Senate

Revised Explanatory Memorandum

(Circulated by authority of the Treasurer, the Hon Peter Costello, MP)

Chapter 2 Friendly societies

Outline of chapter

2.1 Schedule 2 to this bill amends the ITAA 1997 to defer the commencement date of the Review of Business Taxation proposals to tax friendly societies on investment income received that is attributable to funeral policies, scholarship plans and income bonds sold after 30 November 1999. Friendly societies will remain exempt from tax on that investment income until 31 December 2002.

2.2 The amendments also ensure that life insurance companies do not have to change the basis for working out the deduction for the capital component of ordinary life insurance investment policies.

Context of amendments

2.3 Under paragraph 320-35(1)(f) of the ITAA 1997, friendly societies are currently exempt from tax on:

•

all investment income received that is attributable to funeral policies, scholarship plans and income bonds issued before 1 December 1999; and

•

investment income received before 1 July 2001 that is attributable to funeral policies, scholarship plans and income bonds issued after 30 November 1999. Under the current law, friendly societies will be taxed on this income from 1 July 2001 in the same way that life insurance companies are taxed on investment income that is attributable to life insurance investment policies.

2.4 The changes to the tax treatment of investment income received by friendly societies that is attributable to funeral policies, scholarship plans and income bonds issued after 30 November 1999 is integrally linked to the Review of Business Taxation life insurance policyholder reforms. To allow further consultation with industry, those reforms have been deferred, with some modification, until 1 January 2003.

2.5 Section 320-75 allows a deduction to life insurance companies for the capital component of premiums paid in respect of ordinary life insurance investment policies. The methodology for working out the deduction depends on whether the policy is issued before or after 1 July 2001:

•

if the policy issued before 1 July 2001, the amount allowed as a deduction is the net premiums less the amount that an actuary determines to be attributable to fees and charges; or

•

if the policy issued on or after 1 July 2001, the amount allowed as a deduction is the lesser of:

-

the amount specified in the policy to be the capital component (less any adjustments for reinsurance); and

-

the net premiums less the amount that an actuary determines to be attributable to fees and charges.

2.6 Currently, the capital component of premiums is not required to be specified in life insurance policies. However, it was expected that this situation would have changed from 1 July 2001 as life insurance companies developed new policies in response to the Review of Business Taxation life insurance policyholder reforms. Due to the concerns about compliance costs, those reforms will not proceed. Therefore, life insurance companies will not have to change the basis for working out the deduction for the capital component of ordinary life insurance investment policies.

Summary of new law

2.7 Schedule 2 to this bill will amend the ITAA 1997 so that:

•

investment income that friendly societies receive that is attributable to funeral policies, scholarship plans and income bonds issued after 30 November 1999 continues to be exempt from tax until 1 January 2003; and

•

life insurance companies continue to use an actuarial basis to work out the deduction for the capital component of premiums on ordinary life insurance investment policies.

Comparison of key features of new law and current law

Detailed explanation of new law

Exempt income of friendly societies

2.8 Paragraph 320-35(1)(f) will be amended so that it exempts a life insurance company that is a friendly society from tax on:

•

amounts received on or after 1 July 2001 but before 1 January 2003 that are attributable to income bonds or funeral policies;

•

amounts received on or after 1 July 2001 but before 1 January 2003 that are attributable to scholarship plans provided that those amounts would have been exempt from tax if they had been derived before 1 July 2001 - that is, broadly, provided that the friendly society that issued the scholarship plans is a friendly society that is not carried on for profit or gain to individual members; and

•

amounts received on or after 1 January 2003 that are attributable to income bonds, funeral policies or scholarship plans issued before 1 December 1999.

[Schedule 2, item 1, subparagraphs 320-35(1)(f)(ia), (ib) and (ii)]

2.9 Amounts received before 1 July 2001 that are exempt from income tax under section 50-1 will continue to be exempt from tax under subparagraph 320-35(1)(f)(i).

Deductibility of interest credited to income bonds

2.10 Section 320-110 allows a deduction to a life insurance company that is a friendly society for interest credited to the holders of income bonds issued after 30 November 1999 where the interest accrues on or after 1 July 2001. As friendly societies will remain exempt from tax on amounts attributable to income bonds that are received before 1 January 2003, the deduction for interest credited by friendly societies to the holders of income bonds issued after 30 November 1999 will only apply where the interest accrues on or after 1 January 2003. [Schedule 2, item 4, section 320-110]

Capital component of premiums in respect of ordinary life insurance investment policies

2.11 Section 320-75 allows a deduction to life insurance companies for the capital component of premiums paid in respect of ordinary life insurance investment policies. The methodology for working out the deduction currently depends on whether the policy is issued before or after 1 July 2001.

2.12 The proposed change in methodology for working out the deduction for the capital component of premiums on ordinary life insurance investment policies was linked to the introduction of the Review of Business Taxation reforms affecting life insurance policyholders. The rationale for this link was that the policyholder reforms would have required life insurance companies to develop new products. Therefore, it was proposed to require the capital component of premiums to be specified in the policy rather than being based on an actuarial determination.

2.13 However, due to concerns about compliance costs associated with the proposed reforms, those reforms will not proceed.

2.14 Therefore, life insurance companies will continue to use an actuarial basis to work out the deduction for the capital component of premiums on ordinary life insurance investment policies. That is, the amount allowed as a deduction will continue to be the amount of net premiums less the amount that an actuary (having regard to the change over the income year in the sum of the net current termination values of the policies and the movements in those values during the year) determines to be attributable to fees and charges. [Schedule 2, items 2, 3 and 3A, section 320-75]

Application and transitional provisions

2.15 The amendments apply from 1 July 2001.