Senate

Revised Explanatory Memorandum

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

Glossary

The following abbreviations and acronyms are used throughout this explanatory memorandum.

General outline and financial impact

Supplies in return for rights to develop land

Part 1 of Schedule 1 to this bill amends the GST Act to:

•

treat a supply, by an Australian government agency, of a right to develop land as not being consideration for another supply (commonly referred to as an in kind developer contribution) where the other supply complies with requirements imposed by or under an Australian law; and

•

treat the supply, by an Australian government agency, of a right to develop land as a supply that is not made for consideration to the extent it is made in return for another supply (of an in kind developer contribution) that complies with requirements imposed by or under an Australian law.

Date of effect: The amendments apply, and are taken to have applied, in relation to net amounts for tax periods starting on or after 1 July 2000.

Proposal announced: Not previously announced.

Financial impact: Negligible.

Compliance cost impact: Reduction in compliance costs.

Special transitional credits for rental cars

Part 2 of Schedule 1 to this bill amends the GST Transition Act to provide a special one-off credit to businesses that held rental cars on 1 July 2000.

Date of effect: Royal Assent.

Proposal announced: Not previously announced.

Financial impact: $36 million over 2 years. This estimate takes into account the fact that the credit will be subject to income tax.

Compliance cost impact: Minimal.

Summary of regulation impact statement

Regulation impact on business

Impact: The amendment is expected to marginally increase compliance costs for those rental car businesses that choose to claim the special credit. However as a one-off transitional credit the impact is limited.

Main points:

•

Rental car businesses will be required to determine the sale price on the disposal of rental cars that were held at the start of 1 July 2000.

•

Lessees will be required to obtain this information from their lessors. There was consultation with both large and small rental car businesses in determining the calculation method for this special credit.

Income tax-related transactions

Part 3 of Schedule 1 to this bill amends the GST Act to ensure that the following transfers are not subject to GST. Transfers of:

•

tax losses under Subdivision 170-A of the ITAA 1997;

•

net capital losses under Subdivision 170-B of the ITAA 1997; or

•

foreign tax credits under section 160AFE of the ITAA 1936.

Date of effect: The amendments apply, and are taken to have applied, in relation to net amounts for tax periods starting (or that started) on or after 1 July 2000.

Proposal announced: Not announced.

Financial impact: Negligible.

Compliance cost impact: Nil.

General insurance

Schedule 2 to this bill amends the ITAA 1936 affecting general insurance companies to ensure that:

•

the provision for outstanding claims is worked out on a present value basis; and

•

gross premium income is included in assessable income in the year it is received or receivable and net premium income that relates to risk exposure in subsequent years is appropriately deferred.

This Schedule also amends the ITAA 1936 to ensure that the provision for outstanding claims of self insurers in respect of workers' compensation liabilities is taxed consistently with the provision for outstanding claims of general insurance companies.

Date of effect: The amendments relating to the provision for outstanding claims apply to the general insurance activities of general insurance companies from the 1991-1992 income year, the reinsurance activities of general insurance companies from the 1995-1996 income year and to self insurers from the 1996-1997 income year. The amendments relating to the basis of apportioning premium income of general insurance companies apply from the 1999-2000 income year.

Proposal announced: The amendments relating to the provision for outstanding claims were announced in the former Assistant Treasurer's Press Release No. 7 of 18 February 2000. The amendments relating to the basis of apportioning premium income have not previously been announced.

Financial impact: Nil. However, the amendments confirm a long standing view of the law and protect the revenue that otherwise would be at risk.

Compliance cost impact: Nil.

Intercorporate dividend rebate

Schedule 3 to this bill amends subsection 46F(3) of the ITAA 1936 to broaden the eligibility criteria for accessing the ICDR for unfranked dividends paid between members of the same wholly-owned group.

The proposed amendment broadens the current eligibility requirement, which is restricted to a whole of year requirement, to include a rule based on the company paying the dividend and the company receiving it being part of the same wholly-owned group at all times during the period of 12 months ending on the day on which the dividend was paid.

Date of effect: The amendment applies to dividends paid on or after 1 July 2000.

Proposal announced: Minister for Revenue and Assistant Treasurer's Press Release No. C11/02 of 1 March 2002.

Financial impact: The proposed amendment produces a small unquantifiable cost.

Compliance cost impact: The proposed amendment is not expected to impose any significant compliance burden on companies affected by the measure.

Chapter 1 - Supplies in return for rights to develop land

Outline of chapter

1.1 Schedule 1 to this bill amends the GST Act, so that GST does not apply to a supply made in return for a supply, by an Australian government agency, of a right to develop land. GST will also not apply to the corresponding supply of the right to develop land.

Context of amendments

1.2 Local authorities and other government agencies often require entities, such as land developers, to supply them or a third party, assets, real property and/or services in return for the granting of a right to develop land. In this context, the supply made by a developer will be referred to as the supply of an in kind developer contribution.

1.3 Currently, where both parties are registered or required to be registered for GST, the transaction can involve 2 taxable supplies, with both parties required to remit GST.

1.4 Representatives of organisations involved in land development have advised that a number of issues arise from the current treatment of an in kind developer contribution as a taxable supply. For instance, in some circumstances there are significant timing differences that can arise between the time an entity incurs a GST liability on a supply, and the time it is entitled to claim an input tax credit in relation to any corresponding acquisition from the other party to the transaction. There are also practical problems arising from the need to value the consideration received for the supply of an in kind developer contribution. Further, no entity may be entitled to claim an input tax credit where an in kind developer contribution is supplied to a third party in return for the supply by a government agency of a right to develop land.

1.5 In addition, developers may, where possible, be inclined to make a cash payment, and thereby not incur a GST liability, in return for the right to develop land, instead of contributing capital infrastructure that would otherwise have to be provided by government agencies in relation to a development.

Summary of new law

1.6 This bill will amend the GST Act to ensure that:

•

a supply, by an Australian government agency, of a right to develop land, is not treated as consideration for the supply of an in kind developer contribution, if the supply of the in kind developer contribution complies with requirements imposed by, or under, an Australian law. Therefore, the supply of an in kind developer contribution will not be a taxable supply; and

•

a supply, by an Australian government agency, of a right to develop land, is treated as a supply that is not made for consideration to the extent it is made in return for the supply of an in kind developer contribution that complies with requirements imposed by, or under, an Australian law. Therefore, the supply of the right to develop land will not be a taxable supply.

Detailed explanation of new law

1.7 Division 82 is inserted into the GST Act. This Division ensures that GST does not apply to either a supply of an in kind developer contribution, or to the supply by an Australian government agency of a right to develop land that is supplied in return for a supply of an in kind developer contribution. [Schedule 1, item 4, section 82-1]

1.8 Subsection 82-5(1) ensures that the supply, by an Australian government agency, of a right to develop land is not treated as consideration for the supply of an in kind developer contribution, if the supply of the in kind developer contribution complies with requirements imposed by, or under, an Australian law. As noted in paragraph 1.2, the supply can be of anything, such as assets, real property and or services. [Schedule 1, item 4, subsection 82-5(1)]

1.9 Where subsection 82-5(1) applies, a supply of an in kind developer contribution will be a supply that is made for no consideration. Therefore, the supply will not be a taxable supply as defined in section 9-5 of the GST Act.

1.10 Australian government agency and Australian law have the meaning given to those terms as currently contained in section 195-1 of the GST Act.

1.11 Subsection 82-5(2) ensures that the supply of a right to develop land will not be consideration for a supply of an in kind developer contribution, even though the in kind developer contribution is made to an entity other than the Australian government agency that provides the right to develop land. For example, where a developer, in order to obtain a right to develop land from a local council, makes a supply of capital works to a Statutory Authority, the supply of the right will not constitute consideration for the supply of works made by the developer. [Schedule 1, item 4, subsection 82-5(2)]

1.12 Subsection 82-5(3) ensures that section 9-15 of the GST Act will not apply to treat as consideration, the supply of a right to develop land made by an Australian government agency in the circumstances to which subsections 82-5(1) and (2) apply. [Schedule 1, item 4, subsection 82-5(3)]

Example 1.1

Rushmore Council is an Australian government agency. It provides planning approval in the form of a right to develop land under a State Planning Act. The State Planning Act allows Rushmore Council to require developers to provide capital works either to itself, or to another party, in return for the provision of a right to develop land.

Yellow P/L, a local land developer, is provided by Rushmore Council with a right to develop land. Yellow P/L is required to supply to Rushmore Council capital works in relation to the completed development. The supply of the capital works constitutes a supply of an in kind developer contribution.

The supply, by Rushmore Council, of the right to develop land will not constitute consideration for the supply made by Yellow P/L of the capital works. Therefore, Yellow P/L has not made a taxable supply of the capital works to Rushmore Council.

1.13 Subsection 82-10(1) ensures that the supply, by an Australian government agency, of a right to develop land is treated as a supply that is not made for consideration to the extent it is made in return for the supply of an in kind developer contribution that complies with requirements imposed by, or under, an Australian law. [Schedule 1, item 4, subsection 82-10(1)]

1.14 Subsection 82-10(2) ensures that the supply of the right to develop land is treated as a supply that is not made for consideration where the recipient, in order to obtain the right, makes a supply of an in kind developer contribution to a third party. [Schedule 1, item 4, subsection 82-10(2)]

1.15 Where subsections 82-10(1) and (2) apply, a supply by an Australian government agency of a right to develop land is a supply that is made for no consideration, and therefore, the supply will not be a taxable supply as defined in section 9-5 of the GST Act.

1.16 In the term 'right to develop land', land has its common law meaning. The supply of a right to develop land includes, by way of example, approval by an Australian government agency for such things as:

•

a re-configuration with no change in use (subdivision);

•

no re-configuration, but a material change in use (rezoning);

•

re-configuration with use as a right (permitted subdivision); and

•

re-configuration with change in use (subdivision and rezoning).

1.17 The supply, by an Australian government agency, of a right to develop land is made in return for a supply of an in kind developer contribution, even though the right is supplied upon the condition that the recipient has obtained agreement in relation to the proposed development from another entity, such as another government agency. For example, where a local council supplies a right to develop land to a developer upon condition that the developer has obtained agreement in relation to the proposed development from a Statutory Water Authority.

1.18 Under subsection 81-5(1) of the GST Act, the payment of any Australian tax, fee or charge is treated as consideration provided to an Australian government agency to which the tax, fee or charge is payable, for a supply that the agency makes to the payer. The supply, of an in kind developer contribution, made to an Australian government agency in return for the right to develop land, may constitute the payment of an Australian tax, fee or charge. Thus, the supply of a right to develop land may be a taxable supply. Subsection 82-10(3) ensures that if the supply of an in kind developer contribution is a payment of an Australian tax, fee or charge, subsection 82-10(1), and not subsection 81-5(1), applies to the payment. That is, the supply of a right to develop land is not a taxable supply. [Schedule 1, item 4, subsection 82-10(3)]

1.19 Subsection 82-10(4) ensures that section 9-15 of the GST Act, will not apply to treat as consideration, anything supplied to an Australian government agency, in return for a right to develop land in the circumstances to which subsections 82-10(1) and (2) apply. [Schedule 1, item 4, subsection 82-10(4)]

Example 1.2

Assume the same facts as set out in Example 1.1.

Rushmore Council's supply of a right to develop land to Yellow P/L, will be a supply that is not made for consideration, and therefore, will not be a taxable supply.

This will be the case, even if the supply of capital works made by Yellow P/L to Rushmore Council constitutes the payment of an Australian tax, fee or charge imposed by Rushmore Council under the State Planning Act, in relation to the provision of the right to develop land.

1.20 Item 9A is inserted into the table in section 9-39, which is about special rules relating to taxable supplies, while item 30A is inserted into the table in section 37-1, which is a check list of special rules, in recognition of the insertion of Division 82 into the GST Act. [Schedule 1, items 1 and 2]

1.21 A new note is placed at the end of subsection 81-5(1), which is about the treatment of a payment of an Australian tax, fee or charge to an Australian government agency, to provide guidance as to the existence of Division 82. [Schedule 1, item 3]

Application and transitional provisions

1.22 The amendments apply, and are taken to have applied, in relation to net amounts for tax periods starting, or that started, on or after 1 July 2000. [Schedule 1, item 6]

Chapter 2 - Special transitional credits for rental cars

Outline of chapter

2.1 Part 2 of Schedule 1 to this bill amends the GST Transition Act to provide a special one-off input tax credit to businesses that held rental cars on 1 July 2000.

Context of amendments

2.2 Rental car businesses rent out cars on a short term basis and usually hold their cars for a period not exceeding 18 months. The introduction of the GST resulted in these businesses:

•

paying both sales tax on the purchase of the vehicle and GST on the sale of the vehicle; and

•

being denied GST input tax credits until 23 May 2001 on the purchase of new replacement vehicles.

2.3 The introduction of the GST resulted in a reduction in car prices and consequently the value of cars held by rental car businesses. Rental cars constitute a high proportion of the asset base for a rental car business and as these rental cars are turned over in a very short time frame the rental car businesses were forced to absorb the losses in a short time period. These car rental businesses were not able to pass on all of their costs to consumers. For those businesses that leased their cars the credit will still be available to them as the increased costs were also borne by rental car businesses. This special input tax credit will provide some transitional relief for rental car businesses.

Summary of new law

2.4 The amendment will allow a special input tax credit to an entity that in the course of carrying on an enterprise holds cars for the purposes of rental.

2.5 This provision will apply to businesses that own, lease or hold cars under a hire purchase agreement. The entitlement to the credit applies to cars that were held at the start of 1 July 2000 and disposed of before 1 July 2002. The amount of the special credit is generally equal to the GST payable on the first sale of a car on or after 1 July 2000. [Schedule 1, item 7]

Detailed explanation of new law

Entitlement to the special credit

2.6 Where, in relation to the supply of a car, all of the conditions specified in subsection 19B(1) are met, the entity referred to in subsection 19B(6) will be entitled to a special credit.

2.7 The criteria that must be satisfied in relation to the supply of a car for entitlement to a special credit are:

•

the supply takes place on or after 1 July 2000 and before 1 July 2002;

•

the car was held by the entity at the start of 1 July 2000;

•

the supply was the first sale of the car on or after 1 July 2000;

•

during the entire period from 1 July 2000 until the car was disposed of, the car was held for the purposes of supply by way of rental in the course or furtherance of the entity's enterprise and was covered by the appropriate third party insurance for this use; and

•

the car has been the subject of sales tax.

[Schedule 1, item 7, subsection 19B(1)]

2.8 It is a requirement in all States and Territories for rental cars to have the appropriate category of compulsory third party insurance (e.g. as a 'hire and drive yourself' vehicle). If the car does not have this category of compulsory third party insurance no credit will be available in relation to the supply of the vehicle. [Schedule 1, item 7, subsection 19B(4)]

2.9 Paragraph 19B(4)(b) is designed to cover situations such as the case in Tasmania where utilities and vans held by rental car businesses are not required to be insured as hire and drive yourself vehicles (the type of compulsory third party insurance required for rental cars). However, in other States and Territories utilities and vans are required to have this type of compulsory third party insurance. This will allow car rental businesses holding these types of vehicles in Tasmania to be covered by the special credit provisions where all of the other conditions for claiming the credit are met (including the vehicles falling under the definition of car).

2.10 For the purposes of section 19B, car has the meaning given by subsection 995-1(1) of the ITAA 1997. That is, a motor vehicle (except a motor cycle or similar vehicle) designed to carry a load of less than 1 tonne and fewer than 9 passengers. [Schedule 1, item 7, definition of 'car' in subsection 19B(13)]

2.11 A supply by way of rental does not include a supply of a car that involves passengers being transported by or on behalf of the supplier. For example, taxis and chauffeur driven cars are not included. [Schedule 1, item 7, paragraph 19B(14)(a)]

Example 2.1

Rainsford Rental is a rental business which operates through 3 branches in Adelaide. It rents out cars, trucks (over 1 tonne) and minibuses (designed to carry more than 9 passengers) to customers who drive the rental cars themselves. At the start of 1 July 2000 it held 100 cars, 20 trucks and 5 minibuses for the purposes of rental. All of the vehicles are registered in South Australia with the compulsory third party insurance category for hire and drive yourself vehicles. All of the cars, trucks and minibuses held at 1 July 2000 were disposed of before 30 June 2002. The requirements for the special credit have been met only for the cars held by Rainsford on 1 July 2000. A credit is not available in relation to the trucks and minibuses because they are designed to carry a load of more than 1 tonne or more than 9 passengers. The provision only applies to cars.

Example 2.2

Kristen owns several old prestige cars which she hires out for use at weddings and other formal occasions. On the day of the hire either Kristen or her partner Murray drive the cars. Kristen is not entitled to the special credit because the supply involves the transport of passengers by the supplier. Also as Kristen and Murray drive the cars the compulsory third party insurance that they hold for the cars is not the type of compulsory third party insurance required under subsection 19B(4).

Acquisitions at the end of a lease

2.12 Where a lessee acquires a car at the end of the lease this supply is not treated as a sale of the car [Schedule 1, item 7, subsection 19B(2)] . Accordingly the special credit is calculated on the sale of the car after it has been acquired by the lessee. This exception to the criteria in subsection 19B(1) has been inserted in recognition of the fact that a residual amount provided for at the end of a lease is usually less than market value.

Example 2.3

LB Rental Cars is a rental car business. At 1 July 2000 LB holds 150 cars, all of which are under lease. LB holds the appropriate compulsory third party insurance for these cars as required by subsection 19B(4). At the end of the lease LB acquires the cars for an agreed residual amount and then sells the cars on the private market. At 30 June 2002, 140 of the cars that were held at 1 July 2000 have been sold by LB, the rest were sold by 31 December 2002. LB is entitled to the special credit for the 140 cars that were sold. LB is not entitled to a special credit in relation to the other 10 cars because the first sale of these cars occurred after 30 June 2002.

Insurance settlements

2.13 Where a car is supplied to an insurer in settlement of a claim under an insurance policy, this supply will be treated as a sale [Schedule 1, item 7, subsection 19B(3)] . This provision recognises that rental car businesses that disposed of cars in this way were impacted by the introduction of the GST in a similar way to those that disposed of their cars by way of sale.

No entitlement where section 19A credit claimed

2.14 If any entity has claimed a special input tax credit under section 19A of the GST Transition Act in relation to the supply of the car then a credit cannot be claimed under section 19B. [Schedule 1, item 7, subsection 19B(5)]

Who is entitled to the special credit

2.15 The entity entitled to the special credit is the entity that held the car for supply by way of rental [Schedule 1, item 7, subsection 19B(6)] . For the purposes of section 19B the entity will have held the car where it owned, leased or held the car under a hire purchase agreement [Schedule 1, item 7, definition of 'held' in subsection 19B(13)] .

2.16 Only the entity that supplied the car by way of rental is entitled to the credit. A supply by way of rental does not include a supply of a car to an entity that acquires the car for the purposes of supply by way of rental. Accordingly businesses that lease cars to rental car businesses are not entitled to this credit (e.g. finance companies) [Schedule 1, item 7, paragraph 19B(14)(b)] . The intent of this amendment is to provide transitional relief to rental car businesses.

Calculation of the special credit

2.17 The credit will be equal to 1/11th of the price of the supply [Schedule 1, item 7, subsection 19B(7)] . If the supply is made in settlement of an insurance claim then the price of the supply is taken to be the sum of the payment for the settlement and the value of any supplies received from the insurer in settlement of the claim [Schedule 1, item 7, subsection 19B(11)] .

2.18 If the supply of the car is included as part of the supply of something else, then the price of the supply of the car is only that part of the consideration for the supply that represents the supply of the car. [Schedule 1, item 7, subsection 19B(10)]

2.19 If a lessee is unable to find out the price at which the car was sold then the price of the supply is taken to be an amount worked out in the way determined in writing by the Commissioner. [Schedule 1, item 7, subsection 19B(9)]

Example 2.4

Pfeiffer Rental Cars holds cars under finance lease provided by Atkinson Finance. When the cars are either 12 months old or have travelled 50,000 kilometres they are sold at public auction and are replaced by new cars. At 1 July 2000 Pfeiffer held 80 cars which were 6 months old. All of these cars were registered and had appropriate third party insurance for rental cars. Provided that the cars are sold prior to 30 June 2002 Pfeiffer is entitled to a special credit equal to 1/11th of the price Atkinson Finance received on the sale of these cars. If the cars were not disposed of at a public auction and Pfeiffer is not able to obtain the sale price of these cars from Atkinson, Pfeiffer can work out their credit in a way determined by the Commissioner.

Eligible short-term leases

2.20 The amount of the special credit is reduced if the car is covered by an eligible short-term lease agreement with the Commissioner under the sales tax legislation. The credit is reduced by the exempt percentage that was specified in the agreement that was in place at 30 June 2000. Subsection 5(3) of the GST Transition Act refers to the meaning of eligible short-term lease. [Schedule 1, item 7, subsection 19B(8)]

Example 2.5

Goodwin Co operates a rental car business. At 1 July 2000 it held 200 cars. These cars all have the appropriate compulsory third party insurance for rental cars as required by subsection 19B(4). Twenty of these cars were the subject of an eligible short-term lease agreement with the Commissioner. The exempt percentage specified in the agreement in place at 30 June 2000 was 5%. The 20 cars were disposed of before 1 July 2002 for $220,000. Goodwin is entitled to a special credit of $19,000 in relation to these 20 cars ((1/11 $220,000) (100% - 5%)).

Claiming the special credit

2.21 The special credit is treated as an input tax credit and is attributable to any one tax period of choice ending on or after the day on which this bill receives Royal Assent and on or before 7 January 2003 or such later day as the Commissioner determines in writing. [Schedule 1, item 7, subsection 19B(12)]

Consequential amendments

2.22 The special credit is assessable income in the year in which the credit is attributed [Schedule 1, item 8] . This treatment is consistent with other similar transitional input tax credits.

Regulation impact statement

Policy objective

2.23 This provision will provide a special input tax credit for car rental businesses in relation to cars that the businesses held at 1 July 2000. The introduction of the GST resulted in these businesses paying both sales tax on the purchase of cars before 1 July 2000 and GST on the sale of the cars. In addition, until 23 May 2001 GST input tax credits were denied on the purchase of new replacement cars. The introduction of the GST resulted in a reduction in car prices and consequently the value of cars held by rental car businesses. The transitional provisions of the GST had a severe impact on rental car businesses because of the high proportion of their assets that rental cars comprise and the frequent turnover of these cars.

Implementation options

2.24 The following 2 options represent the new provision proposed by this bill and the major alternative. Both options propose a one-off special input tax credit to businesses that held rental cars at the start of 1 July 2000.

Assessment of impacts

Option 1

2.25 This option is to provide a special input tax credit equal to the GST on the sale of rental cars that were held at the start of 1 July 2000 and disposed of before 1 July 2002. This proposal will apply to businesses that own, lease or hold rental cars under a hire purchase agreement. These cars must have been the subject of sales tax.

Impact group identification

2.26 The rental car market largely consists of 4 major companies and their franchisees. Most of this group's cars are leased and are disposed of at public auction. Accordingly the proposal will impact on auction houses and lessors that provide rental car leases.

Analysis of costs / benefits

Compliance costs

2.27 All rental car businesses will be required to determine the sale price on the disposal of rental cars that were held at the start of 1 July 2000. Those businesses that either own or acquire the car at the end of a lease will have this information in their own records.

2.28 Lessees will be required to obtain this information from their lessors. Most rental cars leased by large rental car companies are disposed of by the same auction house. The consultation process has highlighted that these businesses will be able to obtain the information they require from this auction house. Smaller rental car businesses that lease cars have similarly indicated through consultation that they will also be able to obtain the information required to calculate their credit entitlement. However the law does provide a discretion for the Commissioner to provide a calculation method where the rental car business is unable to obtain the relevant sales data. Accordingly it is expected that the compliance cost impact on those businesses impacted will be minimal.

Administration costs

2.29 The ATO will need to provide information to businesses eligible for this one-off special credit as well as respond to requests for any advice. Requests for information may be reduced as:

•

industry representatives have undertaken to provide information to their members; and

•

industry has also indicated through consultation that the calculation of the credit would not be difficult.

2.30 This measure will create some additional verification activity for the ATO to ensure that correct claims are made. The ATO will also be required to provide some businesses with a calculation method where the rental car business is unable to obtain the relevant sales data. This proposal is for a one-off credit, which is simple to calculate and will impact on a limited group of businesses. Accordingly administration costs will be minimal.

Government revenue

2.31 The total net revenue impact of this proposal is $36 million over 2 years. This estimate takes into account the assessability of the credit for income tax purposes.

Option 2

2.32 The second option was to provide a special input tax credit based on the market value of the rental cars held at 1 July 2000. This option was also applicable to businesses that own, lease or hold rental cars under a hire purchase agreement.

Impact group identification

2.33 The group impacted under Option 2 is similar to that impacted under Option 1. However there would not be an impact on auction houses or finance companies.

Analysis of costs / benefits

Compliance costs

2.34 The compliance costs of this proposal are similar to Option 1. However as the credit is based on the market value of rental cars held at 1 July 2000, businesses would be required to undertake a valuation for such cars on that date. The valuation method would be by reference to an accepted industry valuation guide. Accordingly business would be required to gain access to 1 July 2000 data in that guide. They would also need to determine not only cars on hand at that date but also make an estimate of market value based on the guide and the kilometres travelled by the car.

Administration costs

2.35 The administration costs to the ATO of this proposal are similar to the first proposal and are minimal. However for this option verification by the ATO would be more extensive because the credit is determined by reference to more information than GST on disposal.

Government revenue

2.36 The total net revenue impact of this proposal is $43 million over 2 years. This estimate takes into account the assessability of the credit for income tax purposes.

Consultation

2.37 Some consultation was undertaken prior and during the course of drafting legislation. Groups involved in consultation included large and small rental car businesses and their tax advisers. Particular consultation was sought on the application of the proposal to leased cars. Small and large rental car businesses with leased cars both indicated that they would be able to obtain the sale price of the leased car for the purposes of calculating the credit. Industry representatives also gave an undertaking that they would provide assistance to industry members to calculate this credit.

Conclusion and recommended option

2.38 The preferred option for providing this measure is Option 1. Whilst both options present minimal impact on compliance costs, Option 1 would be marginally easier for business to comply with and the ATO to administer. Option 2 requires business to gather more information retrospectively to be able to determine their credit. This means that any verification activity by the ATO would be more extensive. Whilst Option 1 does require some businesses to obtain information from other parties, consultation with industry representatives indicated that this would not present a problem.

2.39 Option 1 also provides a calculation method which is closer to achieving the policy intent because it is based on sale price on disposal rather than on an industry estimation. Option 1 also has a lower revenue impact.

Chapter 3 - Income tax-related transactions

Outline of chapter

3.1 Part 3 of Schedule 1 to this bill will allow companies to transfer tax losses, net capital losses and excess foreign tax credits without attracting GST.

Context of amendments

3.2 The income tax legislation allows companies to transfer income tax amounts (such as losses and foreign tax credits) to members of the same wholly-owned group in certain circumstances.

3.3 Subdivisions 170-A and 170-B of the ITAA 1997 allow a loss company to transfer tax losses and net capital losses to an income company in certain circumstances. The transfer is effected by a transfer document (a written agreement between the 2 companies and signed by a public officer of each company). Subdivision 170-A governs the process by which tax losses are transferred and Subdivision 170-B governs the transfer of net capital losses within wholly-owned groups.

3.4 In addition, section 160AFE of the ITAA 1936 allows for the transfer of foreign tax credits between members of a wholly-owned group. Subsection 160AFE(1D) provides that a credit company can transfer excess foreign tax credits to an income company if they have been members of the same company group for the whole of the income year in which the transfer is made. Again, there must be a signed agreement between the credit company and the income company for the transfer to be effective.

3.5 A transfer of an income tax loss or net capital loss under the ITAA 1997, or of a foreign tax credit under the ITAA 1936, is a supply and will generally be subject to GST under section 9-5 of the GST Act.

3.6 Even where the transfer is made for no consideration, because the supply is between associates, the supply may still be subject to GST under Division 72 of the GST Act where the recipient of the supply is either not registered for GST or is otherwise unable to claim a full input tax credit on the acquisition. Transfers to an associate without consideration will not be taxable under Division 72 of the GST Act where the recipient is entitled to a full input tax credit.

3.7 However, where the transfer is between 2 companies that are members of the same GST group, the transfer will not be subject to GST under Division 48 of the GST Act.

3.8 In most circumstances, the recipient of the supply will be entitled to an input tax credit for any GST paid on the acquisition of the losses or foreign tax credits. However, an entity that is not registered for GST or is involved in making input taxed supplies would be denied all or part of its input tax credits.

Summary of new law

3.9 The amendment ensures that transfers of certain income tax amounts are not subject to GST. That is, where a company transfers:

•

a tax loss in accordance with Subdivision 170-A of the ITAA 1997;

•

a net capital loss in accordance with Subdivision 170-B of the ITAA 1997; or

•

an excess foreign tax credit in accordance with section 160AFE of the ITAA 1936,

these transfers are not subject to GST.

Detailed explanation of new law

3.10 This bill inserts Division 110 into the GST Act. This Division ensures that transfers of certain income tax amounts are not subject to GST. [Schedule 1, item 11, section 110-1]

3.11 Subsection 110-5(1) ensures that where an entity transfers:

•

a tax loss in accordance with Subdivision 170-A of the ITAA 1997; or

•

a net capital loss in accordance with Subdivision 170-B of the ITAA 1997,

the transfer is not subject to GST. [Schedule 1, item 11, subsection 110-5(1)]

3.12Subsection 110-5(2) ensures that section 9-5 of the GST Act about taxable supplies does not apply to these transactions. [Schedule 1, item 11, subsection 110-5(2)]

Example 3.1

Company A and Company B are both members of the same wholly-owned group and otherwise satisfy the requirements to transfer a tax loss under Subdivision 170-A of the ITAA 1997.

Company A enters into a written agreement in December 2002 to transfer a 1998-1999 loss to Company B for the 2001-2002 income year. Because the transfer satisfies the requirements of Subdivision 170-A of the ITAA 1997, the transfer is not subject to GST.

3.13 Similarly, where an entity transfers an excess foreign tax credit in accordance with section 160AFE of the ITAA 1936, the transfer is not subject to GST. [Schedule 1, item 11, subsection 110-10(1)]

3.14 Subsection 110-10(2) ensures that section 9-5 of the GST Act about taxable supplies does not apply to these transactions. [Schedule 1, item 11, subsection 110-10(2)]

3.15 Definitions of net capital loss and tax loss are inserted in section 195-1 of the GST Act and have the meanings given by those terms in the ITAA 1997. [Schedule 1, items 14 and 16]

3.16 Item 5B is inserted into the table in section 9-39 and item 17A is inserted into the table in section 37-1 of the GST Act. These items are included in a check list of special rules to help guide readers to Division 110. [Schedule 1, items 9 and 10]

Application and transitional provisions

3.17 The amendments apply, and are taken to have applied, in relation to net amounts for tax periods starting (or that started) on or after 1 July 2000. [Schedule 1, item 19]

Chapter 4 - General insurance

Outline of chapter

4.1 Schedule 2 to this bill amends the ITAA 1936 affecting general insurance companies to ensure that:

•

the provision for outstanding claims is worked out on a present value basis; and

•

gross premium income is included in assessable income in the year it is received or receivable and net premium income that relates to risk exposure in subsequent years is appropriately deferred.

4.2 The Schedule also amends the ITAA 1936 to ensure that the provision for outstanding claims of self insurers in respect of workers' compensation liabilities is taxed consistently with the provision for outstanding claims of general insurance companies.

Context of amendments

4.3 The basic principles for taxing general insurance companies are outlined in Taxation Ruling IT 2663. The Ruling, which was agreed to by the general insurance industry, applies to the general insurance activities of general insurance companies from the 1991-1992 income year. The same principles have been extended to the reinsurance activities of general insurance companies from the 1995-1996 income year (Taxation Ruling TR 95/5) and to self insurers from the 1996-1997 income year (Taxation Determination TD 97/14).

4.4 A key principle of Taxation Ruling IT 2663 relates to the methodology for working out the amount that general insurance companies can deduct for outstanding claims - that is, claims that a company is liable to pay arising from an insured event that occurred in the year or earlier years but have not been paid in full at the end of the income year.

4.5 The Ruling states that the amount of the deduction in the current income year should be, broadly, the present value of the estimated amount needed to pay out those claims in the future. This methodology is consistent with the methodology used to determine outstanding claims for accounting purposes and was accepted by the general insurance industry as being appropriate for income tax purposes.

4.6 However, the use of this methodology for income tax purposes was challenged in Federal Commissioner of Taxation v Mercantile Mutual Insurance (Workers Compensation) Ltd & Anor
99 ATC 4404 (the Mercantile Mutual case). The Court concluded that the income tax law allows a deduction in the current income year for, broadly, the nominal future value of outstanding claims - that is, the nominal amount that is estimated to be paid out in the future rather than the present value of that amount that the company actually sets aside today.

4.7 Taxation Ruling IT 2663 also specifies the methodology general insurance companies should use to spread premium income. The Ruling requires general insurance companies to spread net premiums over the relevant period of risk. The net premiums approach effectively spreads the deduction for expenses directly related to the gross premiums over the relevant period of risk and is consistent with the outcome achieved by the accounting standard that applies to general insurance companies (i.e. Accounting Standard AASB 1023).

Summary of new law

4.8 Schedule 2 to this bill amends the ITAA 1936 so that, consistent with the methodology used for accounting purposes and with the long standing view of the income tax law expressed in Taxation Ruling IT 2663:

•

the provision for outstanding claims of general insurance companies is worked out on a present value basis:

-

increases in the value of the provision for outstanding claims over the income year are allowed as a deduction; and

-

decreases in the value of the provision for outstanding claims over the income year are included in assessable income; and

•

gross premium income is included in assessable income in the year it is received or receivable. Net premium income that relates to risk exposure in subsequent years is allocated to the unearned premium reserve. The value of the unearned premium reserve at the end of the income year is compared with the value of that reserve at the end of the previous income year:

-

increases in the value of the unearned premium reserve over the income year are allowed as a deduction - this ensures that net premiums that relate to risk exposure in subsequent years is appropriately deferred; and

-

decreases in the value of the unearned premium reserve over the income year are included in assessable income - this ensures that net premiums that relate to risk exposure in the current year are included in assessable income.

4.9 The Schedule also amends the ITAA 1936 to ensure that the provision for outstanding claims of self insurers in respect of workers' compensation liabilities is taxed consistently with the provision for outstanding claims of general insurance companies.

Detailed explanation of new law

4.10 This bill inserts Division 321 into Schedule 2J to the ITAA 1936. Division 321 deals with specific issues relating to the taxation of general insurance companies. [Schedule 2, item 9, section 321-1]

4.11 In particular, Division 321 outlines:

•

the taxation treatment of claims under general insurance policies; and

•

the basis of apportioning premium income by general insurance companies.

4.12 The term general insurance company is defined to mean a body corporate that carries on insurance business. [Schedule 2, items 1 and 10, subsection 6(1) of the ITAA 1936 and subsection 995-1(1) of the ITAA 1997]

4.13 Insurance business is defined to have the same meaning as it has in the Insurance Act 1973. [Schedule 2, items 3 and 11, subsection 6(1) of the ITAA 1936 and subsection 995-1(1) of the ITAA 1997]

4.14 The Insurance Act 1973 defines insurance business to mean, broadly, the business of undertaking liability, by way of insurance (including reinsurance), in respect of any loss or damage, including liability to pay damages or compensation, contingent upon the happening of a specified event, and includes any business incidental to insurance business.

4.15 Therefore, the new Division applies to:

•

companies that are authorised under the Insurance Act 1973 to carry on insurance business; and

•

other companies that carry on insurance business but are not required to be authorised under the Insurance Act 1973 - such as companies that are licensed under the Workers Compensation Act 1987 (NSW).

4.16 A general insurance policy has the same meaning as in the ITAA 1997. A general insurance policy is defined in subsection 995-1(1) of the ITAA 1997 to mean a policy of insurance that is not a life insurance policy or an annuity instrument. [Schedule 2, item 2, subsection 6(1)]

Claims under general insurance policies

4.17 This bill inserts Subdivision 321-A into Schedule 2J. Subdivision 321-A:

•

outlines the taxation treatment of the provision for outstanding claims of general insurance companies; and

•

allows a deduction for amounts paid during the income year in respect of claims under general insurance policies.

[Schedule 2, item 9, section 321-5]

What are outstanding claims?

4.18 Outstanding claims under general insurance policies at the end of an income year are claims that a general insurance company is liable to pay in relation to an insured event that occurred in the year or earlier years but have not been paid in full. That is, outstanding claims are:

•

claims arising from an insured event that occurred in the income year or earlier income years which have been reported to the insurer but have not been paid in full at the end of the income year;

•

claims incurred but not yet reported - that is, claims arising from an insured event that occurred in the income year for which the insurer is presently liable to pay but which have not yet been reported to the insurer at the end of the income year; and

•

claims incurred but not enough reported to the insurer at the end of the income year.

[Schedule 2, items 4 and 12, subsection 6(1) of the ITAA 1936 and subsection 995-1(1) of the ITAA 1997]

Example 4.1

Rachael had a motor vehicle accident in May. The motor vehicle was covered by a general insurance policy with the Jasper Insurance Company. Rachael immediately reported the claim to Jasper Insurance. However, the claim was not paid until the following income year. Therefore, the claim is an outstanding claim at the end of the income year because it was reported to Jasper Insurance in the current income year but not paid until a later income year.

Example 4.2

Christopher had a motor vehicle accident in June and was also covered by a general insurance policy with the Jasper Insurance Company. However, Christopher did not report the accident to Jasper Insurance until the following income year. Even though the claim has not been reported before the end of the income year, Jasper Insurance can estimate on the basis of probabilities that a claim has been incurred. Therefore, the claim was an outstanding claim at the end of the income year because it was incurred in the current income year but not reported to Jasper Insurance until a later income year.

What is the value of the outstanding claims liability?

4.19 The value of the outstanding claims liability at the end of the income year is:

the amount that the company determines, based on proper and reasonable estimates, to be appropriate to set aside which, when invested, will provide sufficient funds to pay the liabilities for outstanding claims plus any direct settlement costs associated with those outstanding claims

less

any part of that amount that the company expects to recover in respect of those claims.

[Schedule 2, items 5 and 9, subsection 6(1) and section 321-20]

4.20 The amount that the company determines, based on proper and reasonable estimates, to be appropriate to set aside which, when invested, will provide sufficient funds to pay the liabilities for outstanding claims plus any direct settlement costs associated with those outstanding claims essentially represents the present value of the outstanding claims liability and the direct settlement costs associated with those outstanding claims.

4.21 In working out the present value of the outstanding claims liability and the direct settlement costs associated with those outstanding claims, a general insurance company can take into account the expected cost of the following factors:

•

direct policy costs - that is, amounts to be paid to the claimant or third party under the policy, medical and hospital fees payable under the policy and any other amounts payable as a condition of the policy;

•

claim investigation and assessment costs - that is, investigation fees, legal fees and claim assessment costs;

•

direct claim settlement expenditures - that is, direct costs attributable to a particular claim; and

•

estimated increased costs of litigation and other direct costs - that is, essentially, trends in claims pay-out experience.

4.22 In the case of short-tail business - that is, general insurance policies under which claims are usually settled within 12 months of the insured event that gives rise to the claim occurring - the present value of the outstanding claims liability is usually the nominal value of that liability.

4.23 Generally, a general insurance company's determination of the present value of the outstanding claims liability and the direct settlement costs associated with those outstanding claims will be accepted as being based on proper and reasonable estimates if a qualified actuary estimates the company's expected final claims liability and calculates the amount that the company needs to set aside in the current year to yield a sufficient amount to meet that liability in the future.

4.24 However, the actuary's determination of the provision is not acceptable for income tax purposes if strong evidence exists to suggest that the actuary's estimate is incorrect. For example, the actuary's determination would not be acceptable if the underlying assumptions on which estimates are based for several years have proved to be consistently incorrect and that fact is not adequately reflected in estimates made in later years.

4.25 Estimates made by people other than actuaries need to be well documented to enable the estimates to be substantiated. The documentation must include the steps used in the estimation process, the factors taken into account in making the estimate and the reasons for the estimate. The company needs to be able, if required, to substantiate the estimate. The credentials of the person selected to make the estimate need to be commensurate with the competence needed for the task.

Prudential margins

4.26 General insurance companies determine the value for the outstanding claims liability on the basis of a 'best' or 'central' estimate (i.e. an estimate with 50% probability of adequacy). The company may decide to hold a provision higher than the best estimate to provide levels of adequacy above 50% - that is, a margin for prudence. The company decides the level of the margin for prudence which it considers to be appropriate for its business based on its experience and actuarial advice.

4.27 Therefore, the amount that the company determines to be appropriate to set aside which, when invested, will provide sufficient funds to pay the liabilities for outstanding claims in the future may include an appropriate margin for prudence. However, the amount of the prudential margin, and how the level of the margin is determined, needs to be well documented. The company's decision on the level of the prudential margin needs to reflect the company's business experience and be made for sound commercial or business reasons and not for income tax purposes.

Indirect settlement costs

4.28 Indirect settlement costs, such as general expenses of running and administering a general insurance company's claims department (i.e. claims handling costs), do not attach to individual claims and are not taken into account in determining the value of the outstanding claims liability.

Amounts expected to be recovered in respect of outstanding claims

4.29 The amount that represents the present value of the liabilities for outstanding claims and direct settlement costs is reduced by the present value of the amount that the company expects to recover in respect of outstanding claims to determine the value of the outstanding claims liability.

4.30 Amounts that the company expects to recover in respect of outstanding claims include:

•

reinsurance recoveries;

•

insurance contributions fund entitlements;

•

supplemental fund entitlements;

•

contribution entitlements from other insurers;

•

policy excesses; and

•

salvage and subrogation.

Example 4.3

Amy has a motor vehicle accident in 2002. The motor vehicle was covered by a general insurance policy with the Jasper Insurance Company. Jasper Insurance estimates that it will have to pay out a nominal amount of $20,000 to Amy for litigation and personal injury claims in 2007. The present value of that amount is $16,000. Jasper Insurance has directly covered $5,000 of the expected $20,000 pay out and the remainder (i.e. $15,000) is covered by a reinsurance policy with the Major Reinsurance Company. The present value of the expected reinsurance recovery of $15,000 is $12,000.

Jasper Insurance's outstanding claims liability is the present value of the nominal amount expected to be paid out to Amy reduced by the present value of the expected reinsurance recoveries from Major Reinsurance. Therefore, the value of Jasper Insurance's outstanding claims liability at the end of the income year in respect of the claim is $4,000 (i.e. $16,000 - $12,000).

What is the impact of changes in the value of the outstanding claims liability over an income year?

4.31 The value of a general insurance company's outstanding claims liability will fluctuate over time because the company will:

•

incur new claims from year to year;

•

review the value of its outstanding claims for previous years having regard to inflationary factors and trends in court awards; and

•

pay out claims previously included in the outstanding claims provision.

4.32 The value of the outstanding claims liability on general insurance policies at the end of an income year is compared with the value of that liability at the end of the previous income year:

•

the amount of any reduction in the value of the outstanding claims liability over the income year is included in assessable income; and

•

the amount of any increase in the value of the outstanding claims liability over the income year is allowed as a deduction.

[Schedule 2, item 9, sections 321-10 and 321-15]

Example 4.4

The value of Jasper Insurance Company's outstanding claims liability is:

•

$225 million at the end of the 2000-2001 income year; and

•

$260 million at the end of the 2001-2002 income year.

Therefore, as the value of the outstanding claims liability has increased over the income year, Jasper Insurance is entitled to a deduction for the amount of that increase ($35 million) in the 2001-2002 income year.

Claims paid are deductible

4.33 A specific deduction is allowed for claims paid under general insurance policies during the year of income by a general insurance company. [Schedule 2, item 9, section 321-25]

Apportionment of premium income

4.34 A general insurance policy typically straddles 2 or more income years. Therefore, the premium income needs to be apportioned over the risk period for income tax purposes into the income years in which it is derived.

4.35 This bill inserts Subdivision 321-B into Schedule 2J. Subdivision 321-B outlines the basis that must be used by general insurance companies to spread premium income over relevant income years. [Schedule 2, item 9, section 321-40]

4.36 Gross premium income is included in assessable income in the year it is received or receivable. Net premium income that relates to risk exposure in subsequent years is allocated to the unearned premium reserve. The value of the unearned premium reserve at the end of the income year is compared with the value of that reserve at the end of the previous income year:

•

increases in the value of the unearned premium reserve over the income year are allowed as a deduction - this ensures that net premiums that relate to risk exposure in subsequent years is appropriately deferred; and

•

decreases in the value of the unearned premium reserve over the income year are included in assessable income - this ensures that net premiums that relate to risk exposure in the current year are included in assessable income.

4.37 The net premiums approach, which is consistent with the methodology used for accounting purposes, effectively spreads the deduction for expenses directly related to the gross premiums (i.e. certain reinsurance premiums and acquisition costs) over the relevant period of risk.

What is the value of the unearned premium reserve?

4.38 The value of a general insurance company's unearned premium reserve at the end of the income year in relation to general insurance policies issued in the course of carrying on insurance business is the sum of the net premiums received or receivable by the company in relation to those policies that the company determines, based on proper and reasonable estimates, to relate to risks covered by the policies in respect of later years of income. [Schedule 2, items 7 and 9, subsection 6(1) and section 321-60]

4.39 The amount that the company determines, based on proper and reasonable estimates, to relate to risks covered by the policies in respect of later years of income will generally be determined by comparing the number of days of risk coverage in a particular income year with the total period of risk covered by the policy.

Example 4.5

Blake takes out a motor vehicle policy with the Jasper Insurance Company on 1 April 2002 and pays a premium of $4,000. The policy expires on 31 March 2003. Therefore, 91 days of risk coverage under the policy occurs in the 2001-2002 income year and 274 days of risk coverage occurs in the 2002-2003 income year. The net premium (i.e. the gross premium less acquisition costs and reinsurance premiums) received by Jasper Insurance in relation to the policy is $3,500.

Therefore, the amount of the net premium received by Jasper Insurance that relates to risk coverage in the 2002-2003 income year is $2,627 (i.e. $3,500 274/365). Consequently, $2,627 is included in the value of the unearned premium reserve at the end of the 2001-2002 income year.

4.40 The terms of a general insurance policy may specify for a single, up-front premium to be paid in respect of a period of risk extending over several years. This situation typically arises, for example, in the case of mortgage insurance policies and credit insurance policies. In these circumstances, the value of the unearned premium reserve at the end of each year reduces over the period of risk. Consequently, net premium income is effectively spread over the relevant period of risk.

Example 4.6

Sam borrows money to buy a car and is required by the lender to take out credit insurance. Sam pays a premium of $200 to the Jasper Insurance Company to cover the 5 year term of the loan.

Jasper Insurance incurs $30 in acquisition costs and pays out $50 in relevant reinsurance premiums. Therefore, Jasper Insurance receives net premium income of $120.

The amount of net premium income that Jasper Insurance determines, based on experience in previous years, to relate to risk exposure in subsequent years is allocated to the unearned premium reserve. Therefore, assuming that Jasper Insurance determines the risk exposure in each year of the policy to be same, the value of Jasper Insurance's unearned premium reserve and the premium earned each year will be the amount set out in Table 4.1.

Table 4.1

Year	1	2	3	4	5
Value of unearned premium reserve	$96	$72	$48	$24	0
Premium earned	$104*	$24	$24	$24	$24

* Gross premiums ($200) less increase in the value of the unearned premium reserve ($96). Acquisition costs ($30) and reinsurance premiums ($50) are deducted from this amount to determine taxable income ($24).

4.41 Under some general insurance policies the incidence of the pattern of risk is not uniform over the period of the policy. Examples of general insurance policies that typically have an uneven spread of the incidence of risk include:

•

mortgage protection insurance policies;

•

credit insurance policies;

•

crop insurance policies; and

•

some forms of construction insurance policies.

4.42 In relation to these policies, the amount that the company determines, based on proper and reasonable estimates, to relate to risks covered by the policies in respect of later years of income will generally be based on the pattern of the incidence of risk as determined by a qualified actuary or a suitably competent person.

Net premiums

4.43 Net premiums are the sum of:

gross premiums received or receivable by the company in relation to the relevant policies during the current income year or in an earlier income year

plus

reinsurance commissions received or receivable by the company that relate to relevant reinsurance premiums

less

apportionable issue costs incurred by the company

less

relevant reinsurance premiums paid by the company.

[Schedule 2, item 9, definition of 'net premiums' in section 321-60]

Gross premiums

4.44 Section 321-45 specifically includes the gross premiums received or receivable in respect of general insurance polices during the income year in the assessable income of a general insurance company. [Schedule 2, item 9, section 321-45]

Reinsurance commissions

4.45 Reinsurance commissions received or receivable by a general insurance company are included in assessable income under section 6-5 of the ITAA 1997.

4.46 A reinsurance company may pay reinsurance commissions to a general insurance company. Reinsurance commissions are based on the reinsurance premiums payable by the general insurance company to the reinsurer. Most reinsurance commissions represent a reimbursement to the general insurance company for part of the apportionable issue costs of the policies that are the subject of the reinsurance arrangements. They also represent a contribution towards the cost of management of those policies. Effectively, the commissions result in the sharing of policy acquisition and management costs between the general insurance company and the reinsurance company.

4.47 Consequently, reinsurance commissions received or receivable that relate to relevant reinsurance premiums are included in the calculation of net premium income.

Apportionable issue costs

4.48 Apportionable issue costs, which are commonly referred to by the general insurance industry as acquisition costs, are generally deductible under section 8-1 of the ITAA 1997.

4.49 The net premiums methodology effectively spreads the deduction for expenses directly related to the gross premiums over the period to which the policy relates. Therefore, the gross premiums are reduced by apportionable issue costs to determine net premiums. The effect is to spread the deduction for apportionable issue costs over the same period as the related gross premium income of the company.

4.50 Apportionable issue costs are costs incurred by the company in connection with the issue of the relevant policies that relate to gross premiums and include:

•

commission and brokerage fees;

•

administration costs of processing insurance proposals and renewals;

•

administration costs of collecting premiums;

•

selling and underwriting costs (such costs as risk assessment and advertising);

•

fire brigade charges;

•

stamp duty; and

•

other charges, levies or contributions imposed by Commonwealth or State governments, or by government authorities, that directly relate to general insurance policies.

[Schedule 2, item 9, definition of 'apportionable issue costs' in section 321-60]

4.51 The effect of including apportionable issue costs in the determination of net premiums is to spread the deduction over the period to which the policy relates. Therefore, the general prepayment provisions do not apply to apportionable issue costs. [Schedule 2, item 8, paragraph (e) of the definition of 'excluded expenditure' in subsection 82KZL(1)]

Relevant reinsurance premiums

4.52 Reinsurance premiums paid by a general insurance company are generally deductible under section 8-1 of the ITAA 1997.

4.53 The net premiums methodology effectively spreads the deduction for expenses directly related to gross premiums over the period to which the policy relates. Therefore, the gross premiums are also reduced by certain reinsurance premiums (relevant reinsurance premiums) paid during the current income year or in an earlier income year for the reinsurance of risks covered by the relevant policies to determine net premiums. The effect is to spread the deduction for relevant reinsurance premiums over the same period as the related gross premium income.

4.54 As the effect of including relevant reinsurance premiums in the determination of net premiums is to spread the deduction over the period to which the policy relates, the general prepayment provisions do not apply to relevant reinsurance premiums. [Schedule 2, item 8, paragraph (f) of the definition of 'excluded expenditure' in subsection 82KZL(1)]

4.55 Relevant reinsurance premiums are reinsurance premiums paid by the company other than:

•

reinsurance premiums that the company cannot deduct because of the application of subsection 148(1) of the ITAA 1936; and

•

treaty non-proportional reinsurance premiums.

[Schedule 2, item 9, definition of 'relevant reinsurance premiums' in section 321-60]

4.56 Subsection 148(1) of the ITAA 1936:

•

denies an income tax deduction to an Australian insurer for reinsurance premiums paid to a non-resident reinsurer; and

•

excludes any amounts recovered by the Australian insurer from the non-resident reinsurer for a loss on any reinsured risk from the assessable income of the Australian insurer.

4.57 Subsection 148(2) allows the Australian insurer to make an election which effectively changes this outcome.

4.58 If subsection 148(1) applies to deny an income tax deduction to an Australian insurer for reinsurance premiums paid to a non-resident reinsurer, then those reinsurance premiums are not relevant reinsurance premiums.

4.59 Treaty non-proportional reinsurance premiums are reinsurance premiums for a class of general insurance policy business where, under the contract for reinsurance, the reinsurer agrees to pay in respect of a loss incurred by the company that is covered by the relevant policy, some or all of the excess over an agreed amount - that is, the reinsurance payable is not in the same proportion as the reinsurance premium received. [Schedule 2, item 9, definition of 'treaty non-proportional reinsurance premiums' in section 321-60]

4.60 Treaty non-proportional reinsurance premiums reduce the overall risk exposure of a general insurer but are not related to any particular premium. These reinsurance premiums are more in the nature of a direct expense applicable to the whole period of the reinsurance cover. Therefore, treaty non-proportional reinsurance premiums are not relevant reinsurance premiums. Consequently, the deduction for treaty non-proportional reinsurance premiums is spread over income years by applying the general prepayment provisions rather than the net premiums methodology.

What is the impact of changes in the value of the unearned premium reserve over an income year?

4.61 The value of a general insurance company's unearned premium reserve will fluctuate from year to year. Consequently, the value of the unearned premium reserve at the end of an income year is compared with the value of that reserve at the end of the previous income year:

•

the amount of any reduction in the value of the unearned premium reserve over the income year is included in assessable income; and

•

the amount of any increase in the value of the unearned premium reserve over the income year is allowed as a deduction.

[Schedule 2, item 9, sections 321-50 and 321-55]

Example 4.7

The value of Jasper Insurance Company's unearned premium reserve is:

•

$165 million at the end of the 2000-2001 income year; and

•

$150 million at the end of the 2001-2002 income year.

Therefore, as the value of the unearned premium reserve has decreased over the income year, the amount of that decrease ($15 million) is included in Jasper Insurance's assessable income in the 2001-2002 income year.

Self insurers

4.62 This bill also inserts Division 323 into Schedule 2J of the ITAA 1936. Division 323 outlines the taxation treatment of outstanding claims for workers' compensation liabilities of companies that are not required by law to insure, and do not insure, in respect of such liabilities - that is, self insurers. [Schedule 2, item 9, section 323-1]

4.63 Under certain State and Territory legislation some employers are permitted to retain a particular amount of their workers' compensation liabilities and, in that sense, are said to be self insurers of their workers' compensation liabilities.

4.64 The amendments ensure that the taxation treatment of outstanding claims for self insurers in respect of workers' compensation liabilities is consistent with the taxation treatment of outstanding claims for general insurance companies.

4.65 That is, self insurers are required to compare the value of the outstanding claims liability for workers' compensation claims at the end of an income year with the value of that liability at the end of the previous income year:

•

the amount of any reduction in the value of the outstanding claims liability over the income year is included in assessable income; and

•

the amount of any increase in the value of the outstanding claims liability over the income year is allowed as a deduction.

[Schedule 2, item 9, sections 323-5 and 323-10]

4.66 The value of the outstanding claims liability at the end of the income year for workers' compensation claims is the amount that the self insurer determines, based on proper and reasonable estimates, to be appropriate to set aside which, when invested, will provide sufficient funds to pay the liabilities for outstanding claims plus any direct settlement costs associated with those outstanding claims - that is, the present value of those liabilities. [Schedule 2, items 6 and 9, subsection 6(1) and section 323-15]

4.67 A self insurer can deduct amounts paid during the income year in respect of workers' compensation claims. [Schedule 2, item 9, section 323-20]

Application and transitional provisions

Claims under general insurance policies

General insurance activities

4.68 The amendments relating to claims under general insurance policies apply to assessments in respect of the general insurance activities of general insurance companies for the 1991-1992 income year (i.e., the date of effect of Taxation Ruling IT 2663) and subsequent income years. [Schedule 2, item 9, subsection 321-30(1)]

4.69 The amendments confirm the long standing view of the law outlined in Taxation Ruling IT 2663 which was agreed to by the general insurance industry. The amendments apply from the 1991-1992 income year in order to protect a substantial amount of revenue that would otherwise be at risk.

4.70 However, as a transitional measure, consistent with Taxation Ruling IT 2663, the opening balance of the outstanding claims liability in relation to general insurance activities for the 1991-1992 income year is the present value of the outstanding claims liability as at that time rather than the closing balance used by the company for tax purposes in the 1990-1991 income year. [Schedule 2, item 9, subsections 321-30(2) and (3)]

Reinsurance activities

4.71 The amendments relating to claims under general insurance policies apply to assessments in respect of the reinsurance activities of general insurance companies from the 1995-1996 income year (i.e., the date of effect of Taxation Ruling TR 95/5) and subsequent income years. [Schedule 2, item 9, subsection 321-35(1)]

4.72 However, as a transitional measure, consistent with Taxation Ruling TR 95/5, the opening balance of the outstanding claims liability in relation to reinsurance activities for the 1995-1996 income year is the present value of the outstanding claims liability as at that time rather than the closing balance used by the company for tax purposes in the 1994-1995 income year. [Schedule 2, item 9, subsections 321-35(2) and (3)]

Apportionment of premium income

4.73 The amendments relating to the apportionment of the premium income of general insurance companies apply to assessments in respect of the 1999-2000 income year and subsequent income years. [Schedule 2, item 9, section 321-65]

4.74 The amendments confirm the long standing view of the law outlined in Taxation Ruling IT 2663 and overcome difficulties with the interaction between the prepayment provisions and the principles used by general insurance companies to apportion premium income.

Self insurers

4.75 The amendments relating to self insurers apply to assessments in respect of the 1996-1997 income year (i.e., the date of effect of Taxation Determination TD 97/14) and subsequent income years. [Schedule 2, item 9, section 323-25]

Consequential amendments

4.76 Section 10-5 of the ITAA 1997 contains a checklist of assessable income to assist users of the legislation to find specific items. Section 12-5 contains a similar checklist of allowable deductions. The checklists in section 10-5 and section 12-5 are updated to include appropriate references to the new provisions. [Schedule 2, items 9A and 9B, sections 10-5 and 12-5]

Chapter 5 - Intercorporate dividend rebate

Outline of chapter

5.1 Schedule 3 to this bill amends subsection 46F(3) of the ITAA 1936 to broaden the eligibility requirements for accessing the ICDR for unfranked dividends paid between members of the same wholly-owned group.

5.2 The proposed amendment broadens the current eligibility requirement, which is restricted to a whole of year requirement, to include a rule based on the company paying the dividend and the company receiving it being part of the same wholly-owned group at all times during the period of 12 months ending on the day on which the dividend was paid.

Context of amendment

What is the current treatment of intercorporate dividends?

5.3 Prior to 1 July 2000 the ICDR was available to all public companies regardless of whether the dividend was franked or not, and to all private companies provided the dividend was franked or paid within the same wholly-owned group.

5.4 However, from 1 July 2000, the tax laws were amended with the effect that the ICDR is now only available in respect of:

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franked dividends; or

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unfranked dividends paid within the same wholly-owned group.

5.5 In determining whether a dividend is paid within the same wholly-owned group, the rules require that the company receiving the dividend be a group company in relation to the company paying the dividend in the income year in which the dividend is paid (see subsection 46F(3)). A company is taken to be a group company in relation to another company in an income year if, broadly speaking, one company is a subsidiary of the other during the whole of the income year (see subsection 160AFE(2)).

Why is the current law being changed?

5.6 The current whole of year requirement operates as an integrity measure by requiring companies to be part of the same wholly-owned group for a reasonable period of time in order to access the benefits of grouping.

5.7 However, the rule can be too restrictive in certain circumstances which hampers the efficient disposal of subsidiary companies by holding companies. These circumstances would include where a holding company forfeits entitlement to the ICDR on a dividend as a result of disposing of a wholly-owned subsidiary during the income year even where it held the subsidiary for a reasonable period of time prior to the time the company received the dividend from the subsidiary.

5.8 To address this inflexibility the proposed amendments will provide for an additional eligibility test. As a result, companies will also be able to access the ICDR provided the company paying the dividend and the company receiving it are part of the same wholly-owned group at all times during the period of 12 months ending on the day on which the dividend was paid.

Summary of new law

5.9 The amendment will allow companies to access the ICDR provided the company paying the dividend and the company receiving it are part of the same wholly-owned group at all times during the period of 12 months ending on the day on which the dividend was paid. The current whole of year eligibility test will also be preserved.

5.10 The amendments apply in respect of dividends paid on or after 1 July 2000, the date when the ICDR on unfranked dividends was limited to dividends paid between wholly-owned group companies.

Detailed explanation of new law

5.11 The proposed amendments repeal subsection 46F(3) which contains the current whole of year test and replaces it with a new provision that contains 2 eligibility tests:

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the first replicates the existing test as it applies to group companies and the whole of year requirement [Schedule 3, item 1, paragraph 46F(3)(a)] ; and

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the second introduces a new test based on whether the subsidiary paying the dividend was wholly-owned by the company receiving it for the 12 months prior to the dividend being paid [Schedule 3, item 1, paragraph 46F(3)(b)] .

5.12 The second test achieves this outcome by modifying the relationship tests contained in section 160AFE. The current test, which tests ownership over the course of an income year, has been changed to an ownership test measured at a particular time. The new test asks whether the shareholder would have been a group company in relation to the company paying the dividend at all times during the period of 12 months ending on the day on which the dividend was paid. [Schedule 3, item 1, paragraph 46F(3)(b)]

5.13 As a result of the second test being based on a particular time, some of the rules contained in section 160AFE as they apply to the whole of year test are not relevant to the new 12 month test. In particular, the special rule that allows access to the ICDR in respect of newly created companies that have not been wholly-owned for the whole of the income year do not extend to the 12 month rule. Therefore, the second test will never be capable of being satisfied unless the companies involved are wholly-owned group companies for a full 12 month period prior to the dividend being paid.

Example 5.1

Banjo Company is a 30 June balancing company. On 30 March 2001 it receives an unfranked dividend from its wholly-owned subsidiary, Patterson Company, a company that it has wholly-owned continually over a number of years. Banjo Company then disposes of Patterson Company on 1 May 2001.

Although Banjo Company would be denied access to the ICDR on the unfranked dividend under the whole of year test, Banjo would be eligible for the ICDR under the 12 month test because Banjo and Patterson were group companies at all times during the period of 12 months prior to the dividend being paid.

Example 5.2

Burke Company is a 30 June balancing company. The company acquires Wills Company on 1 March 2000 (the companies are now wholly-owned group companies). On 1 August 2000, Burke receives from Wills an unfranked dividend. Burke and Wills remain wholly-owned companies for the remainder of the income year in which the dividend is paid.

Although Burke Company would not be able to access the ICDR on the unfranked dividend under the new 12 month test, Burke would continue to be eligible to the ICDR under the whole of year test because Burke and Wills were group companies for the whole of the income year in which the dividend is paid.

Application provisions

5.14 The amendment made by Schedule 3 applies in respect of dividends paid on or after 1 July 2000. [Schedule 3, item 2]

5.15 To accommodate amendments also being made to subsection 46F(3) of the ITAA 1936 contained in Taxation Laws Amendment Bill (No. 2) 2002, the amendment proposed commences at the earlier of:

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date of Royal Assent for this bill; and

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immediately before Schedule 2 of Taxation Laws Amendment Bill (No. 2) 2002 commences.

[Clause 2]

Index