Edited version of your written advice

Authorisation Number: 5010047419401

Date of advice: 21 May 2018

Ruling

Subject: Foreign investment policy

Question 1

Does the Redemption Bond meet the definition of a life insurance policy as set out in ITAA 1997 Section 995-1?

Answer

Yes

Question 2

Is the Redemption Bond an eligible policy under the ITAA 1936 Section 26AH?

Answer

Yes

Question 3

Is any part of the profits receivable on the redemption of the Redemption Bond assessable income?

Answer

Yes

Question 4

Will any capital gain arising from the assignment of the Redemption Bond from the Trustees of “The Trust” to you be disregarded due to the application of ITAA 1997 Section 118-300?

Answer

No

This ruling applies for the following period:

Year ended 30 June 201X

The scheme commenced on:

1 July 201X

Relevant facts and circumstances:

You are an Australian resident taxpayer.

Your relative was a foreign resident throughout their life. Your relative died.

Your relative settled the Trust No (hereafter referred to as “the Foreign Trust”) on #

The current trustees of the trust are foreign residents for tax purposes.

You are the sole beneficiary of this trust.

The foreign trust’s property comprises of a Redemption Bond.

The bond was first purchased by your relative. This property was then transferred into the trust.

This investment is sourced overseas.

The bond is a capital investment bond with a # year term.

Its value reflects a variety of foreign listed investment funds.

The bond can be redeemed at any time, but unless redeemed earlier, will continue to the end of the # year term.

If the bond is held to term, there is a guaranteed reversionary bonus equivalent to the amount invested in the bond, less any withdrawals or surrenders prior to redemption (i.e. the guaranteed return on redemption is at least twice the value invested less sums already withdrawn).

Based on current valuations, redeeming the bond now would result in receipt of $. The initial investment in the bond of $ was made on #.

The Trustees of the Foreign Trust want to assign the bond to the taxpayer absolutely.

The trust will cease to exist upon this happening as there is no longer any trust property.

Once the bond has been assigned to the taxpayer, they intend to redeem the bond.

More than 10 years have expired since the commencement of risk of the policy attached to the bond.

Relevant legislative provisions:

Section 995-1 of the ITAA 1997

Section 9 of the Life Insurance Act 1995

Section 14 of the Life Insurance Act 1995

Section 26AH of the ITAA 1936

Section 118-300 of the ITAA 1997

Reasons for decision

You are an Australian resident who is a beneficiary of the foreign trust. If the foreign trust is redeemed in the 2017-18 income year, you will receive a distribution from the Trust. If so it will be necessary to determine the assessability of the distribution.

Section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997) outlines what income is included in the assessable income of a person who is required to pay tax in Australia. For a resident of Australia, that provision states that all income, whether derived from within Australia or outside is included in their assessable income.

Therefore, the worldwide income of a person residing in Australia is subject to tax in Australia.

Generally, the Australian laws on taxation of life assurance bonuses apply equally to Australian and overseas policies. This is so because the definition of a life assurance policy is the same as the definition of "life policy" used in the Life Insurance Act 1995.

It therefore follows that the foreign trust is an eligible policy under ITAA 1936 Section 26AH – which deals with reversionary bonuses paid on the termination of life insurance policies.

Other sections of the ITAA 1997 such as 118-300 have restricted the meaning of this to only mean that the policies must pay out on death. However 26AH has not similarly restricted the use.

The policy itself would constitute as “investment account contract” and therefore a life policy as it meets the criteria found in section 14(2) of the Life Insurance Act 1995.

- The policy provides for benefits to be paid on a specified date (s 14(2)(a)(ii))

- It also provides for benefits to be calculated by reference to a running account under the contract (section 14(2)(b)(i)).

- It also provides for the account to be increased (section 14(2)(c))

Subsection 14(3) is an exception to subsection (2) in that it states that it will not be considered an investment account contract if it provides for the account to be reduced otherwise by amount of withdrawals by the person responsible for the payment of premiums or by the amounts of charges payable under the contract. Looking at the features of the bond and the associated discounted gift trust, it is not an investment account contract.

Therefore under a strict reading of the legislation, the policy in question is considered a life insurance policy as under section 995-1 of the ITAA 1997 and therefore an eligible policy under section 26AH of the ITAA 1936.

Division 6 of the Income Tax Assessment Act 1997 (ITAA 1997) sets out what amounts are included in the taxpayer's assessable income. It provides that the following amounts are included:

● income according to ordinary concepts; that is, ordinary income (section 6-5 of the ITAA 1997), or

● an amount which is included by a specific provision about assessable income; that is, statutory income (section 6-10 of the ITAA 1997).

Taxation Ruling IT 2504 - income tax: deductibility of interest on borrowed funds - life assurance policies states that bonuses received on a policy of life assurance are not income according to ordinary concepts and therefore do not constitute assessable income.

In your case, the bonuses will not be ordinary income and they will only be included in your assessable income if they are statutory income.

Section 15-75 of the ITAA 1997 provides that assessable income includes any amount you receive as or by way of bonus on a life insurance policy, other than a reversionary bonus. A reversionary bonus is a bonus paid on maturity, forfeiture or surrender of a policy.

Section 26AH of the ITAA 1936 includes in assessable income certain reversionary bonuses received under short term life insurance policies.

You will receive a final bonus on the cashing out of the policy. The final bonus will be considered to be a reversionary bonus.

Bonuses received under a life insurance policy are not assessable under section 26AH of the ITAA 1936 if the policy was taken out after 1983 and has been held for a minimum of 10 years.

In your case, you will receive a bonus from the policy when it is cashed out and the policy has been held for more than 10 years.

Therefore, the bonus you receive will not be assessable under section 26AH of the ITAA 1936.

A capital gain or capital loss may be made if a CGT event happens to a CGT asset. An insurance policy is a CGT asset. An increase in value of an investment is not a CGT event. The surrender of a life insurance policy gives rise to a CGT event (section 104-5 of the ITAA 1997 CGT event C2).

However, section 118-300 of the ITAA 1997 provides that if a CGT event happens to a life insurance policy, any capital gain or loss made from it by the beneficial owner of the policy is ignored for CGT purposes.

There is clear ATO view contained in TD 2007/4 that the life insurance policies that fall for consideration under section 118-300 do not have the same definition as life insurance policies considered under section 995-1 ITAA 1997. Section 118-300 uses the term “a policy of insurance on the life of an individual”.

As mentioned in TD 2007/4, the EM to the New Business Tax System (Miscellaneous) Bill (No 2) 2000 noted:

The amendments ensure that…sections 118-300 and 152-20 are restricted to those policies that qualify as life insurance policies under the current law, that is, policies of insurance that are taken out on the life of an individual.

Therefore based on this ATO view, the policy in question is not considered under this section and section 118-300 does not apply to disregard the capital gain.

Division 128-15(4) of the ITAA 1997 sets out the modifications to the cost base and reduced cost base of the CGT asset in the hands of the legal personal representative or beneficiary. In your case item 3A is applicable and your capital gain is calculated as follows:

Your assessable capital gain will be the difference between the amount you receive and the cost base (as described above).

You can use the discount method to calculate your capital gain, information about the discount method can be found on our website at:

https://www.ato.gov.au/general/capital-gains-tax/working-out-your-capital-gain-or-loss/working-out-your-capital-gain/the-discount-method-of-calculating-your-capital-gain/