Edited version of private advice

Authorisation Number: 1051932823403

Date of advice: 8 March 2022

Ruling

Subject: Income tax exemption status after a merger

Question

Will the amendments to the taxpayer's constitution and the completion of a merger with a third party, disturb the taxpayer's income tax exempt status under section 50-30 of the Income Tax Assessment Act 1997 (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

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 A).

After the merger, the taxpayer will continue to operate under Insurer A's name and logo.

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

The taxpayer is a company, and its policyholders are its members.

The taxpayer has a wholly-owned subsidiary which is a for-profit health insurer (Insurer C).

The taxpayer's constitution has a clause in relation to the application of income and property. The income and property of the taxpayer must be applied solely towards its objects.

The taxpayer's constitution has a clause in relation to the distribution of surplus to members on winding up and the transfer of surpluses. When read in the context of the taxpayer's constitution, no distribution of surplus is made to members whilst the taxpayer is in existence. Specifically:

•         No part of the income and property of the taxpayer shall be paid or transferred, directly or indirectly, by way of dividend, bonus or otherwise to members.

•         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 A 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.

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

Similar to the taxpayer, Insurer A has similar clauses in relation to the application of income and property and in relation to winding up and dissolution of the taxpayer.

The taxpayer 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 the taxpayer in the medium to long term. Hence, the taxpayer decided to proactively seek a suitable partner.

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

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

Under the merger:

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

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

•         The taxpayer changed its fund rules to enable an administrative member to be appointed.

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

•         Insurer A then obtained control over the taxpayer and its wholly owned subsidiary.

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

The effects of the proposed merger are as follows:

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

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

•         The taxpayer's activities will significantly reduce after the merger. After the merger and the transfer of its policies and assets to Insurer A under the merger, the taxpayer will effectively stop issuing more health policies.

•         No amendments were made to the taxpayer's or Insurer A's constitution to permit a distribution of any value to members at any time before, during or after completion.

•         The members of taxpayer were notified that they would not be receiving any monetary payment as a result of the merger but if they became policy holders of Insurer A's health benefit fund, they would receive several benefits from Insurer A for joining Insurer A as a policyholder, such benefits being given to them as policyholders of Insurer A. If they decided not to join Insurer A, they would not gain these benefits.

•         The taxpayer has provided warranties in various agreements forming part of the merger that the relevant deed does not contravene 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 Insurer A in writing that that it will not seek to revoke the taxpayer's registration as a health insurer (as per section 21 of the PHIPS Act) immediately after the merger is finalised. APRA will likely contact the taxpayer approximately 12 months after the effective date of the merger to request whether the taxpayer conducted any health insurer business during previous 12 months. If taxpayer confirms that no such business was conducted, APRA may proceed to cancel the registration of the taxpayer 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

Question

Will the amendments to the taxpayer's constitution and the completion of a merger with a third party, disturb the taxpayer's income tax exempt status under 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 Transaction

Firstly, in order 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 Transaction.

The taxpayer is a not-for-profit mutual fund. The taxpayer is the parent company and has a wholly-owned for-profit subsidiary which is a private health fund (Insurer C).

The PHIPS Actdefines 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 the taxpayer and Insurer A, to be registered as a private health insurer under the PHIPS Act 2015 with APRA.

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

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 Transaction

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 a non-profit where its constituent or governing documents prevent it from distributing profits or assets for the benefit of its members - both operating and on winding up.

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

Based on 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 conditions 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 transferred its assets and shares in Insurer C to Insurer A whilst its members were still its policyholders under the section 33 Arrangement implementation. At this point, Insurer A had not yet become the sole member of the taxpayer. The transaction which enabled Insurer A to become a member of the taxpayer only occurred after the section 33 Deed of Arrangement was effective. As Insurer A was not a member of the taxpayer when the transfer of assets and shares in Insurer C took place, the not-for-profit clauses of the taxpayer's constitution were not breached.

•         Under the merger, the taxpayer's policy holders and members will receive financial benefits but only as an Insurer A health fund policy holder and not due to their status as a health fund policy holder and member of the taxpayer. If the taxpayer's policy holders do not continue being Insurer A's policy holders after the merger, they do not receive any of the financial benefits.

•         None of the taxpayer's policyholders (members of the taxpayer prior to the merger) received any monetary payment as a result of the merger.

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

•         No amendments were made to the taxpayer's or Insurer A's constitution to permit a distribution of any value to members at any time before, during or after completion.

It is accepted that there are no financial benefits given to any of the members of the taxpayer or Insurer A because of the merger.

•         It is a material fact that the not-for profit clause and the dissolution clauses in the taxpayer's constitution continue to be materially 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 or Insurer A; and that, upon its dissolution, any property that remains after satisfaction of all its debts and liabilities will not be distributed among its members or Insurer A, 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 not-for-profit clause of the taxpayer's constitution has not been breached by the merger and the taxpayer maintains its not-for-profit status.

Post Changes to the Taxpayer's Constitution

Under the merger, changes were made to the taxpayer's constitution as follows:

•         The taxpayer amended its constitution to permit the addition of a special member. Its members approved such amendment, and the taxpayer appointed a special member.

•         The special member (being the only member left of the taxpayer) resolved to amend the taxpayer's constitution to allow Insurer A to become a member of the taxpayer.

These changes to the taxpayer's constitution were done to enable Insurer A to become the sole member of the taxpayer.

These changes do not amend the taxpayer's not for profit status clause and do not result in actions which contravene the not-for-profit clause. The transfer of the assets and liabilities from the taxpayer to Insurer A occurred when Insurer A was not a member of the taxpayer.

Hence, the amendments in the taxpayer's constitution do not affect its not for profit status.

Conclusion

Therefore, the amendments to the taxpayer's constitution and subsequently the completion of the merger will not disturb the taxpayer's income tax-exempt status in accordance with section 50-30 of the ITAA 1997.