House of Representatives

Explanatory Memorandum

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

Chapter 6 - Demutualisation of friendly societies

Outline of chapter

6.1 Schedule 6 to this bill amends the ITAA 1936 to ensure that mutual friendly societies that are life insurance companies can benefit from the taxation framework that applies to other mutual life insurance companies that demutualise.

Context of amendments

6.2 Division 9AA of Part III of the ITAA 1936 provides a taxation framework for mutual insurance companies that demutualise. That taxation framework, among other things:

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ensures that any capital gain or capital loss that arises from a CGT event that happens to members who exchange membership rights in a demutualising entity for shares in the demutualised entity (demutualisation shares) is disregarded so that no CGT liability arises until a subsequent CGT event happens to the demutualisation shares; and

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establishes a cost base for the demutualisation shares for CGT purposes that broadly reflects the market value of the demutualisation shares.

6.3 Some mutual friendly societies that qualify as life insurance companies have restructured by demutualising. However, due to technicalities in the law, the taxation framework under Division 9AA does not apply to those friendly societies.

6.4 The proposed amendments will ensure that members of friendly societies that are life insurance companies which restructure by demutualising receive the same taxation benefits as members of other life insurance companies which restructure by demutualising.

Summary of new law

6.5 The amendments will modify the definition of a mutual insurance company under subsection 121AB(1) so that it includes a mutual friendly society that qualifies as a life insurance company.

6.6 This will ensure that mutual friendly societies that are life insurance companies can benefit from the taxation framework that applies to other mutual life insurance companies which demutualise.

6.7 Therefore, if a mutual friendly society that is a life insurance company demutualises:

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any capital gain or capital loss arising from a CGT event that happens to members who receive demutualisation shares in exchange for giving up membership rights in the demutualising friendly society will be disregarded;

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no CGT liability will arise for those members until a subsequent CGT event happens to the demutualisation shares; and

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those members will receive an enhanced cost base for the demutualisation shares for CGT purposes that broadly reflects the market value of the demutualisation shares.

Detailed explanation of new law

6.8 The taxation framework contained in Division 9AA applies to a company that is a mutual insurance company as defined in subsection 121AB(1).

6.9 The definition of a mutual insurance company in subsection 121AB(1) will be modified so that it includes an insurance company that:

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was a friendly society as at 7.30 pm (by legal time in the Australian Capital Territory) on 9 May 1995;

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was an insurance company on 1 July 1999; and

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does not have capital divided into shares.

[Schedule 6, items 1 and 2, paragraph 121AB(1)(c)]

6.10 A friendly society will be a mutual insurance company that qualifies for the Division 9AA taxation framework if it satisfies each of the three conditions.

The first condition - the friendly society must have been a friendly society on 9 May 1995

6.11 The first condition that a friendly society must satisfy to be a mutual insurance company is that it must have been a friendly society as at 7.30 pm (by legal time in the Australian Capital Territory) on 9 May 1995. [Schedule 6, item 2, subparagraph 121AB(1)(c)(i)]

6.12 This condition ensures that the application of Division 9AA to mutual friendly societies that carry on life insurance business is consistent with its application to other mutual insurance companies.

6.13 In this regard, Division 9AA applies to mutual insurance companies that existed at 7.30 pm (by legal time in the Australian Capital Territory) on 9 May 1995. The Division defines an insurance company to mean a life insurance company or a general insurance company. A life insurance company is defined to mean a company registered under the Life Insurance Act.

6.14 Friendly societies that carry on life insurance business did not satisfy the definition of a life insurance company in 1995 because, at that time, they were not required to be registered under the Life Insurance Act. Rather, they were regulated under State and Territory legislation.

The second condition - the friendly society must be an insurance company

6.15 The second condition that a friendly society must satisfy to be a mutual insurance company is that:

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it must have been registered under the Life Insurance Act (and therefore was an insurance company) as at 1 July 1999 [Schedule 6, item 2, subparagraph 121AB(1)(c)(ii)] ; and

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it must be registered under the Life Insurance Act (and therefore is an insurance company) at the time of demutualisation (subsection 121AB(1)).

6.16 In this regard, the Financial Sector Reform (Amendments and Transitional Provisions) Act (No. 1) 1999 brought friendly societies that carry on life insurance business within the regulatory regime that applies to other life insurance companies. Consequently, friendly societies that carry on life insurance business have been registered under the Life Insurance Act since 1 July 1999.

The third condition - the friendly society must not have capital divided into shares

6.17 A mutual friendly society that restructures by demutualising does not lose its status as a friendly society. Therefore, the third condition that a friendly society must satisfy to be a mutual insurance company is that, immediately before the time of the demutualisation, it must not have capital divided into shares. [Schedule 6, item 2, subparagraph 121AB(1)(c)(iii)]

6.18 This condition will distinguish mutual friendly societies from non-mutual friendly societies for the purposes of Division 9AA.

Application and transitional provisions

6.19 The amendments discussed in this chapter will commence on 1 July 2000. [Subclause 2(1), item 3 in the table]

6.20 This will ensure that the Division 9AA taxation framework will apply to mutual friendly societies that have already demutualised. Consequently:

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any capital gain or capital loss arising from a CGT event that happened to members who received demutualisation shares in the exchange for giving up membership rights in those friendly societies that have demutualised will be disregarded;

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no CGT liability will arise for those members until a subsequent CGT event happens to the demutualisation shares; and

those members will receive an enhanced cost base for the demutualisation shares for CGT purposes that broadly reflects the market value of the demutualisation shares.