Taxation Ruling
IT 2492
Income tax : eligible annuities and eligible policies - unreasonable deferral of annuity income
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FOI status:
May be releasedFOI number: I 1010762PREAMBLE
The Taxation Laws Amendment Act 1988 (introduced as the Taxation Laws Amendment Bill (No.5) 1987) received Royal Assent on 26 April 1988. Sections 11, 17 and 18 of the Act inserted in the Income Tax Assessment Act 1936 new rules governing the availability of certain tax concessions in respect of annuities issued by life assurance companies, friendly societies, trade unions and other employee associations. The new conditions are set out in paragraph (b) of the new definition of "eligible annuity" in section 27A and in paragraph (b) of the new definitions of "eligible policy" in sections 110 and 116E of Divisions 8 and 8A respectively. An annuity purchased after 12 January 1987 with an eligible termination payment (ETP) must satisfy the "eligible annuity" tests if the purchase is to qualify as a roll-over payment, so that the tax on the ETP is deferred and the income of the annuity issuer derived from that annuity business is either exempt from tax (if derived from immediate annuity business or derived before 1 July 1988 from deferred annuity business) or taxed at a concessional rate (income derived after 30 June 1988 from deferred annuity business). Immediate annuities purchased after 9 December 1987 other than with a rolled-over ETP must meet the similar tests in the definition of "eligible policy" if the earnings derived by annuity issuers from such business are to be exempt from tax.
2. One of the new conditions is that the Commissioner of Taxation must be satisfied that annuity payments made under the annuity contract will not be unreasonably deferred, having regard to the matters specified in subparagraph (b)(v) of the definition of "eligible annuity" and subparagraph (b)(vi) of the definitions of "eligible policy." At pages 11, 12, 36 and 37 of the explanatory memorandum circulated on introduction of the Bill, substantial guidance was given as to the expected operation of these provisions and the policy underlying their insertion in the law. The purpose of this ruling is to give further guidance on the way in which the discretion will be exercised and on other aspects of the new definitions.
RULING
Guaranteed component of annuity payments
3. The new definitions clearly envisage that annuity payments may consist of both guaranteed components (where the amount is independent of actual performance or profits - sub-subparagraph (B) of subparagraphs (b)(v) and (b)(vi) respectively) and bonus components (sub-subparagraph (A) of those subparagraphs). The definitions also envisage that the relationship between guaranteed components of different years' annuity payments is to be controlled. The definitions do not, however, specify what the absolute size of a guaranteed component is to be, nor that there is to be any control over the relative sizes of the guaranteed and bonus components of a particular annuity payment. It is relevant to the last point, however, that Taxation Ruling IT 2480 contains guidance as to what is an acceptable proportion of guaranteed component in annuity payments. It will also be clear from paragraphs 5 and 6 below that, the smaller the guaranteed component and the greater the rate at which it is indexed, the greater will be the proportion of a bonus declaration that has to be paid out within the year following declaration.
4. The size of a guaranteed component of an annuity payment will be ascertainable from the terms of the annuity contract and without reference to the issuer's investment performance or profits. The component could be a fixed dollar amount or an amount that is calculated by applying to a dollar amount fixed for the first year a rate of increase that is described with certainty in the contract - e.g., a fixed rate (say, 5% p.a.) or a rate equal to the rate of increase in the consumer price index from time to time. If a fixed rate is written into the contract it should not exceed the average rate of increase for the previous three years in the All Groups Consumer Price Index, being the weighted average of the 8 capital cities, published by the Australian Statistician.
Bonus component of annuity payments
5. The explanatory memorandum made the following points about bonus components of annuity payments (sub-subparagraph (A) of subparagraphs (b)(v) and (b)(vi) respectively of the definitions of "eligible annuity" and "eligible policy") :
- (a)
- the size of bonuses should bear a consistent relationship to the income out of which they are paid;
- (b)
- bonuses should be declared annually (assuming the contract provides for them to be paid); and
- (c)
- a bonus should normally be paid within the year following its declaration.
6. Points (a) and (b) in paragraph 5 above are, of course, subject to the usual right of insurers to set aside reasonable reserves to meet their fixed obligations. Point (c) is not taken to mean that a bonus, once declared, must always be paid within the following year. For example, if the guaranteed component was not indexed, or was indexed at a low rate, it would be acceptable for a bonus to be distributed over the remaining term of the annuity to such an extent that the revised stream of guaranteed components did not increase in any year at a rate greater than the 3-year average rate of CPI increase (calculated, at the time of declaration, as in paragraph 4 above). Once the revised profile of guaranteed payments reached that limit, future bonuses would have to be paid within the year following declaration of the bonus.
"Such other matters as the Commissioner considers relevant"
7. It was explained at page 37 of the explanatory memorandum that one of the matters that would be relevant for the purposes of sub-subparagraph (C) of subparagraphs (b)(v) and (b)(vi) respectively of the new definitions would be whether the term of an annuity was excessive. Any fixed or guaranteed minimum term for which an annuity is payable should not exceed the period equal to the life expectancy of the annuitant at the annuitant's last birthday, ascertained by reference to the most recent version of the Australian Life Tables published by the Australian Government Actuary at the time when the annuity commences to be payable (currently the Australian Life Tables 1980-82). The life expectancy may be rounded up to the next whole number. Where the annuity is payable to a husband and wife jointly (not relevant for a rollover annuity) the longer of the two life expectancies may form the basis of the fixed term. The same applies where an annuitant's spouse is nominated as the reversionary annuitant (applicable to both rollover and non-rollover annuities).
8. The restriction described in paragraph 7 does not apply if the guaranteed annuity payments are not increasing or indexed and the annuity contract does not provide for bonus payments or otherwise for participation in profits or surpluses.
Commutation payment limits / "final" annuity payment
9. Subparagraphs (b)(iii) and (iv) of the new definition of "eligible annuity" and subparagraphs (b)(iv) and (v) of the new definitions of "eligible policy" limit the size of commutation payments permitted under annuity contracts to the "reduced purchase price" (a term that is defined in section 27A). The effect of the restriction in the case of indexed annuities is to prevent concessionally taxed earnings of the annuity issuer, set aside within the law to meet future guaranteed payments, from being passed on to the annuitant as a concessionally taxed ETP on early termination of the contract. This constraint, however, does not prevent the parties to an annuity contract agreeing that the full "capital value" of the annuity is payable in the event of commutation, the accrued income component being payable as a final (or supplementary) annuity payment that is taxable at marginal income tax rates. In other words, the amendments do not affect the size of the total payments that can be made on commutation.
Eligible annuities - income accretion and commutation before age 65
10. The constraints on deferral of annuity income and size of commutation payments that this ruling has dealt with do not apply for the purposes of the "eligible annuity" definition in respect of the period prior to the 65th anniversary of the annuitant's birth. Annuities purchased with rolled-over ETPs can therefore defer annuity payments until after that date and provide on commutation before that date for the full "capital value" to be paid as a commutation payment.
11. If a deferred annuity purchased with a rolled-over ETP is not commuted prior to age 65 it will, from that date, have to satisfy paragraphs 3 to 9 of this ruling. Paragraphs 5 and 6, however, would apply only to bonuses declared after age 65. It follows that income (that is, bonuses) accrued prior to that date may be paid as guaranteed components spread over the remaining term of the annuity, subject to the requirements of paragraph 4. In this regard, the reference to "purchase price" in subparagraph (b)(ii) of the definition of "eligible annuity" is a reference to the original purchase price of the annuity and not to the capital value of the annuity at age 65. It will need to be made clear in the contract in these cases that subparagraph (b)(v) of the new definition of "eligible annuity" will be satisfied during the period after the age of 65 is reached.
COMMISSIONER OF TAXATION
28 July 1988