House of Representatives

Explanatory Memorandum

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

Chapter 12 - Transfer of life insurance business

Outline of chapter

12.1 Schedule 12 to this bill amends the income tax law to alleviate unintended tax consequences that arise when a life insurance company transfers some or all of its life insurance business to another life insurance company under Part 9 of the Life Insurance Act 1995 or under the Financial Sector (Transfers of Business) Act 1999.

Context of amendments

12.2 Division 320 of the Income Tax Assessment Act 1997 (ITAA 1997) contains special rules for taxing life insurance companies. These amendments overcome concerns raised by the life insurance industry about the taxation consequences that arise when life insurance business is transferred under Part 9 of the Life Insurance Act 1995 or under the Financial Sector (Transfers of Business) Act 1999.

Summary of new law

12.3 When a life insurance company (the originating company) transfers some or all of its life insurance business to another life insurance company (the recipient company) under Part 9 of the Life Insurance Act 1995 or under the Financial Sector (Transfers of Business) Act 1999, these amendments ensure that:

•

consideration paid in relation to certain life insurance policies transferred is a life insurance premium for the purposes of Division 320;

•

the originating company and the recipient company are taxed appropriately when risk policies are transferred;

•

segregated assets of the originating company become segregated assets of the recipient company;

•

immediate annuity policies purchased before 10 December 1987 and certain policies issued by friendly societies before 1 January 2003 retain their character for taxation purposes; and

•

assets notionally segregated by the originating company continue to be treated as separate assets.

12.4 In addition, if the originating company and the recipient company are members of the same wholly-owned group, these amendments:

•

ensure that transitional provisions that apply to continuous disability policies and to life insurance policies issued by the originating company before 1 July 2000 continue to apply; and

•

allow a capital gains tax (CGT) roll-over for capital gains and capital losses that arise when life insurance business is transferred.

Comparison of key features of new law and current law

Detailed explanation of new law

12.5 These amendments:

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insert Subdivision 320-I into Division 320 to ensure that life insurance companies are taxed appropriately when life insurance business is transferred from one life insurance company to another life insurance company; and

•

allow a CGT roll-over for capital gains and capital losses that arise when life insurance business is transferred if the recipient company and the originating company are members of the same wholly-owned group and the transfer occurs before the end of the consolidation period.

12.6 Subdivision 320-I and the new CGT roll-over will apply if all or part of the life insurance business of a life insurance company is transferred to another life insurance company:

•

in accordance with a scheme confirmed by the Federal Court of Australia under Part 9 of the Life Insurance Act 1995; or

•

under the Financial Sector (Transfers of Business) Act 1999.

[Schedule 12, item 5, section 320-305]

Transferring life insurance policy liabilities

Ordinary investment policy liabilities

12.7 An ordinary investment policy is defined in subsection 995-1(1) to be a life insurance policy that is not a virtual pooled superannuation trust policy, an exempt life insurance policy, a policy that provides for participating or discretionary benefits or a risk policy.

12.8 The amount or value of any consideration the recipient company receives from the originating company in respect of ordinary investment policy liabilities transferred will be a life insurance premium for the purposes of Division 320. This will ensure that the recipient company is appropriately taxed on fees and risk premiums that it deducts from ordinary investment policy liabilities transferred from the originating company. [Schedule 12, item 5, section 320-320]

Participating policy liabilities

12.9 Participating policies are policies that provide participating or discretionary benefits. The key feature of participating policies is that policyholders are entitled to share in the profit the company makes on this part of their business.

12.10 The amount or value of any consideration the recipient company receives from the originating company that relates to participating policy liabilities transferred (other than participating policy liabilities that were discharged from the originating company's virtual pooled superannuation trust or segregated exempt assets just before the transfer occurred) will be a life insurance premium for the purposes of Division 320. This will ensure that the recipient company is taxed appropriately when these policy liabilities are transferred from the originating company. [Schedule 12, item 5, subsection 320-320(1)]

12.11 However, the amount or value of any consideration the recipient company receives for the risk component of participating policies that relates to contracts of reinsurance (other than any consideration in respect of a risk in relation to which subsection 148(1) of the Income Tax Assessment Act 1936 (ITAA 1936) applies) will not be a life insurance premium for the purposes of Division 320. [Schedule 12, item 5, paragraph 320-320(2)(b)]

Risk policy liabilities

12.12 Risk policies are policies (other than participating policies, exempt life insurance policies or funeral policies) under which benefits are payable only on the death or disability of a person.

12.13 These amendments ensure that both the originating company and the recipient company are taxed appropriately when risk policy liabilities are transferred.

12.14 If the originating company pays an amount to the recipient company for the risk policy liabilities transferred, then:

•

the originating company can deduct the amount it pays to the recipient company in respect of the liabilities under the net risk components of life insurance policies transferred to the recipient company; and

•

the amount or value of any consideration the recipient company receives from the originating company that relates to the net risk policy liabilities transferred is a life insurance premium for the purposes of Division 320. Consequently, the recipient company will include this amount in its assessable income under paragraph 320-15(1)(a).

[Schedule 12, item 5, subsection 320-310(1) and section 320-320]

12.15 The net risk component of a life insurance policy is defined in subsection 995-1(1) to be so much of the policy's risk component as is not reinsured under a contract of reinsurance (other than a contract of reinsurance to which subsection 148(1) of the ITAA 1936 applies).

12.16 Consequently, the amount paid or received in respect of the liabilities under the net risk components of life insurance policies transferred, includes the amount or value of any consideration in respect of a risk in relation to which subsection 148(1) of the ITAA 1936 applies. [Schedule 12, item 5, paragraph 320-320(2)(b)]

12.17 The recipient company could pay, or in effect pay, an amount to the originating company if the net risk liabilities transferred are negative. The amount the recipient company pays to the originating company includes any amount taken into account for the transfer of these policy liabilities in the agreement between the companies to transfer the business.

12.18 If the recipient company pays, or in effect pays, an amount to the originating company for the risk policy liabilities transferred, then:

•

the originating company will include in assessable income the amount it receives from the recipient company in respect of the liabilities under the net risk components of life insurance policies transferred; and

•

the recipient company can deduct the amount it pays to the originating company in respect of the liabilities under the net risk components of life insurance policies transferred to the recipient company.

[Schedule 12, item 5, subsections 320-310(2) and (3)]

Virtual pooled superannuation trust and exempt life insurance policy liabilities

12.19 Virtual pooled superannuation trust policies are, broadly, complying superannuation policies. Exempt life insurance policies are, broadly, policies that provide immediate annuities. Life insurance companies can discharge these policies from their virtual pooled superannuation trust or segregated exempt assets.

Policies discharged from the originating company's segregated assets

12.20 If the originating company transfers liabilities that relate to virtual pooled superannuation trust policies or exempt life insurance policies to the recipient company, it discharges its liability to pay any amounts under the policies. If, prior to the transfer, the liabilities under these policies were to be discharged from the originating company's virtual pooled superannuation trust or segregated exempt assets, the originating company must pay the full amount required to discharge these liabilities (i.e. transfer the assets) directly from its virtual pooled superannuation trust or segregated exempt assets respectively (subsections 320-195(4) and 320-250(3)).

12.21 To ensure that the recipient company is taxed appropriately when assets relating to these policies are transferred:

•

any assets that were virtual pooled superannuation trust assets or segregated exempt assets of the originating company when the transfer occurred will, immediately after the transfer, be virtual pooled superannuation trust assets and segregated exempt assets of the recipient company respectively; and

•

any part of the consideration received from the originating company that relates to liabilities that, immediately before the transfer occurred, were discharged from the originating company's virtual pooled superannuation trust or segregated exempt assets will not be a life insurance premium.

[Schedule 12, item 5, section 320-315 and paragraph 320-320(2)(a)]

Policies not discharged from the originating company's segregated assets

12.22 The originating company could hold assets that support liabilities under virtual pooled superannuation trust policies and exempt life insurance policies outside of its segregated assets.

12.23 To ensure that the recipient company is taxed appropriately when these policies are transferred, the consideration it receives from the originating company that relates to virtual pooled superannuation trust and exempt life insurance policy liabilities that were not discharged from the originating company's segregated assets will be a life insurance premium. [Schedule 12, item 5, section 320-320]

Liabilities relating to certain policies issued by friendly societies before 1 January 2003

12.24 As a transitional rule, amounts derived by life insurance companies that are friendly societies that are attributable to income bonds, funeral policies, sickness policies or certain scholarship plans issued before 1 January 2003 are treated as non-assessable non-exempt income (paragraph 320-37(1)(d)).

12.25 This transitional rule will continue to apply to these policies when they are transferred to the recipient company if:

•

the originating company and the recipient company are friendly societies immediately before the transfer occurs; and

•

the terms of the replacement policies issued by the recipient company are not materially different to the terms of the original policies issued by the originating company.

[Schedule 12, item 5, section 320-325]

12.26 That is, if these conditions are met, amounts derived by the recipient company that are attributable to income bonds, funeral policies or certain scholarship plans issued by the originating company before 1 January 2003 will continue to be non-assessable non-exempt income.

Immediate annuity policy liabilities

12.27 Generally, immediate annuity policies are exempt life insurance policies only if they satisfy certain conditions. However, as a transitional rule, those conditions do not need to be satisfied for certain immediate annuity policies that were purchased before 10 December 1987 (paragraph 320-246(1)(e)).

12.28 This transitional rule will continue to apply to these policies when they are transferred to a recipient company if the terms of the replacement policies issued by the recipient company are not materially different to the terms of the original policies issued by the originating company. [Schedule 12, item 5, section 320-330]

Liabilities relating to continuous disability policies transferred between companies within the same wholly-owned group

12.29 From 1 July 2000, life insurance companies must use the 'Valuation Standard' (as defined in subsection 995-1(1)) as the basis for valuing liabilities relating to continuous disability policies (section 320-85). As the value of liabilities used before 1 July 2000 was usually higher than the value calculated using the Valuation Standard, transitional arrangements were introduced to spread the impact of the change in values over five years (section 320-30).

12.30 When the originating company transfers all of the liabilities under its continuous disability policies, the balance of the difference in the value of liabilities caused by the change in the basis of valuation is included in its assessable income.

12.31 The outstanding balance of the difference in the value of liabilities for continuous disability policies is not included in the originating company's assessable income in the year of the transfer if:

•

the originating company and the recipient company are members of the same 'wholly-owned group' (as defined in section 975-500) when the transfer occurs;

•

all of the liabilities under the continuous disability policies of the originating company are transferred to the recipient company; and

•

the transfer occurs before the income year in which 1 July 2005 occurs.

[Schedule 12, item 5, subsection 320-340(1)]

12.32 Companies are members of the same wholly-owned group if one of the companies is a 100% subsidiary of the other company, or the companies are a 100% subsidiary of the same third company (section 975-500).

12.33 If the conditions in paragraph 12.31 are satisfied, then:

•

in the income year the transfer occurs:

-

the originating company will include in its assessable income the amount it would have included in the income year if the transfer had not occurred, multiplied by the part of the year that the company held the continuous disability policies; and

-

the recipient company will include in its assessable income the balance of the amount the originating company did not include in its assessable income in the income year; and

•

for each relevant year after the transfer, the recipient company will include in its assessable income the amount the originating company would have included in the income year if the transfer had not occurred.

[Schedule 12, item 5, subsections 320-340(2) to (5)]

Liabilities relating to certain life insurance policies issued before 1 July 2000 transferred between companies within the same wholly-owned group

12.34 As a transitional rule, one-third of specified management fees in respect of life insurance policies entered into before 1 July 2000 are treated as non-assessable non-exempt income (section 320-40). This transitional rule ceases to apply after 30 June 2005.

12.35 This transitional rule will continue to apply to these policies when they are transferred to a recipient company if:

•

the originating company and the recipient company are members of the same 'wholly-owned group' (as defined in section 975-500) when the transfer occurs;

•

the terms of the replacement policies issued by the recipient company are not materially different to the terms of the original policies issued by the originating company; and

•

the transfer occurs before 1 July 2005.

[Schedule 12, item 5, subsections 320-345(1) and (2)]

12.36 That is, if these conditions are satisfied, one-third of specified management fees derived by the recipient company in relation to life insurance policies transferred from the originating company that were issued by the originating company prior to 1 July 2000 will be non-assessable non-exempt income. The amount of specified management fees that will qualify for transitional relief cannot exceed the amount of any fees or charges that the originating company was entitled to make under the terms of the policies as applying immediately before 1 July 2000. [Schedule 12, item 5, subsection 320-345(3)]

Transfer of notionally segregated assets

12.37 Life insurance companies were required to segregate virtual pooled superannuation trust assets and segregated exempt assets with effect from 1 July 2000 (sections 320-170 and 320-225). As a transitional rule, part of a large asset could be certified to be a separate asset for these purposes (sections 320-170 and 320-225 of the Income Tax (Transitional Provisions) Act 1997).

12.38 When the originating company transfers an asset that it notionally segregated to the recipient company, the parts of the asset that the originating company certified to be separate assets, must be treated by the recipient company as separate assets. [Schedule 12, item 5, section 320-335]

CGT roll-over for assets transferred between companies within the same wholly-owned group

12.39 A CGT roll-over will apply to capital gains and capital losses that arise when life insurance business is transferred between companies within the same wholly-owned group. The roll-over is broadly consistent with the CGT roll-over under Subdivision 126-B of the ITAA 1997 that applies to companies that are members of the same wholly-owned group.

Conditions for the CGT roll-over

12.40 When a life insurance company transfers some or all of its life insurance business to another life insurance company under Part 9 of the Life Insurance Act 1995 or under the Financial Sector (Transfers of Business) Act 1999, the originating company can qualify for the CGT roll-over if:

•

the originating company and the recipient company are members of the same wholly-owned group just before the transfer; and

•

the transfer occurs before the end of the consolidation transitional period (i.e. before the later of 30 June 2004 and, if the head company of the consolidated group of which the originating company and the recipient company are members has a substituted accounting period, the end of the head company's income year in which 30 June 2004 occurs).

[Schedule 12, item 8, paragraphs 126-150(1)(a), (b) and (d) of the Income Tax (Transitional Provisions) Act 1997]

12.41 In addition:

•

a CGT asset of the originating company must become an asset of the recipient company;

•

a CGT asset of the originating company must end and the recipient company must acquire an equivalent replacement asset; or

•

the originating company must create a CGT asset in the recipient company.

[Schedule 12, item 8, paragraph 126-150(1)(c) of the Income Tax (Transitional Provisions) Act 1997]

12.42 A CGT asset of the originating company could end and the recipient company could acquire an equivalent replacement asset if, for example:

•

the originating company has rights under a contract that come to an end because under the transfer agreement the contract is novated to the recipient company; or

•

the originating company holds units in a trust which are cancelled and replaced by equivalent units that are issued to the recipient company.

12.43 However, the CGT roll-over will not apply if the asset is trading stock of the recipient company just after the transfer occurs. In addition:

•

if the transfer occurs before 1 July 2001 and the roll-over asset is a right, a convertible note or an option and the recipient company acquires another CGT asset by exercising the right or option, or by converting the convertible note - the CGT roll-over will not apply if the other asset becomes trading stock of the recipient company just after the recipient company acquired it; or

•

if the transfer occurs on or after 1 July 2001 and the roll-over asset is a right, convertible interest, an option or an exchangeable interest and the recipient company acquires another CGT asset by exercising the right or option, by converting the convertible interest or in exchange for the disposal or redemption of the exchangeable interest - the CGT roll-over will not apply if the other asset becomes trading stock of the recipient company just after the recipient company acquired it.

[Schedule 12, items 8 and 9, subsections 126-150(2) and (3) of the Income Tax (Transitional Provisions) Act 1997]

12.44 The CGT roll-over will occur only if the originating company and recipient company both choose in writing to obtain the roll-over and either:

•

the CGT event would have resulted in the originating company making a capital gain, or making no capital loss and not being entitled to a deduction;

•

the originating company acquired the roll-over asset before 20 September 1985; or

•

the CGT event would have resulted in the originating company making a capital loss.

[Schedule 12, item 8, subsections 126-155(1) and (2) of the Income Tax (Transitional Provisions) Act 1997]

12.45 The choice to obtain the roll-over must be made by the latest of:

•

12 months after the date of Royal Assent to this bill; and

•

a later day allowed by the Commissioner of Taxation.

[Schedule 12, item 8, subsection 126-155(3) of the Income Tax (Transitional Provisions) Act 1997]

Consequences of the capital gains tax roll-over

12.46 If a CGT roll-over occurs, the originating company disregards the capital gain or capital loss it makes from the CGT event. [Schedule 12, item 8, subsection 126-160(1) of the Income Tax (Transitional Provisions) Act 1997]

12.47 When the recipient company disposes of a roll-over asset:

•

the first element of the cost base of the original asset or the replacement asset for the recipient company is the cost base of the original asset for the originating company just before the transfer occurred;

•

the first element of the reduced cost base of the original asset or the replacement asset for the recipient company is the reduced cost base of the original asset for the originating company just before the transfer occurred; and

•

if the originating company acquired the original CGT asset before 20 September 1985, the recipient company is taken to have acquired the original asset or the replacement asset before that date.

[Schedule 12, item 8, subsections 126-160(2), (3) and (5) of the Income Tax (Transitional Provisions) Act 1997]

12.48 If, as a result of the transfer, the originating company creates a CGT asset in the recipient company (i.e. CGT event D1, D2, D3 or F1 occurs), the first element of the asset's cost base in the hands of the recipient company is:

•

if the asset is created as a result of CGT event D1 - the incidental costs the originating company incurred that relate to the CGT event;

•

if the asset is created as a result of CGT event D2 - the expenditure the originating company incurred to grant the option;

•

if the asset is created as a result of CGT event D3 - the expenditure the originating company incurred to grant the right; and

•

if the asset is created as a result of CGT event F1 - the expenditure the originating company incurred on the grant, renewal or extension of the lease.

[Schedule 12, item 8, subsection 126-160(4) of the Income Tax (Transitional Provisions) Act 1997]

12.49 The first element of the asset's reduced cost base is worked out similarly. [Schedule 12, item 8, subsection 126-160(4) of the Income Tax (Transitional Provisions) Act 1997]

12.50 For the purposes of working out the asset's cost base, expenditure can include giving property. [Schedule 12, item 8, subsection 126-160(4) of the Income Tax (Transitional Provisions) Act 1997]

Interaction with other parts of the income tax law

12.51 A reference to Subdivision 126-B of the ITAA 1997 in the income tax law will be taken to include a reference to Subdivision 126-B of the Income Tax (Transitional Provisions) Act 1997. This will ensure that the provisions in the income tax law that apply when there is a CGT roll-over under Subdivision 126-B of the ITAA 1997 for companies within the same wholly-owned group also apply to a CGT roll-over under Subdivision 126-B of the Income Tax (Transitional Provisions) Act 1997. [Schedule 12, item 8, section 126-165 of the Income Tax (Transitional Provisions) Act 1997]

12.52 Consequently, for example:

•

the new CGT roll-over will be included in the list of same asset roll-overs in section 112-150;

•

CGT event J1 (section 104-175) may happen if the recipient company subsequently ceases to be a member of the same wholly-owned group;

•

a tax cost setting amount of the recipient company may be affected if it joins a consolidated group (section 705-50); and

•

the allocable cost amount of the recipient company may be affected if it joins a consolidated group (section 705-150).

Interaction with former Division 138

12.53 Former Division 138 contained provisions to prevent tax benefits arising when assets were shifted between companies under common ownership. The effect of Division 138 was to adjust the cost bases and reduced cost bases of shares (and other interests). Division 138 has been repealed and replaced with Part 3-95 with effect from 24 October 2002. However, the Division continues to apply to relevant events that happened before 1 July 2002 or under a scheme entered into before 27 June 2002.

12.54 Division 138 may apply inappropriately when a transfer occurs because the assumption of liabilities by the recipient company may not be taken into account in determining whether value has been shifted from the originating company.

12.55 These amendments ensure that, for the purpose of applying Division 138, the market value of liabilities assumed by the recipient company in respect of the transfer is taken to be money received (and therefore will be 'capital proceeds' as defined in subsection 116-20(1)) by the originating company in respect of the transfer of assets, except to the extent that an amount is already taken into account as capital proceeds. [Schedule 12, item 1, section 138-25]

Interaction with Division 170

12.56 Division 170 contains rules for the transfer of losses between members of a wholly-owned group and supporting integrity measures.

12.57 Subdivision 170-C adjusts the cost base and/or reduced cost base of certain debt and equity interests if a tax loss or net capital loss is transferred between companies in the same wholly-owned group. This Subdivision is designed to prevent the duplication of losses.

12.58 An effective transfer of losses could arise when a life insurance company transfers its life insurance business because the CGT roll-over in Subdivision 126-B of the Income Tax (Transitional Provisions) Act 1997 will allow unrealised capital losses to be transferred from the originating company to the recipient company. The recipient company will be able to realise those losses by disposing of the CGT assets.

12.59 In addition, the value of membership interests held in the originating company may reduce as a result of the fall in value of the asset before its transfer. If the recipient company (or a related company) holds those membership interests, it could duplicate the losses by disposing of the membership interests.

12.60 These amendments ensure that Subdivision 170-C applies to unrealised capital losses disregarded by the originating company because they are rolled over to the recipient company under Subdivision 126-B of the Income Tax (Transitional Provisions) Act 1997. [Schedule 12, item 10, section 170-300 of the Income Tax (Transitional Provisions) Act 1997]

Application and transitional provisions

12.61 These amendments apply to transfers of life insurance business that take place on or after 1 July 2000. [Schedule 12, item 11]

12.62 In this regard, the measure has been actively sought by the life insurance industry and removes unintended taxation consequences that arise under the current law that act as an impediment to transfers of life insurance business. In addition, some life insurance companies have undertaken transfers of life insurance business since 1 July 2000 based upon the announcement of this measure.

Consequential amendments

12.63 Consequential amendments insert various notes to guide readers and modify headings. [Schedule 12, items 2 to 4, 6 and 7, subsections 320-30(1), 320-37(1), 320-40(1), the definition of 'life insurance premium' in subsection 995-1(1) of the ITAA 1997 and Division 126 of the Income Tax (Transitional Provisions) Act 1997]