Explanatory Memorandum
(Circulated by the authority of the Treasurer, the Hon John Dawkins, M.P.)Deductibility of interest on borrowings to finance superannuation contributions and life insurance premiums
Summary of proposed amendments
Purpose of amendment: To ensure that an income tax deduction is not allowable for interest and other borrowing expenses incurred on loans used to finance personal superannuation contributions and certain life insurance premiums.
Date of Effect: From 19 August 1992
Allowing a deduction for interest on borrowings undertaken to finance superannuation contributions allows people to access the superannuation tax concessions without having to use their own savings. This is inconsistent with the Government's policy objective of encouraging greater savings by future retirees for their own retirement.
In addition, allowing a deduction for interest on moneys borrowed to finance personal superannuation contributions creates scope for taxpayers to obtain a tax advantage through taxation arbitrage. (This can arise where there is a difference between the tax rates applying to the deduction for interest and the assessable income earned from investing the money in the superannuation fund.)
Under the existing tax law a deduction is generally not allowable under subsection 51(1) (or any other provision) for interest on moneys borrowed to pay premiums on life insurance policies. This is because the life insurance policy is either of a private or capital nature and because the connection between the payment of interest and the possibility of earning assessable income is too remote. (Bonuses derived from such policies may only be considered to be assessable income if the policy is redeemed within 10 years). The Commissioner considers this to be the case even where the premiums paid on the life insurance policy contain an investment component. (The Commissioners views on this issue are clearly set out in Taxation Ruling No. IT 2504.)
There is an exception to this general rule that interest on moneys borrowed to pay life insurance premiums is not deductible. The exception is where a loan is used to finance premiums on a life insurance policy which does not have an investment component (ie they are pure risk policies) where the benefits of the policies would constitute assessable income. For example, employers can claim a deduction for premiums paid on (stand alone) term life insurance policies taken out on key employees; the benefits from such a policy are assessable income in the hands of the employer.
An employer may also be able to claim a deduction for the RISK COMPONENT of premiums in a "split dollar arrangement" where the proceeds of that policy would be assessable income. (The term "split dollar arrangement" is explained in the Glossary.)
Explanation of proposed amendments
The Bill proposes to insert new section 67AAA into the Act. Subsection 67AAA(1) will deny a deduction for " financing costs" (see the meaning below) in relation to superannuation contributions paid to a superannuation fund by a taxpayer for the purpose of providing superannuation benefits for the taxpayer or another person (or for the dependants of the taxpayer on the other person) unless those contributions are deductible under existing subsection 82AAC(1) of the Act.
Broadly, existing subsection 82AAC (1) allows a deduction for contributions made by a taxpayer to a superannuation fund for the purpose of providing superannuation benefits for an eligible employee or for the dependants of an eligible employee. The meaning of " eligible employee" and " dependant" is set out in the Glossary at the end of this chapter.
Essentially the amendments will deny tax deductions for personal superannuation contributions. However, employers will still be able to claim a tax deduction for contributions to a superannuation fund for their employees (including the directors of a company or the employees of a partnership).
What expenses are effected by the amendment?
This amendment only applies to a " financing cost" incurred on a loan (or any other financing arrangement) entered into after 18 August 1992 or a loan resulting from a "rollover" after 18 August 1992 of the whole or part of a previous loan.
The term " financing cost" is defined in subsection 67AAA(3) to include expenditure incurred in obtaining finance to pay superannuation contributions such as interest or a payment in the nature of interest and borrowing expenses.
A loan will be taken to be the result of a "roll over" if the loan exists on or before 18 August 1992 and it is renewed or a new loan is granted in its place after 18 August 1992.
If the period of a loan which existed prior to 19 August 1992 is extended on or after that date then any financing costs incurred in respect of the period of the loan extension are not deductible.
A self employed business woman borrows money to pay superannuation contributions for herself and her employees. The interest on this loan would only be deductible to the extent that it was incurred to fund the employee's superannuation contributions. The portion of interest which related to her personal contributions would not be an allowable deduction.
Would a contract for a loan which was made prior to 18 August 1992 be caught by these amendments if the contract contained a provision entitling the borrower to extend the loan and the borrower does so after 18 August 1992?
Once the borrower extends the loan any financing costs in relation to the extended loan will not be an allowable deduction if the loan is or has been used to pay personal superannuation contributions. This is because the loan was extended after18 August 1992.
The proposed amendment relating to life insurance premiums is intended to clarify (by legislation) the Commissioner's existing view that interest and other borrowing expenses incurred on loans used to finance premiums on life insurance policies are generally not tax deductible.
New subsection 67AAA(2) will deny a taxpayer a deduction for " financing costs" (see the meaning below) in relation to premiums for a life insurance policy unless:
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- the proceeds of the policy (when paid out) would be included in the taxpayer's assessable income; and
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- the whole of the premium received by the insurer consists of a " RISK COMPONENT" in terms of section 110 of the Act.
The whole of a premium received by the insurer will consist of a " RISK COMPONENT" where the premium is received in respect of a:
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- term insurance policy; or
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- a rider or supplementary benefit attached to another policy where the sum insured is payable on death within a specified term.
Can a premium payable on a life insurance policy which contains an investment component consist wholly of a RISK COMPONENT?
Where a life insurance policy contains an investment component the whole of the premium will not consist of a RISK COMPONENT; part of the premium will consist of an investment component (in terms of section 110 of the Act). Consequently, financing costs would not be deductible if they were incurred in relation to such a premium.
What expenses are effected by the amendment?
This amendment applies to a " financing cost" incurred on a loan (or other financing arrangement) entered into after 18 August 1992 or a loan resulting from a "rollover" after 18 August 1992 of the whole or part of a previous loan.
The term " financing cost" is defined in subsection 67AAA(3) to include expenditure incurred in obtaining finance to pay life insurance premiums such as interest or a payment in the nature of interest and borrowing expenses.
A loan will be taken to be the result of a roll over if the loan exists on or before 18 August 1992 and it is renewed or a new loan is granted in its place after 18 August 1992.
If the period of a loan which existed prior to 19 August 1992 is extended on or after that date then any financing costs incurred in respect of the period of extension are not deductible.
How does this amendment alter the existing tax law?
The proposed amendment does not alter the existing tax treatment of interest and other borrowing expenses on loans taken out to finance premiums on stand alone life insurance policies (such as term insurance policies) where the benefits are assessable income; interest and other borrowing expenses will continue to be deductible in these circumstances.
Nor does the amendment alter the existing tax treatment of other life insurance policies (other than "split dollar arrangements") such as those which contain an investment component; the finance costs associated with these policies are non-deductible under the existing tax law. The Commissioner has made this clear in Taxation Ruling No. IT 2504.
These amendments will affect the tax treatment of interest and other borrowing expenses incurred in financing "split dollar arrangements" on or after 19 August 1992. At present under a split dollar arrangement, the premiums are usually split between the employer and the employee, ie. the employer finances the RISK COMPONENT and the employee finances the investment component. Because premiums on such policies are not wholly made up of a RISK COMPONENT, neither the employer or employee will be able to claim a tax deduction under the proposed amendment.