House of Representatives

Explanatory Memorandum

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

Chapter 2 - Capital gains tax roll-over for medical defence organisations

Outline of chapter

2.1 Schedule 2 to this Bill amends the Income Tax Assessment Act 1997 (ITAA 1997) to provide a capital gains tax (CGT) roll-over for membership interests in medical defence organisations (MDOs). The roll-over will generally be available when a membership interest in an MDO is replaced with a similar membership interest in another MDO and both MDOs are companies limited by guarantee.

Context of amendments

2.2 Subdivision 124-M of the ITAA 1997 provides a CGT scrip for scrip roll-over when a taxpayer disposes of shares or certain trust interests they own and those shares or trust interests are replaced with other shares or trust interests, for example, when there is a merger or a takeover. This roll-over ensures that any capital gain made on the exchange of the original shares or trust interests is deferred until after the exchange and a further CGT event happens to the replacement shares or trust interests.

2.3 The Review of Business Taxation, chaired by Mr John Ralph AC, recommended this roll-over in 1999 to achieve a better allocation of the nation's capital resources by removing CGT as an impediment to mergers and takeovers.

2.4 However, the roll-over is not available for membership interests in companies limited by guarantee. This is because members of companies limited by guarantee do not hold shares in the company but hold a membership interest instead.

2.5 These amendments will provide a roll-over for membership interests in companies limited by guarantee that are also MDOs. This will ensure that CGT need not be an impediment to mergers or takeovers of MDOs.

2.6 MDOs provide indemnity insurance to members of the medical profession through wholly-owned captive insurers.

2.7 For historical reasons, MDOs have a strong presence in particular jurisdictions but more limited claims experience in other jurisdictions. A medical indemnity insurer created through a merger or takeover of MDOs should benefit from pooled claims data in setting its premiums. It will also benefit from economies of scale.

Summary of new law

2.8 This Schedule amends Division 124 of the ITAA 1997 by inserting Subdivision 124-P. This Subdivision will provide a CGT roll-over when a membership interest in an MDO is replaced with a similar membership interest in another MDO and both MDOs are companies limited by guarantee.

Comparison of key features of new law and current law

Detailed explanation of new law

2.9 An 'MDO' is defined under section 5 of the Medical Indemnity Act 2002 .

Exchange of membership interests in an MDO

2.10 The roll-over will be available to defer the making of a capital gain from the exchange of a membership interest, acquired on or after 20 September 1985, in an MDO for a similar interest in another MDO [Schedule 2, item 5, paragraphs 124-980(1)(d) and (f)] . The roll-over is not available to defer the making of a capital loss.

2.11 Both MDOs must be companies limited by guarantee. [Schedule 2, item 5, paragraph 124-980(1)(b)]

2.12 A member of an MDO can choose whether or not to obtain the roll-over. [Schedule 2, item 5, paragraph 124-980(1)(e)]

Example 2.1

Doctors Defence Ltd (Doctors Defence) and Practitioners Protection Ltd (Practitioners Protection) are both companies limited by guarantee. Each is an MDO. Doctors Defence proposes to merge with Practitioners Protection under an arrangement whereby membership interests in Doctors Defence are exchanged for membership interests in Practitioners Protection.

Phil is a member of Doctors Defence. If the exchange of Phil's membership interest in Doctors Defence for a similar interest in Practitioners Protection realises a capital gain, and the other requirements of the roll-over are satisfied, then he may choose to roll-over the gain into the replacement interest he receives in Practitioners Protection.

2.13 The roll-over will only be available for a member who receives an interest in the acquiring MDO that is similar to their membership interest in the original MDO. [Schedule 2, item 5, paragraph 124-980(1)(a)]

2.14 In determining whether the replacement interest is similar to the original interest, a difference that consists only of a right to receive distributions of income or capital is ignored. [Schedule 2, item 5, subsection 124-980(2)]

Example 2.2

In addition to the facts in Example 2.1, Lauren has been a continuous member of Doctors Defence since 1999. In exchange for her membership interest in Doctors Defence, she receives a membership interest in Practitioners Protection. Lauren's interest in Doctors Defence did not provide her with the right to receive distributions of income and capital from the company. However, the interest she receives in Practitioners Protection does include the right to receive distributions of income and capital.

In determining whether Lauren receives a similar interest in Practitioners Protection for her interest in Doctors Defence, her right to receive distributions of income and capital from Practitioners Protection is ignored.

2.15 The exchange of a membership interest in the original MDO for a membership interest in the acquiring MDO must be in consequence of a single arrangement [Schedule 2, item 5, paragraph 124-980(1)(c)] . The arrangement must result in the acquiring MDO becoming the sole member of the original MDO [Schedule 2, item 5, paragraph 124-980(3)(a)] .

Example 2.3

For the roll-over to be available to the members of Doctors Defence who receive interests in Practitioners Protection, Practitioners Protection must become the sole member of Doctors Defence as a result of the merger.

2.16 In addition, participation in the exchange of membership interests must be on substantially the same terms for all the holders of particular interests in the original MDO. Holders of particular interests in the original MDO however, are not required to be able to participate in the exchange of membership interests on the same terms as holders of different interests. [Schedule 2, item 5, paragraph 124-980(3)(b)]

Example 2.4

In addition to the facts in Example 2.1, Doctors Defence has two different classes of members. It has ordinary members and student members.

The roll-over will be available if:

•

all the ordinary members in Doctors Defence are able to participate on substantially the same terms; and

•

all the student members in Doctors Defence are able to participate on substantially the same terms.

Student members would not be required to be able to participate on substantially the same terms as ordinary members.

Roll-over for post-CGT membership interests

2.17 If a member with a post-CGT membership interest chooses to obtain the roll-over then the CGT consequences are as follows:

•

a capital gain made from the original interest is disregarded [Schedule 2, item 5, subsection 124-985(1)] ; and

•

the first element of the cost base of the replacement interest will be the cost base of the original interest that was exchanged for it [Schedule 2, item 5, subsection 124-985(2)] .

Example 2.5

Surgeons Services Ltd (Surgeons Services) is a company limited by guarantee that is also an MDO. It proposes to merge with Anaesthetists Assurance Ltd (Anaesthetists Assurance) under an arrangement whereby the membership interests in Surgeons Services are cancelled and the members receive similar interests in Anaesthetists Assurance. Anaesthetists Assurance is also a company limited by guarantee and an MDO.

Joe is an ordinary member of Surgeons Services. He has claimed all the costs of his membership interest as an income tax deduction. Consequently the cost base of his membership interest in Surgeons Services is zero.

Joe's membership interest in Surgeons Services is cancelled and he receives a similar membership interest in Anaesthetist Assurance.

The first element of the cost base of Joe's replacement interest in Anaesthetist Assurance will be zero.

2.18 The cost base of the original interest is its cost base just before the exchange of interests. In situations when a member receives ineligible proceeds, in addition to an interest in the acquiring MDO (similar to their interest in the original MDO), the cost base of the original interest will be reduced [Schedule 2, item 5, subsections 124-985(2) and (3)] . In these circumstances a partial roll-over may be available. The availability of a partial roll-over is discussed in paragraphs 2.19 to 2.21.

Partial roll-over

2.19 The roll-over will not be available to the extent that a member receives ineligible proceeds for their original interest. Ineligible proceeds can be anything that the member receives other than a replacement interest in the acquiring MDO that is similar to their original interest. Cash would be an example of ineligible proceeds. [Schedule 2, item 5, subsection 124-990(1)]

2.20 To work out the amount of any capital gain or loss made on the cancellation or disposal of the ineligible interest, the cost base of the original interest is apportioned to reflect the ineligible proceeds received. The apportionment is done on a reasonable basis. [Schedule 2, item 5, subsection 124-990(2)]

Example 2.6

Assume the same facts as Example 2.5, except that all student members of Surgeons Services will receive $5 cash in addition to a replacement interest in Anaesthetists Assurance that is similar to their interest in Surgeons Services.

Michael is a student member of Surgeons Services. The cost base of his membership interest is $10. (Michael has not claimed the cost of his membership interest as an income tax deduction.)

Michael exchanges his interest in Surgeon Services for a similar interest in Anaesthetists Assurance and receives ineligible proceeds of $5.

The $5 ineligible proceeds cannot be rolled over.

The market value of Michael's replacement interest in Anaesthetists Assurance is $20.

In this case it will be reasonable to allocate a portion of the cost base of the original membership interest having regard to the total proceeds ($25) according to the following formula:

{ineligible proceeds * original cost base) / total proceeds - apportioned cost base


That is:

($5 * $10) / $25 = $2


The apportioned cost base of Michael's interest in Surgeons Services will be $2.

Michael would calculate his capital gain as follows:

Ineligible proceeds - apportioned cost base = capital gain


That is:

$5 - $2 = $3


Michael would determine the cost base of his membership interest in Anaesthetists Assurance as follows:

[original cost base - apportioned cost base] / number of interests = cost base of replacement interest


That is:

[$10 - $2] / 1 = $8


Michael will make a $3 capital gain. The cost base of his membership interest in Anaesthetists Assurance will be $8.

2.21 The first element of the reduced cost base of a replacement asset is worked out similarly. [Schedule 2, item 5, subsection 124-985(4)]

Pre-CGT membership interests

2.22 The roll-over is not available for pre-CGT membership interests in the original MDO. [Schedule 2, item 5, paragraph 124-980(1)(f)]

2.23 A member who exchanges a pre-CGT membership interest for a replacement membership interest in the acquiring MDO will acquire their replacement interest at the time it is issued to them. The first element of the cost base of the replacement interest will be zero. [Schedule 2, item 5, section 124-995]

Example 2.7

Megan has a pre-CGT membership interest in Cardiologists Cover Ltd (Cardiologists Cover) which is a company limited by guarantee that is also an MDO. Cardiologists Cover merges with Immunologists Indemnity Ltd (Immunologists Indemnity) which is also a company limited by guarantee and an MDO. As part of the merger, Megan exchanges her interest in Cardiologists Cover for a similar interest in Immunologists Indemnity.

The first element of the cost base of Megan's post-CGT replacement interest in Immunologists Indemnity will be zero.

Application and transitional provisions

2.24 These amendments will commence on Royal Assent.

2.25 These amendments will apply to CGT events that happen on or after 14 February 2007.

Consequential amendments

2.26 Consequential amendments will also be made to the ITAA 1997 to reflect the availability of this roll-over.

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References to this roll-over will be added to Subdivision 112-B. Subdivision 112-B lists situations when the general cost base and reduced cost base rules may be modified [Schedule 2, items 1 and 2] .

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A reference to Subdivision 124-P will be added to the guide material of Division 124 [Schedule 2, item 3] .

•

A reference to this roll-over will be added to the note in subsection 124-5(2) [Schedule 2, item 4] .