Edited version of private advice

Authorisation Number: 1051932822497

Date of advice: 8 March 2022

Ruling

Subject: Income tax exemption status after a merger

Question

Will a merger with a third party disturb the taxpayer's income tax exempt status in accordance with section 50-30 of the ITAA 1997?

Answer

No.

This ruling applies for the following periods:

Year ended 30 June 20XX

Year ended 30 June 20XX

Year ended 30 June 20XX

Year ended 30 June 20XX

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

The taxpayer is registered as a private health insurer under Division 3 of Part 2 of the Private Health Insurance (Prudential Supervision) Act 2015 (PHIPS Act) and is listed on the register of private health insurers published on the APRA website.

The taxpayer proposes to merge with another private health insurer (Insurer B) and continue to operate under its own name and logo.

At the date of the proposed merger, the taxpayer is exempt from income tax.

The taxpayer's constitution has a clause in relation to the application of income and property. This can be summarised as follows:

•         The income and property of the taxpayer must be applied solely towards its objects;

•         No part of the income and property of the taxpayer may be paid to the members except in certain circumstances (to pay for services or goods rendered to the taxpayer by a member or the reimbursement of expenses incurred by a member).

The taxpayer's constitution has a clause in relation to winding up and dissolution of the taxpayer. This can be summarised as follows:

•         Any property that remains after winding up or other dissolution of the taxpayer is not paid to or distributed among its members, but transferred to other persons determined by members which:

­   have objects similar to the taxpayer's objects; and

­   prohibit the distribution of its income and property to an extent at least as great as is imposed on the taxpayer.

Insurer B is also registered as a private health insurer under Division 3 of Part 2 of the PHIPS Act and is listed on the register of private health insurers published on the APRA website. Insurer B had a wholly owned subsidiary which was a for-profit private health insurer.

At the date of the proposed merger, Insurer B is exempt from income tax.

Similar to the taxpayer, Insurer B has a clause in relation to the application of income and property and a clause in relation to winding up and dissolution of Insurer B.

Insurer B faced significant risks due to narrow margins, high operating expenses, reduced participation in the fund, particularly among younger members, and limited capacity to invest in growth initiatives or in new products or services.

APRA became concerned over the viability of Insurer B in the medium to long term. Hence, Insurer B decided to proactively seek a suitable partner.

After careful consideration and reviewing merger proposals from several other private health insurers, Insurer B accepted the taxpayer's offer to merge.

APRA approved the arrangement for the merger of the taxpayer and Insurer B pursuant to subsection 33(3) of the PHIPS Act.

Under the merger:

•         All of Insurer B's members/ policy holders ceased to be members of Insurer B and became policyholders of the taxpayer.

•         Insurer B's assets and liabilities were transferred to the taxpayer (including shares in its wholly owned subsidiary).

•         Insurer B changed its fund rules to enable an administrative member to be appointed.

•         The administrative member amended Insurer B's constitution to enable the taxpayer to be the sole member of Insurer B.

•         The taxpayer then obtained control over Insurer B and its wholly owned subsidiary.

After a transitional period of approximately 12 months from the merger date, Insurer B and its wholly owned subsidiary will be wound up or liquidated.

The effects of the proposed merger are as follows:

•         There was no diminution of benefits to Insurer B members from becoming policyholders of the taxpayer.

•         The health benefits fund to which Insurer B's health fund rules are referable became the taxpayer's health benefits fund, resulting in benefits to the incoming Insurer B health policyholders being carried by the taxpayer. This will also eventually occur with respect to Insurer B's wholly owned subsidiary's health benefits fund.

•         Insurer B's activities will significantly reduce after the merger.

•         After the merger and the transfer of its policies and assets to the taxpayer under the merger, Insurer B will effectively stop issuing more health policies.

•         No amendments have been made to either entity's constitution to permit a distribution of any value to members at any time before, during or after completion. No distribution has been made to members at any time before, during or after completion.

•         The taxpayer has provided warranties in various agreements forming part of the merger that the relevant deed does not contravene with its constitution and continues to comply with the PHI laws.

•         Although the taxpayer changed its fund rules under the merger, these changes did not contravene its constitution.

APRA has confirmed to the taxpayer in writing that that it will not seek to revoke Insurer B's registration as a health insurer (as per section 21 of the PHIPS Act) immediately after the merger is finalised. APRA will likely contact Insurer B approximately 12 months after the effective date of the merger to request whether Insurer B conducted any health insurer business during previous 12 months. If Insurer B confirms that no such business was conducted, APRA may proceed to cancel the registration of Insurer B as a private health insurer from that date (in the future) pursuant to section 21 of the PHIPS Act.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 50-30

Reasons for decision

Issue 1

Question

Will a merger with a 3^rd party disturb the taxpayer's income tax exempt status in accordance with section 50-30 of the ITAA 1997?

Answer

No.

Detailed Summary

Section 50-1 of the ITAA 1997 provides that the total ordinary income and statutory income of certain entities is exempt from income tax. In some cases, the exemption is subject to special conditions.

Table item 6.3 of section 50-30 of the ITAA 1997provides that a private health insurer within the meaning of the PHIPS Actis an income exempt entity if it is not carried on for the profit or gain of its individual members.

Private health insurer- Post Merger

Firstly, to qualify as an income tax exempt entity under item 6.3 of ITAA 1997, the taxpayer must be a private health insurer after the completion of the merger.

The PHIPS Act defines a private health insurer as a body that is registered under Division 3 of Part 2 of the Act. In particular:

•         Subsection 12(1) provides that a body that is a company within the meaning of the Corporations Act 2001 and is a constitutional corporation may apply to APRA for registration as a private health insurer.

•         Section 14 provides that APRA rules may set out criteria for the registration of bodies as private health insurers.

APRA maintains a register of private health insurers on its website (https://www.apra.gov.au/register-of-private-health-insurers). The taxpayer is listed as an institution which is regulated by APRA in accordance with the PHIPS Act. Therefore, the taxpayer continues, after APRA's approval of the arrangement for the merger of Insurer B and the taxpayer, to be registered as a private health insurer under the PHIPS Act by APRA.

Consequently, the taxpayer currently meets the requirement in item 6.3 that it is a 'private health insurer' within the meaning of that term under the PHIPS Act.

Not for profit entity- Post Merger

Secondly, in order to qualify as an income tax exempt entity under item 6.3 of ITAA 1997, the taxpayer must also have a not-for-profit status after the completion of the merger.

The phrase 'not carried on for the profit or gain of its individual members' is not defined in the income tax provisions. The meaning of this phrase was considered in Taxation Ruling TR 2021/D6 Income tax: the games and sports exemption (TR 2021/D6)

In TR 2021/D6, the Commissioner discusses this phrase in the context of the income tax exemption provision that applies to sporting organisations under paragraph c of item 9.1 of the table in section 50-45 of the ITAA 1997:

"Non- profit"

10. To qualify for the games and sports exemption, a club must be not-for-profit (the 'not-for-profit requirement' in this Ruling). The club must not be carried on for the purposes of individual members' profit or gain, either while the club is operating or on its winding up.

11. Club members may receive communal membership benefits, such as the use of the facilities, that are incidental to the club's objects. This will not prevent the club meeting the not-for-profit requirement. The club may also pay members reasonable remuneration for services they perform for the club.

12. Clubs can use various mechanisms to ensure they meet the not-for-profit requirement. 'Not-for-profit' clauses in governing documents are the most common way. These prevent the distribution of profits or assets for the benefit of particular persons while the club is operating and on winding up.

13. Examples of suitable not-for-profit clauses are:

•         Not-for-profit clause - the assets and income of the club shall be applied solely in furtherance of its objects and no portion shall be distributed directly or indirectly to the members of the club except as bona fide compensation for services rendered or expenses incurred on behalf of the club.

•         Dissolution clause - in the event of the club being dissolved, the amount that remains after dissolution and the satisfaction of all debts and liabilities of the club shall be transferred to any organisation that is carried on for a similar purpose, which is not carried on for the profit or gain of its individual members.

14. If a club is prohibited by statute from distributing profits or assets (for example, state or territory laws for incorporated associations) for the benefit of particular persons while the club is operating and on winding up11, the club's governing documents are taken to contain the appropriate not-for-profit clauses.

15. To meet the not-for-profit requirement, a club's actions must also be consistent with its non-profit clauses which prohibit distributions for the private benefit of its members."

As such, the ATO accepts an entity as non-profit where its constituent or governing documents prevent it from distributing profits or assets for the benefit of its members - both when operating and on winding up.

It is relevant in this regard that taxpayer's constitution prevents the distribution of income or property to its members whilst the taxpayer is operating and upon winding up.

On the basis of the existing terms of the taxpayer's constitution, it is not carried on for the profit or gain of its individual members, and therefore meets the special condition in item 6.3 of section 50-30.

In respect of the issue of whether the merger affected the taxpayer's not-for-profit status as a private health insurer, the following matters are considered relevant:

•         The taxpayer provided warranties under the various agreements forming part of the merger that the relevant agreement does not contravene the taxpayer's constitution and that it continues to comply with applicable private health insurance laws. This ensured that the taxpayer did not contravene its constitution during the merger in a way that might affect its not-for-profit status or contravene the private health insurance laws in a way that might affect its private health insurer registration with APRA.

•         While the taxpayer changed its fund rules under the merger, the changes do not contravene the terms of its constitution. Further, where any inconsistency exists between the fund rules and the taxpayer's constitution, the taxpayer's constitution will prevail.

•         The projected transfer balance sheet under the merger reflects the expectation that the combined assets of the taxpayer and Insurer B will continue on under the taxpayer and there is no leakage or distribution of any net assets to another 3rd party or any of its members (including the taxpayer's members).

•         Consequently, it is accepted that there are no financial benefits given to any of the members of the taxpayer as a result of the merger.

•         It is a material fact that the not-for profit clauses and the dissolution clause in the taxpayer's constitution continue to be retained and remain operative following the merger, such that the assets and income of the taxpayer continue to be applied in furtherance of its objects and will not be distributed to its members; and that, upon its dissolution, any property that remains, after satisfaction of all its debts and liabilities, will not be distributed among the members but must be given to an entity which has objects similar to the taxpayer's and which prohibits the distribution of its income and property to its members.

Consequently, it is considered that the taxpayer continues to meet the special condition in item 6.3 of section 50-30 and will be an income tax exempt entity under section 50-30.