Foreign investment funds guide

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Chapter 5: Foreign life assurance policies

This chapter explains the application of the FIF measures to taxpayers who have an interest in a FLP. It explains:

• what a FLP is
• when a taxpayer is considered to have an interest in a FLP
• the period where the interest in the FLP is taxable
• what a FLP's notional accounting period is, and
• the two methods of taxation that are used to determine FIF income in relation to an interest in a FLP.

Meaning of a FLP

Your FLP for an income year is a life assurance policy issued by an entity that was not a resident at any time in that income year.

A life assurance policy is one that provides for the payment of benefits:

• upon death, other than death by accident or specified sickness only, or
• on the happening of a specified event which relates to the ending or continuing of a human life.

A life assurance policy also includes an instrument that grants an annuity for a term dependent upon a human life. [subsection 482(2)]

The FIF measures do not apply to the following four categories of life policies:

• an Australian policy, provided that the entity which issued the policy was authorised under the Life Insurance Act 1995 to carry on life insurance business in Australia when it issued the policy
• policies that provide for payment of benefits only on death, or on death or permanent disability, and for which the premiums or premium instalments are calculated solely by reference to the period for which the life concerned is expected to continue, or within which the life concerned is expected to terminate
• policies issued before 1   July 1992 that cannot, after that date, be cancelled, surrendered or redeemed and for which the terms have not, after that date, been materially altered, or
• a contract of reinsurance between a resident insurer and a non-resident reinsurer for life assurance policies that provide only life cover. [paragraphs 482(2)(e) and (f)]

You have an interest in a FLP if you have legal title to the FLP. [subsection 483(3)]

Interest in a FLP subject to taxation

Your assessable income for an income year includes FIF income if:

• you had an interest in a FLP at any time during the FLP's notional accounting period that ends in your income year, and
• you were a resident of Australia at any time in that income year. [subsection 485(4)]

Notional accounting period of a FLP

The FIF income that is included in your assessable income is calculated for a 'notional accounting period' of the FLP.

A notional accounting period of your FLP will generally coincide with your income year - that is, a 12-month period ending 30   June each year.

If the FLP existed before 1   January 1993, the first notional accounting period of the FLP commences on 1   January 1993 and ends on 30   June 1993. If the policy came into existence on or after 1   January 1993, the first notional accounting period commences on the day that it came into existence and ends on the following 30   June. [subsection 487(7)]

Electing a notional accounting period

You may elect a different notional accounting period if a cash surrender value of your FLP is available on a day in the same month of each calendar year ('the relevant day'). This election is irrevocable for as long as you hold an interest in that particular FLP.

If you elect a different notional accounting period, your FLP's new notional accounting period will begin on the first day of the month following the last day of the month in which the relevant day occurs, and ends at the end of the month in which the next relevant day occurs.

Example: Election of notional accounting period for a FLP

The current notional accounting period of Judith's FLP is 1   July to 30   June each year. In November of each year a cash surrender value becomes available for her FLP. In September 2006 she elected to use a different notional accounting period for her FLP. The new notional accounting period will begin on the first day of the month following November - that is, 1   December - and end 12 months later on 30   November each year.

However, the first new notional accounting period of Judith's FLP did not begin in the December following the election (December 2006) but in the December before the election was made (December 2005). Therefore, the first new notional accounting period for Judith's FLP was 1   December 2005 to 30   November 2006.

The months between the start of her old notional accounting period (1   July 2005) and the start of her new notional accounting period (1   December 2005) are also a notional accounting period - that is, 1   July 2005 to 30   November 2005. [section 487]

Judith's FIF income for the period 1   July 2005 to 30   November 2005 was returned in the 2005-06 income year. Her FIF income for the period 1   December 2005 to 30   November 2006 was included in the 2006-07 income year.

Methods of taxation applicable to FLPs

You must work out FIF income for an interest in a FLP using either:

• the deemed rate of return method, or
• the cash surrender value method.

Choosing the taxation method

The deemed rate of return method is applied to your interest in a FLP unless you elect to use the cash surrender value method. [subsections 536(1) and (2)]

If you elect to use the cash surrender value method, you must also elect to use a notional accounting period for the FLP that coincides with the period for which the cash surrender values are available. [section 487 and subsection 536(3)]

An election to apply the cash surrender value method is irrevocable. [subsections 487(3) and 536(5)]

Deemed rate of return method

The deemed rate of return method for FLPs is similar to the deemed rate of return method for FIFs. Four steps are used to work out your FIF income.

The following information will help you to complete Worksheet 4: Deemed rate of return method for FLPs .

Step 1: Interests in a FLP

Determine whether you have one or more interests in the FLP during a notional accounting period.

If you acquired interests in the same FLP at different times during a notional accounting period, you must apply the deemed rate of return method separately for each interest for the period from when you acquired it. [section 585]

Step 2: Working out the opening value

Box   A

This step decides the opening value of the FLP.

If you had the interest in the FLP at the beginning of a notional accounting period, the opening value is the value on the day before the first day of the period.

Opening value where the deemed rate of return method has been applied in the previous year

If you used the deemed rate of return method in the immediately preceding notional accounting period, work out the opening value as follows.

• Determine the deemed value of the FLP at the commencement of the preceding notional accounting period.
• Add the FIF income of the FLP for its preceding notional accounting period.
• Add the value of any premiums paid during the preceding notional accounting period.
• Take away any distributions the FLP made in the preceding notional accounting period. [sections 586 and 590].

Opening value where the interest is acquired during the notional accounting period

If you acquired the interest in the FLP during a notional accounting period, the opening value is its cost if you paid the full consideration. In any other case, the opening value is the amount of the first premium paid. [paragraph 586(b) and section 591]

Note: There are also special rules when reverting to the deemed rate of return method following the application of the cash surrender method. [subsections 536(8) to (9)]

Step 3: Working out the movement in the value of the FLP

Box   C

Once you have determined the opening deemed value, work out the FIF amount - that is, the movement in the value of the FLP - by applying the following formula. [section 592]

opening value

X

deemed rate of return

X

number of days held                     365

Opening value is the amount determined in step   2.

Deemed rate of return is the 'base interest rate' plus 4%.

The base interest rate is the monthly average yield of the 90-day bank accepted bill rate [subsection 8AAD(2) of the Taxation Administration Act 1953 ]. The interest rate is published by the Reserve Bank of Australia every quarter. If two or more rates apply in the relevant income year, use the weighted average of those rates.

Number of days held is the number of days in the notional accounting period in which you had the interests in the FLP.

Step 4: Working out the amount to include in assessable income

Box   D

The final step in applying the deemed rate of return method is to convert the FIF amount to Australian currency.

Use the rate of exchange that applied at the end of the notional accounting period to convert each FIF amount at   C to FIF income in Australian currency. [sections 593 and 594]

The FIF income at F is included in your assessable income, subject to reduction by certain assessable distributions from the FLP. Chapter 6: Avoiding double taxation has more information.

Example: Use of the deemed rate of return method for FIF income from a FLP

Lal acquires a FLP on 1   January 2003 for HK$250,000.

For the first year, under the deemed rate of return method, he multiplies the opening value by the deemed rate of return as follows:

HK$250,000 x 8.79%* x (181/365)

FIF income = HK$10,897

Lal includes the FIF income in his assessable income after converting it to Australian dollars using the exchange rate applicable on 30   June.

* 8.79% = weighted average of two quarterly rates

[(8.84 x 90/181) + (8.75 x 91/181)]

Cash surrender value method

Overview

The cash surrender value method of working out FIF income applies only to FLPs.

This method decides whether any FIF income accrues to you from an interest in a FLP by taking into account changes in the cash surrender value of your interest in the FLP over a 12-month period.

Under the cash surrender value method, the amount of the FIF income is calculated in two steps:

1. The first step works out the movement in the cash surrender value of the FLP, generally between two annual reporting dates.
2. The second step allows an adjustment for losses of prior years.

The result of these calculations is the amount of foreign investment fund income that you must include in your assessable income.

The following information will help you to complete Worksheet 5: Cash surrender value method for FLPs.

Step 1: Working out the movement in the cash surrender value

The movement in the cash surrender value of your interests in the FLP which have a cash surrender value at the end of the notional accounting period is worked out as follows. [subsection 596(2)]

Use the same currency at B to G as you use for the cash surrender value at A . [subsection 596(3)]

Box A

Write the cash surrender value of your interests in the FLP on the last day of the notional accounting period at A .

Box B

Write the value of distributions the FLP made to you during the notional accounting period for those interests held on the last day of the notional accounting period at B .

Boxes C and D

If you disposed of an interest in the FLP during the notional accounting period, write:

• the value of distributions the FLP made to you for that disposed interest at C , and
• the amount you received for the disposal at D .

Box E

Insert the opening cash surrender value of the interest at the commencement of the notional accounting period.

If you used the deemed rate of return method for the same interest in the immediately preceding notional accounting period, use the value determined by that method for the last day of that period.

Box F

Insert the amount you paid or gave in respect of contributions to the interest in the FLP during the notional accounting period.

Box G

Subtract the sum of E and F from the sum of A to D . This gives you the FIF amount.

• Gross FIF income

If the FIF amount is positive, it is your gross FIF income from the FLP. [section 598]

• FIF loss

If the FIF amount is negative, a FIF loss has occurred. In certain circumstances, you may use this FIF loss to offset your assessable income in later income years. See Chapter 6: Avoiding double taxation . [sections 533 and 599]

Step 2: Working out the amount to include in assessable income

In this step you calculate the amount of FIF income by subtracting the total of any 'unapplied previous FIF losses' from the gross FIF income calculated in step   1. [section 600]

Unapplied previous FIF losses

An unapplied previous FIF loss represents an amount equal to the losses you have incurred from the FLP for previous notional accounting periods that exceed the gross FIF income from the FLP for those periods.

When working out the unapplied previous FIF losses, the undeducted amount of a FIF loss is that part of a FIF loss that has not been allowed as a deduction from your assessable income in a previous income year. [subsection 600(6)]

If, for a particular notional accounting period, you are entitled to an exemption for a FLP interest of $50,000 or less, the loss must be reduced by the gross FIF income calculated as if the exemption did not apply for that particular notional accounting period. [subsection 600(5)]

Once you have used a FIF loss to work out if there was, for any notional accounting period, an unapplied previous FIF loss, you cannot use that loss again in later notional accounting periods. [subsection 600(7)]

Also, in determining the gross FIF income to use to work out the unapplied previous FIF losses, apply only that gross FIF income accruing after the notional accounting period in which you incurred the loss and before the current notional accounting period in which you have a gross FIF income. [subsection 600(5)]

Box H

Insert the total of any unapplied previous FIF losses for your FLP. [subsection 600(2)]

If it is not already the case, use the exchange rate that applied at the end of the notional accounting period to convert the unapplied previous FIF loss to the same currency as the gross FIF income at G. [subsection 600(8)]

Box I

Subtract the amount at H from the amount at G . This will give you your FIF income.

Box J

Convert your FIF income to Australian dollars at the exchange rate that applied at the end of the relevant notional accounting period. Insert the converted amount at J. [subsections 600 (3) & (4)]

The amount at J is your FIF income. Include it in your assessable income after allowing for a reduction for certain assessable distributions from the FLP. Read chapter 6 for more information.

Boxes K, L and M

If any of the distributions referred to at B , C and D above are payments made by the entity which issued the FLP to you, use K , L and M to arrive at the amount to include in your assessable income.

You must read chapter 6 because the reduction of your FIF income cannot be more than the total of your FIF income for the current income year. [sections 530 and 603]

Example: Increase in cash surrender value

The opening cash surrender value of an interest in a FLP at 1   July was HK$50,000   ( E ).

At the end of the notional accounting period, 30   June, the closing value of the interest was HK$53,000   ( A ).

There were no brought forward losses and no acquisitions, disposals or distributions ( B , C , D and F ) during the notional accounting period.

The increase in cash surrender value, the FIF amount, is HK$3,000, worked out as follows:

[HK$53,000 ( A ) + nil ( B ) + nil ( C ) + nil ( D )] - [HK$50,000 ( E ) - nil ( F ) = HK$3,000 ( G )]

ATO references:
NO NAT 2130