for incurred claims'. This refers to the liability for incurred claims (used in AASB 17) that is adjusted for tax purposes under the amendments.

6.18 The provisions compare the value of a general insurance company's adjusted liability for incurred claims at the end of an income year with the value of those adjusted liabilities at the end of the previous income year.

•

If the value of the adjusted liability for incurred claims at the end of an income year is less than the value at the end of the previous income year, the difference is included as assessable income as this represents a decrease in the relevant liabilities in that income year.

•

If the value of the adjusted liability for incurred claims at the end of an income year exceeds the value at the end of the previous income year, the excess is recognised as deductible as this represents an increase in the relevant liabilities in that income year.

[Schedule 6, items 1, 2, 3 and 4, sections 321-10 and 321-15]

Working out the adjusted liability for incurred claims

6.19 To work out the adjusted liability for incurred claims, step 1 of the method statement in section 321-20 requires a measurement of the liability for incurred claims at the end of the income year using AASB 17. [Schedule 6, item 5, step 1 of the method statement in section 321-20]

6.20 However, the measurement of liability for incurred claims is adjusted for tax purposes to exclude certain accounting values from the calculation of liability for incurred claims, specifically, claims handling costs that are not attached to, nor directly attributable to, a particular claim.

6.21 The tax adjustment under the amendments broadly replicates the tax treatment of general insurance policies prior to the amendments, by including only settlement costs directly associated with the relevant claim. Indirect settlement costs (also known as indirect claims handling costs) include the general expenses of running and administering a general insurer's claims department. These types of costs do not attach to, nor are they attributable to, a particular claim, so they are not included in the calculation of the liabilities for a particular claim. Examples of indirect settlement costs may include items in paragraphs B65(f) and (l) of AASB 17. For the purposes of the amendments, the term 'direct settlement costs' is replaced with 'claims handling costs that are neither attached to, nor directly attributable to, a particular claim', to align with the terminology used in AASB 17. For clarity, the law prior to the amendments included direct settlement costs whereas the amendments achieve a similar result by disregarding 'indirect' claims handling costs.

6.22 Step 2 in the method statement is to reduce the step 1 amount by the amount that the company expects to recover under a contract of reinsurance held by the general insurance company, as measured using AASB 17. [Schedule 6, item 5, step 2 of the method statement in section 321-20]

6.23 However, the step 1 amount is not reduced by the amount that the company expects to recover under a contract of reinsurance to which subsection 148(1) of the ITAA 1936 applies. If the step 2 amount was reduced by this amount, the reinsured company's taxable income would effectively be increased by the amount of the expected reinsurance recoveries. This would be inconsistent with the objective of subsection 148(1).

6.24 Subsection 148(1) applies, so far as is relevant, to a reinsurance policy taken out by a general insurance company carrying on business in Australia with a non-resident company. If the subsection applies, broadly:

•

the Australian general insurance company cannot deduct premiums paid in respect of the policy and is not assessable on any reinsurance recoveries; and

•

the non-resident reinsurance company is not assessed in Australia on the premiums received or receivable.

Claims paid – deduction

6.25 The amendments do not alter the taxation treatment of general insurance companies in respect of the payment of claims (see section 321-25). A general insurance company continues to deduct the amounts paid during an income year in respect of claims under general insurance policies.

Subdivision 321-B: Premium income of general insurance companies

Gross premiums – assessable income

6.26 The amendments alter the taxation treatment of gross premium income. A general insurance company continues to include gross premiums received as assessable income. However, a general insurance company does not include as assessable income, gross premiums that are receivable. [Schedule 6, item 6, section 321-45]

6.27 To broadly reflect the accounting treatment, the timing of when gross premiums of a general insurance company are included as assessable income is achieved through a combination of premiums received and the changes in the adjusted liability for remaining coverage. This treatment recognises income when services are performed. To ensure that the tax treatment of premium income appropriately aligns with the accounting treatment under AASB 17, section 321-45 only requires gross premiums received to be included as assessable income; and for the changes in the adjusted liability for remining coverage to be worked out separately (see below).

Liability for remaining coverage

6.28 The liability for remaining coverage comprises of the fulfilment cash flows related to future services allocated to the relevant group of contracts at that date.

6.29 To align the income tax provisions with AASB 17, the concept of 'unearned premium reserve' is replaced with the 'adjusted liability for remaining coverage'. This refers to the liability for remaining coverage (used in AASB 17) that is adjusted for tax purposes under the amendments.

6.30 The provisions compare the value of a general insurance company's adjusted liability for remaining coverage at the end of an income year with the value of the liability at the end of the previous income year.

•

If the value of the adjusted liability for remaining coverage at the end of an income year is less than the value at the end of the previous income year, the difference is included as assessable income as this represents a decrease in the relevant liabilities in that income year.

•

If the value of the adjusted liability for remaining coverage at the end of an income year exceeds the value at the end of the previous income year, the excess is recognised as deductible as this represents an increase in the relevant liabilities in that income year.

[Schedule 6, items 7, 8, 9, 10, 11 and 12, sections 321-50 and 321-55]

Working out the adjusted liability for remaining coverage

6.31 To work out the adjusted liability for remaining coverage, step 1 of the method statement in section 321-60 requires a measurement of the liability for remaining coverage at the end of the income year using AASB 17. [Schedule 6, item 13, step 1 of the method statement in section 321-60]

6.32 However, the measurement of liability for remaining coverage is adjusted for tax purposes to exclude certain accounting values in the calculation of liability for remaining coverage. Specifically, this is the treatment of onerous contract loss components and loss recovery components within AASB 17.

6.33 The treatment of onerous contracts in AASB 17 immediately expenses any losses for accounting purposes on recognition. This is not applied for tax purposes. Instead, the treatment of the loss components and loss recovery components of onerous contracts under AASB 17 is disregarded for tax purposes. To determine the value of the adjusted liability for remaining coverage for tax purposes, the loss components and loss recovery components of such contracts are treated the same as non-onerous contracts, resulting in the release of the net loss component over the contract service period.

6.34 Step 2 of the method statement is to reduce the step 1 amount by any asset for insurance acquisition cash flows. These assets arise where acquisition cash flows have occurred but cannot be identified against a contract group. [Schedule 6, item 13, step 2 of the method statement in section 321-60]

6.35 Step 3 of the method statement is to reduce the result from step 2 by the premiums (relevant reinsurance premiums) paid or payable by the company, in that or an earlier income year, under a contract of reinsurance held by the general insurance company in respect of later years, as measured using AASB 17, other than:

•

reinsurance premiums that the company cannot deduct because of subsection 148(1) of the ITAA 1936; and

•

certain types of reinsurance premiums. Specifically, those that were paid or payable in respect of a particular class of insurance business, where, under the contract of reinsurance, the reinsurer agreed to pay an amount in respect of the loss incurred by the company that is covered by the relevant policy, some or all of the excess over an agreed amount.

[Schedule 6, item 13, step 3 of the method statement in section 321-60]

6.36 Under the amendments, it is intended that the treatment of reinsurance premiums in step 3 is consistent with the treatment of reinsurance premiums in respect of the later income years prior to the amendments.

6.37 Under AASB 17, it is noted that reinsurance premiums paid are recorded against the asset for remaining coverage, which is similarly recalculated at reporting dates to only reflect the future contract service period.

6.38 Step 4 of the method statement works to increase the result from step 3 by the amount of any reinsurance commissions received or receivable by the company that relate to the relevant reinsurance premiums in step 3. [Schedule 6, item 13, step 4 of the method statement in section 321-60]

Consequential amendments

6.39 The amendments update references throughout the ITAA 1997 as applicable, to ensure consistency with the concepts adapted from AASB 17 and with the above amendments. [Schedule 6, items 15, 16, 17, 18, 19, 20 and 21, tables under sections 10-5 and 12-5, paragraphs 705-70(1AC)(c), 713-710(a) and 713-710(b), and notes 1 and 2 to section 713-710]

6.40 However, amendments are not made to outstanding claims or tainted outstanding claims with reference to the tax framework in relation to the controlled foreign company regimes. In these circumstances, references to outstanding claims or tainted outstanding claims are not intended to align with the update to the accounting standard under AASB 17. Further, these concepts are separately provided for under section 446 of the ITAA 1936.

6.41 Consequential amendments are made in relation to the rules applying to income tax consolidation. The basis for working out the value of the liability for incurred claims and the liability for remaining coverage under the income tax law is adjusted from the calculation of liabilities under AASB 17. These differences cause distortions to arise under the tax cost setting rules.

6.42 Differences that are reflected in the accounting standard but not in the income tax treatment of general insurance companies include:

•

Assets for insurance acquisition cash flows to the extent they are used to measure the company's adjusted liability for remaining coverage;

•

Deferred reinsurance expenses to the extent that they are used to measure the company's adjusted liability for remaining coverage;

•

Recoveries receivable or potential recoveries to the extent they relate to insurance contracts or reinsurance contracts;

•

Claims handling costs that are neither attached to, nor directly attributable to, a particular claim, to the extent these costs are used to measure the company's adjusted liability for incurred claims; and

•

The loss components and loss-recovery components on onerous contracts to the extent that they are used to measure the company's adjusted liability for remaining coverage.

[Schedule 6, item 22, subsection 713-725(4)]

6.43 Deferred reinsurance expenses arise from the premiums that have been paid for the reinsurance of risks to the extent those risks relate to later income years. Under AASB 17, it is noted that reinsurance premiums paid are recorded against the asset for remaining coverage, which is similarly recalculated at reporting dates to only reflect the future contract service period.

6.44 The tax cost setting rules are modified to reflect these differences where a general insurance company joins or leaves a consolidated group and brings or takes with it these things that exist in the accounting standard.

6.45 The amendments also repeal the definition of 'outstanding claims' in subsection 995-1(1). [Schedule 6, item 23]

Commencement, application, and transitional provisions

6.46 The amendments commence on the first day of the first quarter following Royal assent of the Bill. [Clause 2]

6.47 The amendments apply to income years starting on or after 1 January 2023 (this is the 'start year' in Part 3 of Schedule 6 to the Bill). The application date is consistent with the general application of the AASB 17 for financial reporting purposes. The application of the tax law and the accounting standards are aligned to minimise compliance costs for relevant taxpayers. [Schedule 6, items 24 and 25]

Transitional arrangements

6.48 Transitional arrangements ensure that no permanent tax differences arise for general insurance companies on the application of the amendments that broadly reflect the adoption of AASB 17.

6.49 To avoid doubt, the transitional provisions however, do not impact Subdivisions 321-A and 321-B to the extent that those subdivisions are not altered by items 26 and 27 of Schedule 6 to the Bill. Therefore, a taxpayer continues to work out assessable income and deductions under sections 321-25 and 321-45.

Transitional arrangements – first income year for which amendments apply

6.50 Unless the taxpayer chooses to apply item 27 of Schedule 6 to the Bill (see below – extended transitional arrangements), the following transitional arrangements apply, and apply only to the start year. [Schedule 6, subitem 26(1)]

6.51 Item 26 of Schedule 6 to the Bill modifies the operation of sections 321-10, 321-15, 321-20 (regarding adjusted liability for incurred claims), 321-50, 321-55, and 321-60 (regarding adjusted liability for remaining coverage) under the amendments for the start year. For this income year, the transitional arrangements require a comparison between the values worked out under the amendments, with the values worked out under the provisions immediately prior to the amendments:

•

with respect to working out the assessable income or deduction following sections 321-10, 321-15 and 321-20 in Subdivision 321-A, compare the following with reference to the start year:

-

the value of the adjusted liability for incurred claims (under the amendments) at the end of the year; with

-

the value of the liability for outstanding claims (immediately prior to the amendments) at the end of the previous income year; and

•

with respect to working out the assessable income or deduction following sections 321-50, 321-55 and 321-60 in Subdivision 321-B, compare the following with reference to the start year:

-

the value of the adjusted liability for remaining coverage (under the amendments) at the end of year; with

-

the value of the unearned premium reserve (immediately prior to the amendments) at the end of the previous income year.

[Schedule 6, subitems 26(2), (3), (4) and (5)]

Transitional arrangements – extended transitional arrangements

6.52 The taxpayer may choose to apply the following extended transitional arrangements instead of the transitional arrangements provided for under item 26 of Schedule 6 to the Bill. These extended transitional arrangements under item 27 are designed to isolate the changes that occur due to the adoption of AASB 17 (as captured by the amendments in the new method statements) and reallocate them over five income years ('relevant income years').

6.53 The choice to apply these transitional arrangements under item 27 of Schedule 6 to the Bill is irrevocable and is made by the taxpayer providing an approved form to the Commissioner. The approved form must be provided either by the day the taxpayer's income tax return is due to be lodged for the applicable income year, or the day that tax return is lodged; whichever is earlier. [Schedule 6, subitem 27(2)]

6.54 The reallocation of assessable income or deductions applies for the relevant income years, comprising of the start year and the four following income years. [Schedule 6, subitem 27(1)]

6.55 To avoid doubt, when applying item 27 of Schedule 6 to the Bill, no further modification is made to the provisions as amended by the Schedule with respect to Subdivisions 321-A and 321-B for the relevant income years. Therefore, the taxpayer must still work out their income or deductions according to Subdivisions 321-A and 321-B (as amended) for those income years (including for the start year, by working out the adjusted liability for incurred claims and the adjusted liability for remining coverage for the year previous to the start year), alongside the application of item 27 of Schedule 6 to the Bill that only seeks to reallocate the relevant assessable income and deductions (see below). [Schedule 6, subitem 26(3)]

6.56 To work out the amounts to be reallocated for over the five income years, work out the following with reference to the start year:

•

If the value of the liability for outstanding claims (immediately prior to the amendments) at the end of the previous income year, exceeds the value of the adjusted liability for incurred claims (under the amendments) at the end of the previous income year; reallocate the excess amount as assessable income over the relevant income years as one-fifth of that amount; or

-

if the value of the adjusted liability for incurred claims (under the amendments) at the end of the previous income year, exceeds the value of the liability for outstanding claims (immediately prior to the amendments) at the end of the previous income year; reallocate the excess amount as deductions over the relevant income years as one-fifth of that amount.

•

If the value of the unearned premium reserve (immediately prior to the amendments) at the end of the previous income year; exceeds the value of the adjusted liability for remaining coverage (under the amendments) at the end of previous income year; reallocate the excess amount as assessable income over the relevant income years as one-fifth of that amount; or

-

if value of the adjusted liability for remaining coverage (under the amendments) at the end of previous income year; exceeds the value of the unearned premium reserve (immediately prior to the amendments) at the end of the previous income year; reallocate the excess amount as deductions over the relevant income years as one-fifth of that amount.

[Schedule 6, subitems 27(4), (5), (6) and (7)]

6.57 As the policy intention is to reduce compliance costs for the general insurance industry on the adoption of AASB 17 in financial reporting by broadly aligning the tax law (by updating new terminology and method statements), these transitional provisions require a comparison of the following information considered largely available to the taxpayer, with reference to the start year:

•

the relevant values at the end of the previous year immediately prior to the amendments; and

•

the relevant values at the end of the previous year worked out under the amendments (which broadly align with AASB 17); as the financial reports that correspond to the start year include corresponding values for the previous year worked out in accordance with AASB 17.

If the taxpayer ceases to carry on an insurance business at any time during the relevant income years, the extended transitional provisions will also cease to apply. Where this occurs, any amount of excess worked out under the extended transitional provisions are not further reallocated and instead worked out as assessable income or a deduction (as the case requires) for that income year where the taxpayer ceases to carry on an insurance business. [Schedule 6, subitem 27(8)]

6.58 Where there has not been a complete cessation of the insurance business in the relevant income years, the taxpayer will continue to apply the extended transitional provisions.