House of Representatives

Explanatory Memorandum

Circulated by the authority of the Treasurer, the Hon Wayne Swan MP

Chapter 1

Demutualisation of private health insurers

Outline of chapter

1.1 Schedule 1 to this Bill amends the Income Tax Assessment Act 1997 (ITAA 1997) to provide relief from capital gains tax (CGT) to private health insurance policy holders when their insurer converts, by demutualising, from being a not for profit to a for profit insurer. A key requirement for this relief will, in general, be the Private Health Insurance Administration Council's approval of the insurer's conversion under the Private Health Insurance Act 2007 (PHIA 2007).

Context of amendments

1.2 For taxation purposes, the principle of mutuality applies when a number of individuals associate together for a common purpose and contribute to a common fund in which all the individuals have an interest.

1.3 Demutualisation involves the participants of such a fund giving up their rights to participate in the fund. In effect, this involves the participants giving up the right to benefit in the future from any mutual surplus that has been (or may be) built. Upon demutualisation there is effectively a distribution of any accumulated mutual surplus to the participants.

1.4 Ordinarily, this would trigger a CGT taxing point.

1.5 Division 9AA of the Income Tax Assessment Act 1936 (ITAA 1936), which does not apply to private health insurers, provides that any capital gains or losses that arise on these transactions for members and policy holders of life insurers and general insurers that demutualise are disregarded. Schedule 2H to the ITAA 1936 provides members of other mutual entities that demutualise with similar relief.

1.6 It is a requirement of the PHIA 2007 that when a not for profit private health insurer converts to a for profit health insurer by demutualising, the financial benefits of that conversion must not be distributed inequitably between policy holders and other insured persons of the insurer.

1.7 Many policy holders of not for profit private health insurers are not 'members' in the sense that is required under Schedule 2H to the ITAA 1936. This means that such policy holders of a not for profit private health insurer that converts to a for profit insurer by demutualising are not covered by the existing demutualisation provisions and would be subject to the general income and CGT provisions of the tax law on demutualisation.

1.8 A health insurance policy and the policy holder's right to participate in the fund may be bound up in a single, indivisible CGT asset that is a personal use asset of the policy holder. The existing CGT provisions disregard any capital gain arising from a personal use asset if the first element of the asset's cost base is less than $10,000. In addition, the existing CGT provisions disregard any capital loss arising from a personal use asset.

1.9 It is a question of fact whether the insurance policy and the policy holder's right to participate in the fund are parts of a single, indivisible CGT asset which may be eligible for the personal use asset exemption.

1.10 The CGT relief provided by these amendments is intended to facilitate the demutualisation of private health insurers and is available in specific situations only. More generally, these amendments are not intended to affect whether or not a health insurance policy is a personal use asset.

Summary of new law

1.11 This Schedule amends the ITAA 1997 by inserting a new Division, Division 315, which broadly disregards capital gains or losses that arise from various transactions that occur when a private health insurer converts to a for profit insurer, by demutualising, under subsection 126-42(5) of the PHIA 2007.

1.12 Specifically, Subdivision 315-A disregards capital gains or losses that arise under the insurer's demutualisation. Subdivision 315-C disregards capital gains or losses, and sets out other CGT consequences, that arise when shares are transferred to lost policy holders following the private health insurer's demutualisation.

1.13 In addition, this Division provides a market value cost base for shares, or rights to acquire shares, in the demutualised private health insurer issued to policy holders under the insurer's demutualisation. These provisions are located in Subdivision 315-B. Subdivision 315-D sets out the cost base rules for shares, or rights to acquire shares, in another company that are issued to policy holders under a private health insurer's demutualisation.

1.14 Subdivision 315-E sets out special rules for legal personal representatives and beneficiaries of a deceased policy holder's estate who receive shares, or rights to acquire shares, that would have otherwise been issued to the deceased policy holder under the private health insurer's demutualisation.

1.15 Non-CGT tax consequences arising from a private health insurer's demutualisation are set out in Subdivision 315-F.

1.16 Division 315 is located in a new Part, Part 3-32, which will deal with co-operatives and mutual entities.

Comparison of key features of new law and current law

Detailed explanation of new law

1.17 The PHIA 2007 requires entities carrying on health insurance business to be registered with the Private Health Insurance Administration Council. The Council is an independent statutory authority that regulates the private health insurance industry. Private health insurers may be registered as a not for profit private health insurer or a for profit private health insurer.

1.18 Under subsection 126-42(1) of the PHIA 2007, a private health insurer may apply to the Council for approval to convert from being a not for profit private health insurer to being a for profit private health insurer. Paragraph 126-42(2)(b) of the PHIA 2007 requires the private health insurer to provide the Council with its conversion scheme as part of its application.

1.19 Generally, the Council is required to approve the insurer's conversion under subsection 126-42(3) of the PHIA 2007 if it is satisfied that the insurer's conversion scheme would not in substance involve the insurer's demutualisation.

1.20 However, if the Council is satisfied that the insurer's conversion scheme would in substance involve the demutualisation of the insurer then it must approve the conversion scheme under subsection 126-42(5) of the PHIA 2007 only if it is satisfied that the scheme:

•

would not result in a financial benefit to any person who is not a policy holder of, or another person insured by the insurer; and

•

would not result in financial benefits from the scheme being distributed inequitably between such policy holders and insured persons.

1.21 A decision by the Private Health Insurance Administration Council to refuse an application to approve, under subsection 126-42(5) of the PHIA 2007, a private health insurer's conversion to a for profit insurer is reviewable by the Administrative Appeals Tribunal under item 6A of section 328-5 of the PHIA 2007.

1.22 Division 315 of the ITAA 1997 does not mean that a private health insurer, who converts to a for profit insurer by demutualising and distributing its accumulated mutual surplus in any of the ways provided for in the Division, will necessarily meet the requirements of subsection 126-42(5) of the PHIA 2007.

Eligible demutualisations

1.23 The following requirements must be satisfied for the relief in Division 315 of the ITAA 1997 to be available.

Eligible entities

1.24 Prior to its demutualisation, the private health insurer must be a tax exempt entity under item 6.3 in the table in section 50-30 of the ITAA 1997. Item 6.3 applies to entities which are private health insurers within the meaning of the PHIA 2007 that are not carried on for the profit or gain of their individual members. [ Schedule 1, item 11, subparagraph 315-15(a)(i) ]

1.25 In addition, the private health insurer must be an entity that is not registered under Part 3 of the Life Insurance Act 1995 . [ Schedule 1, item 11, subparagraph 315-15(a)(ii) ]

1.26 The private health insurer must not have capital divided into shares. [ Schedule 1, item 11, subparagraph 315-15(a)(iii) ]

Approval and conversion

1.27 The private health insurer's application to convert to a for profit insurer must be approved under subsection 126-42(5) of the PHIA 2007 and, consistent with its conversion scheme, the insurer must become registered in due course as a for profit private health insurer. [ Schedule 1, item 11, paragraphs 315-15(b) and (c) ]

Example 1.1

Healthy Health Insurance Ltd (Healthy Health) is a private health insurer that is not carried on for the profit or gain of its individual members. It is therefore an exempt entity under item 6.3 in the table in section 50-30 of the ITAA 1997. Healthy Health is a company limited by guarantee.

Healthy Health is registered as a not for profit private health insurer under the PHIA 2007 and proposes to convert to a for profit insurer. Consequently, it applies to the Private Health Insurance Administration Council under subsection 126-42(1) of the PHIA 2007 to be registered as a for profit health insurer. A copy of Healthy Health's conversion scheme is included in its application. As part of this scheme, Healthy Health proposes to issue shares, which would reflect the value of the accumulated mutual surplus, to its participating policy holders.

Assume the Council approves this conversion and Healthy Health converts, by demutualising, to a for profit private health insurer.

Division 315 of the ITAA 1997 would apply to the demutualisation of Healthy Health.

Example 1.2

Impressive Insurance Ltd (Impressive Insurance) is a private health insurer registered as a not for profit private health insurer under the PHIA 2007. It is a tax exempt entity under item 6.3 in the table in section 50-30 of the ITAA 1997 and is a company limited by guarantee.

Impressive Insurance proposes to convert to a for profit private health insurer as part of a broader takeover arrangement with another for profit private health insurer. Instead of issuing shares, Impressive Insurance proposes to distribute the accumulated mutual surplus to its policy holders in the form of a cash payment. Impressive Insurance proposes to use a members' scheme to facilitate this conversion and so issues its participating policy holders with membership interests.

Under Impressive Insurance's proposal, these membership interests will be held on trust for the policy holders and, in exchange for the cash payment (made from its accumulated mutual surplus), the membership interests will be cancelled.

Assume the Private Health Insurance Administration Council approves this conversion and Impressive Insurance converts, by demutualising, to a for profit entity.

Division 315 of the ITAA 1997 would apply to the demutualisation of Impressive Insurance.

Relief for policy holders and other insured persons

1.28 CGT relief will generally be available for individuals who are:

•

policy holders (within the meaning of the PHIA 2007) of the private health insurer;

•

former policy holders of the insurer; and

•

other insured persons (within the meaning of paragraph 126-42(5)(b) of the PHIA 2007) or former insured persons of the insurer.

1.29 If such an individual dies during the demutualisation process, then CGT relief may also be available for their legal personal representative and beneficiaries of their estate.

1.30 'Policy holder' is defined in Schedule 1 to the PHIA 2007.

Relief for policy holders

1.31 Capital gains or losses that arise under a private health insurer's demutualisation to a policy holder will be disregarded for CGT events that happen to:

•

an interest the policy holder has in the insurer as a policy holder;

•

a right or any other kind of interest the policy holder has in the insurer; and

•

a right or any other kind of interest that arises under the demutualisation.

[ Schedule 1, item 11, section 315-5 and paragraphs 315-20(a), (c) and (d) ]

1.32 It will be a question of fact as to whether a specific transaction (and therefore a capital gain or loss) arises under the private health insurer's demutualisation. Transactions are likely to vary between demutualising private health insurers.

1.33 Consistent with the policy objective of facilitating the demutualisation of private health insurers and the distribution of any accumulated mutual surplus, transactions that occur after this distribution will not be transactions that occur under the insurer's demutualisation. This will be the case even if the transactions occur as part of a broader scheme for reorganising the private health insurer's affairs.

Example 1.3

Further to Example 1.1.

Philip is a policy holder of Healthy Health and under the terms of Healthy Health's constitution, as a policy holder, Philip has a number of rights. These include the right to receive notice of Healthy Health's Annual General Meeting, the right to attend and be heard at the meeting and the right to require Healthy Health to manage its assets in a certain way and to operate on a not for profit basis.

Under Healthy Health's conversion scheme, Philip also acquires the right to receive 1,000 shares.

These rights are satisfied when Healthy Health distributes its accumulated mutual surplus and Philip receives his 1,000 shares.

As these rights arise under the demutualisation, Philip disregards any capital gains or losses that arise from the satisfaction of these rights.

1.34 In addition, if a policy holder has a membership interest in the private health insurer (held directly or on trust for their benefit), then any capital gains or losses that arise under the private health insurer's demutualisation to the policy holder in relation to that interest will be disregarded. [ Schedule 1, item 11, section 315-5 and paragraph 315-20(b) ]

Example 1.4

Further to Example 1.2.

John is a policy holder of Impressive Insurance who receives a membership interest under its conversion scheme. Impressive Insurance subsequently cancels John's membership interest in exchange for a cash payment of $500 and thereby distributes John's share of the accumulated mutual surplus.

John disregards any capital gains or losses arising from receiving the membership interest and from its cancellation.

Former policy holders

1.35 A former policy holder is an individual who was previously a policy holder of the private health insurer but is no longer a policy holder insurer at the time the accumulated mutual surplus is distributed. Depending on the terms of the private health insurer's conversion scheme, a former policy holder may be entitled to receive a share of the insurer's accumulated mutual surplus.

Example 1.5

Further to Example 1.1.

Jennelle was a policy holder at the time Healthy Health announced its proposed demutualisation and when its policy holders approved its demutualisation. Under the terms of Healthy Health's demutualisation she is entitled to receive an allocation of shares in Healthy Health. Jennelle is no longer a policy holder of Healthy Health.

Jennelle is a former policy holder of Healthy Health.

1.36 Capital gains or losses that arise under a private health insurer's demutualisation to a former policy holder will be disregarded for CGT events that happen to:

•

an interest the former policy holder had in the insurer as a policy holder;

•

a right or any other kind of interest the former policy holder had or, continues to have, in the insurer; and

•

a right or any other kind of interest that arises under the demutualisation.

[ Schedule 1, item 11, section 315-5 and paragraphs 315-20(a), (c) and (d) ]

Example 1.6

Further to Example 1.5.

Jennelle has a right to receive 1,500 shares. Jennelle subsequently receives 1,500 shares when Healthy Health distributes its accumulated mutual surplus and so her right to receive the shares ends.

As Jennelle's right to the 1,500 shares arises under Healthy Health's demutualisation, Jennelle disregards any capital gains or losses arising from the ending of her right to the 1,500 shares.

1.37 In addition, if a former policy holder had, or continues to have, a membership interest in the private health insurer (held directly or on trust for their benefit), then any capital gains or losses that arise under the private health insurer's demutualisation to the former policy holder in relation to that interest will be disregarded. [ Schedule 1, item 11, section 315-5 and paragraph 315-20(b) ]

Other insured persons

1.38 Capital gains or losses that arise under a private health insurer's demutualisation to any other insured person, or former insured person, will be disregarded for CGT events that happen to:

•

a right or any other kind of interest (including a membership interest) the insured person has or had in the insurer; and

•

a right or any other kind of interest that arises under the demutualisation.

[ Schedule 1, item 11, section 315-5 and paragraphs 315-20(b) to (d) ]

Legal personal representatives and beneficiaries of a deceased policy holder

1.39 Where a policy holder, former policy holder or other insured person or former insured person dies during the private health insurer's demutualisation process, then any capital gains or losses that arise to their legal personal representative or a beneficiary of their estate under the insurer's demutualisation will be disregarded for CGT events that happen to:

•

an interest the deceased individual had in the insurer as a policy holder;

•

a right or any other kind of interest the deceased individual had in the insurer; and

•

a right or any other kind of interest that arises under the demutualisation.

[ Schedule 1, item 11, section 315-10 and paragraphs 315-20(a), (c) and (d) ]

1.40 In addition, if the deceased policy holder had a membership interest in the private health insurer (held directly or on trust for their benefit), then any capital gains or losses that arise under the private health insurer's demutualisation to their legal personal representative or a beneficiary of their estate in relation to that interest will also be disregarded. [ Schedule 1, item 11, section 315-10 and paragraph 315-20(b) ]

Relief for the demutualising insurer

1.41 Capital gains or losses that arise under the private health insurer's demutualisation to the insurer will be disregarded. [ Schedule 1, item 11, section 315-25 ]

Relief for other entities

1.42 Capital gains or losses that arise under the private health insurer's demutualisation to other entities will also be disregarded when the following three requirements are satisfied. [ Schedule 1, item 11, subparagraph 315-30(c)(i) ]

1.43 Firstly, the entity must be established for the sole purpose of participating in the private health insurer's demutualisation. It will be a question of fact whether an entity meets this requirement. However, in determining this, regard should be given to the private health insurer's conversion scheme and whether, for example, it provides for the creation of the entity. [ Schedule 1, item 11, paragraph 315-30(a) ]

1.44 Secondly, the entity must not be a trust that is covered by Subdivision 315-C. This Subdivision provides for the operation of a lost policy holders trust and this is described in paragraphs 1.68 to 1.95. [ Schedule 1, item 11, paragraph 315-30(b) ]

1.45 Thirdly, the capital gains or losses realised by the entity must be connected to the allocation or distribution of the private health insurer's accumulated mutual surplus and arise either prior to, or at the time, the surplus is allocated or distributed [ Schedule 1, item 11, subparagraphs 315-30(c)(ii) and (iii) ].

•

Similar to the first requirement, it will be a question of fact whether these requirements are satisfied. For example, gains or losses arising from the entity distributing the private health insurer's accumulated mutual surplus, on the insurer's behalf, will be connected to the allocation or distribution of the surplus and will arise at the time the surplus is distributed.

•

There is no requirement that the surplus must be distributed in one transaction only for this relief to be available. For example, the private health insurer's conversion scheme may provide for the insurer to distribute its surplus in two transactions. In this case, relief would be available for both transactions. However, if a private health insurer distributes its mutual surplus in the form of shares for example, then there will be cost base implications for the shares if they are not all issued at the same time. Further information about these cost base rules are set out in paragraph 1.47.

Example 1.7

Further to Example 1.2.

Impressive Insurance's conversion scheme provides for the creation of a trust, the Impressive Trust, to hold a membership interest for each of the participating policy holders in Impressive Insurance. This trust is not a lost policy holders trust.

As part of Impressive Insurance's demutualisation, the trustee of the Impressive Trust makes a cash payment to each of the participating policy holders for the cancellation of their membership interest.

As the Impressive Trust was created for the purpose of participating in the demutualisation of Impressive Insurance, any capital gains or losses that arise when the trustee makes the cash payment and the membership interest is cancelled will be disregarded as these transactions occur at the time Impressive Insurance's surplus is distributed and are connected to its distribution.

Shares issued to participating policy holders

1.46 A private health insurer may distribute its mutual surplus in the form of shares in the demutualised insurer or shares in another company. Alternatively, the mutual surplus may be distributed in the form of rights to acquire shares. These rights to acquire shares are separate from any rights in the private health insurer that a participating policy holder gives up under the demutualisation. (A private health insurer may also distribute its mutual surplus in the form of a cash payment.)

1.47 However, participating policy holders who receive shares or rights to acquire shares under their private health insurer's demutualisation will only receive a cost base for those shares or rights that reflects the market value of the insurer at the time of the demutualisation when the following requirements are satisfied [ Schedule 1, item 11, paragraph 315-85(1)(b) ].

•

The shares or rights must be issued in connection with the participating policy holder having rights or assets in the demutualising private health insurer varied or cancelled [ Schedule 1, item 11, paragraph 315-85(1)(c) ].

•

The shares or rights must be issued simultaneously to all participating policy holders and the trustee of the lost policy holders trust [ Schedule 1, item 11, subsection 315-85(3) ].

•

Where shares are issued, the shares must be issued in the demutualised private health insurer or a company that acquires the insurer under the demutualisation and so wholly owns the insurer [ Schedule 1, item 11, subparagraphs 315-85(1)(a)(i) and (iii) ].

•

Where rights to acquire shares are issued, the rights must allow only for shares in the demutualised private health insurer or a company that wholly owns the insurer to be acquired [ Schedule 1, item 11, subparagraphs 315-85(1)(a)(ii) and (iv) ]. In addition, the rights must not have an exercise price [ Schedule 1, item 11, subsection 315-85(2) ].

1.48 Participating policy holders include policy holders, former policy holders, other insured persons and former insured persons of the private health insurer who are entitled to receive an allocation of shares or rights under the insurer's demutualisation. [ Schedule 1, item 11, subsection 315-90(1) ]

1.49 In addition, an entity, such as a legal personal representative, who becomes entitled to receive an allocation of shares or rights under a private health insurer's demutualisation because of a participating policy holder's death, is also taken to be a participating policy holder, provided the shares or rights are issued to the entity in connection with the deceased participating policy holder having rights or assets in the demutualising private health insurer varied or cancelled. [ Schedule 1, item 11, subsection 315-90(2) ]

1.50 For certainty, the issue of these shares or rights to the participating policy holders will be transactions that arise under the private health insurer's demutualisation. Further dealings with the shares or rights by the participating policy holders (such as selling the shares or exercising the rights) however, will not be transactions that arise under the private health insurer's demutualisation.

1.51 Specific CGT rules relating to the issue of rights to participating policy holders are set out in paragraphs 1.62 to 1.67.

Acquisition time of shares

1.52 Participating policy holders who receive shares under the private health insurer's demutualisation will be taken, for CGT purposes, to have acquired each of the shares at their issue time. [ Schedule 1, item 11, subsections 315-80(2) and 315-210(3) ]

1.53 There are specific rules which apply when shares or rights are issued to a deceased participating policy holder's legal personal representative. These rules are set out in paragraph 1.100.

Cost base of shares

1.54 The first element of the cost base (or reduced cost base) of each of the shares issued to a participating policy holder under the private health insurer's demutualisation is calculated as described in paragraphs 1.55 to 1.60.

Shares issued in the demutualised private health insurer

1.55 The first element of the cost base (or reduced cost base) of each of the shares issued in the demutualised private health insurer will be equal to the share's market value on the day of issue. [ Schedule 1, item 11, subsection 315-80(1), subparagraph 315-85(1)(a)(i) ]

Example 1.8

Further to Examples 1.1, 1.3 and 1.6.

Healthy Health issues shares to its participating policy holders on 17 October 2007. The market value of Healthy Health's shares on the day of issue is $7.

Philip is entitled to an allocation of 1,000 shares under Healthy Health's demutualisation and Jennelle is entitled to an allocation of 1,500 shares.

The first element of the cost base of the shares Philip and Jennelle receive is $7.

As Healthy Health issued shares on 17 October 2007, Philip and Jennelle are both taken to have acquired their shares in Healthy Health on 17 October 2007.

Shares issued in a holding company

1.56 A private health insurer may distribute its mutual surplus in the form of shares in a holding company. This may involve:

•

the demutualising private health insurer becoming a company limited by shares;

•

the insurer issuing all its shares to a holding company; and

•

the holding company issuing shares to all the participating policy holders.

1.57 The first element of the cost base (or reduced cost base) of each of the shares issued in a holding company will be equal to the share's market value on the day of issue, provided the holding company owns no other assets apart from shares in the demutualised private health insurer. [ Schedule 1, item 11, subsection 315-80(1) and subparagraph 315-85(1)(a)(iii) ]

Shares issued in a holding company with other assets

1.58 As part of a broader arrangement, a private health insurer may distribute its mutual surplus in the form of shares in another company. Such a company may own other assets in addition to the shares it acquires in the demutualised private health insurer.

1.59 The first element of the cost base (or reduced cost base) of each of the shares issued in this company is equal to the demutualising private health insurer's market value on the day shares in the other company are issued divided by the total number of shares issued in the company under the demutualisation and any shares that can be acquired by exercising rights that are issued under the demutualisation to acquire such shares. [ Schedule 1, item 11, subsections 315-210(1) and (2) ]

1.60 The number of shares that are issued under the demutualisation include shares that are issued to participating policy holders and shares issued to the trustee of the lost policy holders trust. The number of rights that are issued under the demutualisation includes rights issued to participating policy holders and rights issued to the trustee of the lost policy holders trust. [ Schedule 1, item 11, subsection 315-210(2) ]

Non - CGT tax consequences

1.61 No amount is to be included in a participating policy holder's assessable income because they received an allocation of shares or rights to acquire shares under a private health insurer's demutualisation. [ Schedule 1, item 11, paragraphs 315-310(1)(a) and (2)(a) ]

Rights issued to participating policy holders

1.62 Rather than issue shares in the demutualised private health insurer or a company that wholly owns the insurer, the insurer may instead distribute its accumulated mutual surplus in the form of rights to acquire such shares.

Acquisition time of rights

1.63 Participating policy holders who receive rights under their private health insurer's demutualisation will be taken, for CGT purposes, to have acquired each of the rights at their issue time. [ Schedule 1, item 11, subsections 315-80(2) and 315-210(3) ]

Cost base of rights

1.64 The first element of the cost base (or reduced cost base) of each of the rights issued to a participating policy holder under the private health insurer's demutualisation is calculated as described in paragraphs 1.65 to 1.67.

Rights to acquire shares in the demutualised private health insurer

1.65 The first element of the cost base (or reduced cost base) of each of the rights to acquire shares in the demutualised private health insurer will be equal to the right's market value on the day of issue. [ Schedule 1, item 11, subsection 315-80(1), subparagraph 315-85(1)(a)(ii) ]

Rights to acquire shares in a holding company

1.66 The first element of the cost base (or reduced cost base) of each of the rights to acquire shares in a holding company will be equal to the right's market value on the day of issue, provided the holding company owns no other assets apart from shares in the demutualised private health insurer. [ Schedule 1, item 11, subsection 315-80(1) and subparagraph 315-85(1)(a)(iv) ]

Rights to acquire shares in a holding company with other assets

1.67 The first element of the cost base (or reduced cost base) of each of the rights issued in this company is equal to the demutualising private health insurer's market value on the day the rights are issued, divided by the total number of shares that are issued under the demutualisation and any shares that can be acquired by exercising the rights issued under the demutualisation, with the result multiplied by the number of shares that can be acquired by the right. [ Schedule 1, item 11, subsections 315-210(1) and (2) ]

Lost policy holders trust

What is a lost policy holders trust ?

1.68 As part of a private health insurer's demutualisation, a trust may be set up to hold shares, or rights to acquire shares, for individuals who are entitled to receive a share of the insurer's surplus, but are unable to receive their allocation of shares or rights directly. The trust generally exists for a finite period to allow these individuals an opportunity to receive either:

•

their shares or rights from the trust; or

•

have the trustee, on their behalf, dispose of their shares or rights and distribute the proceeds to them.

1.69 It is usually a requirement of the demutualisation that eligible individuals must verify their details with their private health insurer and agree to receive their allocation of shares or rights. Often, there will be a significant number of eligible individuals who, for a variety of reasons, fail to verify their details and agree to receive their allocation of shares or rights. Shares or rights that would otherwise be allocated to these individuals may instead be held on trust.

1.70 In addition, shares or rights will typically not be issued to individuals who are registered at an overseas address (regardless of whether or not they are an Australian resident for tax purposes). Instead, the shares or rights that would otherwise be issued to these individuals are held on trust. This generally occurs because these individuals may only be permitted to receive shares after certain foreign regulatory conditions are satisfied.

1.71 Lost policy holders include unverified and overseas policy holders. In this context, the phrase lost policy holder includes individuals who may be former policy holders, other insured persons and former insured persons as well as policy holders of the private health insurer. The trust that holds these shares or rights is commonly known as a lost policy holders trust . Lost policy holders who subsequently receive shares or rights from the trust will be referred to as found policy holders .

1.72 Broadly, Subdivision 315-C provides a legislative framework for shares and rights issued to the trustee of a lost policy holders trust, under a private health insurer's demutualisation, to be held for lost policy holders and subsequently transferred to them without adverse or advantageous CGT consequences for either the trustee or the lost policy holder. This is consistent with the policy of providing CGT relief for transactions that arise under a private health insurer's demutualisation to facilitate the distribution or allocation of the accumulated mutual surplus.

1.73 Other dealings with the shares or rights issued to the trustee of the lost policy holders trust will not be transactions that arise under the private health insurer's demutualisation. However, the framework allows for the issued shares or rights to be exchanged for other assets such as under a takeover or corporate reorganisation (provided any capital gains or losses can be rolled over into the replacement asset) and the replacement asset to be transferred to the found policy holder.

1.74 Specifically, Subdivision 315-C modifies the CGT outcomes that would ordinarily arise from the operation of the trust to:

•

the trustee of the trust; and

•

entities that receive shares or rights from the trust.

Requirements for the rules to apply

1.75 These rules will only be available when the following conditions are satisfied:

•

the private health insurer's conversion scheme provides for the trust [ Schedule 1, item 11, paragraph 315-140(a) ];

•

the trust exists solely for the purpose of holding shares and rights on behalf of individuals (these individuals, known as lost policy holders, may include unverified and overseas policy holders) [ Schedule 1, item 11, subparagraph 315-140(c)(i) ]. If the individual has died, then the trust must hold the shares and rights on behalf of the deceased individual's legal personal representative or a beneficiary of their estate [ Schedule 1, item 11, subparagraph 315-140(c)(ii) ]; and

•

shares or rights are issued to the trustee of the trust under the private health insurer's demutualisation [ Schedule 1, item 11, paragraph 315-140(b) ].

Example 1.9

Further to Example 1.1.

Healthy Health's conversion scheme that was included in its application to the Private Health Insurance Administration Council provides for a trust, the Healthy Lost Trust, which has the sole purpose of holding shares on behalf of unverified policy holders and policy holders who are registered at an overseas address. The Healthy Lost Trust deed provides that the Trust will cease after three years.

Under Healthy Health's demutualisation, the Healthy Lost Trust receives 100,000 shares in Healthy Health.

Subdivision 315-C will apply to the Healthy Lost Trust.

Trustee of the lost policy holders trust

Acquisition time of shares or rights

1.76 The trustee of the lost policy holders trust who receives shares or rights will be taken, for CGT purposes, to have acquired the shares or rights at their issue time. [ Schedule 1, item 11, subsection 315-145(2) ]

Cost base of shares or rights

1.77 The first element of the cost base (or reduced cost base) of shares or rights issued to the trustee of a lost policy holders trust under the private health insurer's demutualisation is calculated as described in paragraphs 1.78 to 1.84.

Shares issued in the demutualised private health insurer

1.78 The first element of the cost base (or reduced cost base) of each of the shares that are issued in the demutualised private health insurer will be equal to the share's market value on the day of issue. [ Schedule 1, item 11, subsection 315-145(1) and subparagraph 315-85(1)(a)(i) ]

Shares issued in a holding company

1.79 The first element of the cost base (or reduced cost base) of each of the shares issued in a holding company will be equal to the share's market value on the day of issue, provided the holding company owns no other assets apart from shares in the demutualised private health insurer. [ Schedule 1, item 11, subsection 315-145(1) and subparagraph 315-85(1)(a)(iii) ]

Shares issued in a holding company that has other assets

1.80 The first element of the cost base (or reduced cost base) of each of the shares issued in this company is equal to the demutualising private health insurer's market value on the day shares in the other company are issued, divided by the total number of shares issued in the company under the demutualisation and any shares that can be acquired by exercising rights that are issued under the demutualisation to acquire such shares. [ Schedule 1, item 11, subsections 315-145(1), 315-210(1) and (2) ]

Rights to acquire shares in the demutualised private health insurer

1.81 The first element of the cost base (or reduced cost base) of each of the rights to acquire shares in the demutualised private health insurer will be equal to the right's market value on the day of issue. [ Schedule 1, item 11, subsection 315-145(1) and subparagraph 315-85(1)(a)(ii) ]

Rights to acquire shares in a holding company

1.82 The first element of the cost base (or reduced) cost base of each of the rights to acquire shares in a holding company will be equal to the right's market value on the day of issue, provided the holding company owns no other assets apart from shares in the demutualised private health insurer. [ Schedule 1, item 11, subsection 315-145(1) and subparagraph 315-85(1)(a)(iv) ]

Rights to acquire shares in a holding company that has other assets

1.83 The first element of the cost base (or reduced cost base) of each of the rights issued in this company is equal to the demutualising private health insurer's market value on the day the rights are issued in the company divided by the total number of shares that are issued under the demutualisation, and any shares that can be acquired by exercising the rights that are issued under the demutualisation, with the result multiplied by the number of shares that can be acquired by the right. [ Schedule 1, item 11, subsections 315-145(1), 315-210(1) and (2) ]

1.84 Paragraphs 1.55 to 1.60 and 1.64 to 1.67 provide further information about calculating these cost bases.

Example 1.10

Further to Example 1.9.

The trustee of the Healthy Lost Trust acquires 100,000 shares in Healthy Health on 17 October 2007. The first element of the cost base of these shares will be $7.

Transfer of assets to found policy holders

1.85 Any capital gains or losses arising to the trustee from the transfer of assets in the lost policy holders trust to a found policy holder, on whose behalf the trustee was holding the asset will be disregarded. In addition, any capital gains or losses arising to the trustee from the found policy holder becoming absolutely entitled to assets in the lost policy holder will be disregarded. [ Schedule 1, item 11, subsections 315-150(1) and (2) ]

Example 1.11

Further to Example 1.10.

Mark is a policy holder of Healthy Health and under its demutualisation was entitled to receive 600 shares. However, because Mark moved house he was unaware of Healthy Health's demutualisation and his entitlement to shares. One year after Healthy Health demutualised Mark becomes aware of his entitlement to shares and contacts the trustee of the Healthy Lost Trust.

Any capital gains or losses arising to the trustee from Mark becoming absolutely entitled to 600 shares are disregarded.

Example 1.12

Further to Example 1.10.

Debbie is also a policy holder of Healthy Health, entitled to receive 900 shares when Healthy Health demutualised. Debbie was aware of Healthy Health's demutualisation, but she did not agree to receive her shares.

Eighteen months after demutualising, Healthy Health reorganises its affairs by interposing a holding company Healthy Holding Ltd (Healthy Holding) between itself and its shareholders. Under the scheme for reorganising its affairs, shareholders in Healthy Health receive two shares in Healthy Holding for each share they hold in Healthy Health. The trustee of the Healthy Lost Trust subsequently receives shares in Healthy Holding and, assuming the requirements of Subdivision 124-G of the ITAA 1997 are satisfied, a roll-over of any CGT liability that would have otherwise arisen from the exchange.

Six months later (two years after Healthy Health demutualised), Debbie realises that she had an entitlement to shares under Healthy Health's demutualisation and contacts the trustee of the Healthy Lost Trust.

Any capital gains or losses arising to the trustee from Debbie becoming absolutely entitled to 1,800 shares in Healthy Holding are disregarded.

1.86 The lost policy holders trust may also provide for the trustee to dispose of shares or rights in the trust held on behalf of a lost policy holder and give the net proceeds to the policy holder, on whose behalf the trustee was holding the shares or rights. This will typically occur when the lost policy holder is registered at an overseas address.

Example 1.13

Further to Example 1.10.

Nick is a policy holder in Healthy Health and is entitled to receive 300 shares under its demutualisation. However, Nick is registered at an overseas address although he remains an Australian resident for tax purposes. Instead of directly receiving his 300 shares when Healthy Health demutualises, Nick's shares are issued to the trustee of the Healthy Lost Trust to sell on his behalf. Six months after Healthy Health demutualises the trustee sells the 300 shares for $10 each.

There are no CGT consequences to the trustee.

Transfer of assets to a legal personal representative or beneficiary

1.87 If the lost policy holder dies before receiving shares or rights from the lost policy holders trust then any capital gains or losses arising from the trustee transferring assets in the trust to the deceased lost policy holder's legal personal representative or a beneficiary of their estate will also be disregarded. [ Schedule 1, item 11, subsections 315-150(1) and (2) ]

Other dealings with the assets

1.88 Any capital gains arising from the trustee dealing with the shares or rights in the lost policy holders trust in any other way will, broadly, be assessed to the trustee under section 99A of the ITAA 1936. [ Schedule 1, item 11, section 315-155 ]

1.89 Specifically, for the purposes of sections 97, 98A and 100 of the ITAA 1936, the share of the net income of the trust that is attributable to the capital gains arising from these transactions will not be included in the income of any beneficiaries of the trust. In addition, the trustee will not be assessed on this share of net income under section 98 of the ITAA 1936. [ Schedule 1, item 11, subsection 315-155(2) ]

Example 1.14

Further to Example 1.12.

After three years, the remaining shares in the Healthy Lost Trust are acquired by Healthy Holding for $5 each (the then current market value of shares in Healthy Holding).

Of the remaining shares in the Healthy Lost Trust, 600 were held on behalf of Bronwyn, a lost policy holder of Healthy Health.

The disposal of the remaining shares in the Healthy Lost Trust triggers a CGT taxing point and a subsequent capital gain for the trustee of the Healthy Lost Trust. Assuming the trustee incurred no other costs in relation to holding the shares, the trustee would realise a capital gain of $1.50 on each share acquired (ie, $5 capital proceeds less a $3.50 cost base).

The share of the net income of the trust that is attributable to these capital gains will be assessed to the trustee under section 99A of the ITAA 1936.

Found policy holders who receive shares or rights

1.90 The found policy holder will be taken to have acquired each of the shares or rights at the same time as the trustee of the lost policy holders trust acquired them. [ Schedule 1, item 11, subsection 315-150(4) ]

1.91 The first element of the cost base (or reduced cost base) of each of the shares or rights that are transferred to a found policy holder from the lost policy holders trust will be equal to the asset's cost base in the trustee's hands. [ Schedule 1, item 11, subsection 315-150(3) ]

Example 1.15

Further to Example 1.11.

Mark becomes absolutely entitled to 600 Healthy Health shares held in the Healthy Lost Trust. The first element of the cost base of each of his shares will be $7.

As the trustee of the Healthy Lost Trust acquired the shares in Healthy Health on 17 October 2007, Mark will also be taken to have acquired his 600 shares in Healthy Health on 17 October 2007.

Example 1.16

Further to Example 1.12.

Debbie becomes absolutely entitled to 1,800 Healthy Holding shares in the Healthy Lost Trust. The first element of the cost base of each share that Debbie receives in Healthy Holding is $3.50.

Debbie receives this cost base because the trustee exchanged shares in Healthy Health for shares in Healthy Holding and received a roll-over under Subdivision 124-G of the ITAA 1997.

Debbie is taken to have acquired her shares in Healthy Holding on 17 October 2007.

1.92 The trustee of the lost policy holders trust would be able to inform the found policy holder, when they receive their shares or rights from the trust, what the first element of the asset's cost base will be in the found policy holder's hands. The trustee would also be able to advise the found policy holder of the date that the trustee originally acquired the shares or rights as that date will be the same date that the lost policy holder will be taken to have acquired the assets.

Example 1.17

Further to Example 1.13.

Nick becomes absolutely entitled to 300 shares in Healthy Health. The first element of the cost base of his shares is $7.

The trustee of the Healthy Lost Trust then sells the shares on behalf of Nick for $10. Assuming no other costs are incurred, Nick realises a capital gain of $3 on each share sold (ie, $10 capital proceeds for each share less a cost base of $7).

Legal personal representatives and beneficiaries who receive shares or rights

1.93 If a lost policy holder dies before receiving shares or rights from the lost policy holders trust then their legal personal representative or a beneficiary of their estate who receives the shares or rights will be taken to have acquired each of the shares or rights at the same time they were acquired by the trustee of the lost policy holders trust. [ Schedule 1, item 11, subsection 315-150(4) ]

1.94 The first element of the cost base (or reduced cost base) of each of the shares or rights that are transferred from the lost policy holders trust to a deceased individual's legal personal representative or a beneficiary of their estate will be equal to the share or right's cost base in the trustee's hands. [ Schedule 1, item 11, subsection 315-150(3) ]

1.95 If a found policy holder dies after receiving shares or rights from the lost policy holders trust then, if they still held the shares or rights at the time of their death, Division 128 of the ITAA 1997 may apply to the shares or rights.

Shares and rights issued to legal personal representatives and beneficiaries of a deceased participating policy holder

1.96 If a participating policy holder dies during the demutualisation process before receiving shares or rights, then those shares or rights will typically be issued to their legal personal representative.

1.97 An entity that becomes entitled, under a private health insurer's demutualisation, to receive shares or rights, because of a participating policy holder's death, is also taken to be a participating policy holder for the purposes of Division 315. [ Schedule 1, item 11, subsection 315-90(2) ]

1.98 Consequently, this entity who receives the shares or rights will:

•

be taken, for CGT purposes, to have acquired each of the shares or rights at their issue time; and

•

receive the same first element of the cost base for each of the shares or rights that the deceased participating policy holder would have received.

These rules are set out in paragraphs 1.52 to 1.67.

Consequences for legal personal representatives

1.99 Any capital gains or losses arising to the legal personal representative from each of the shares or rights passing to a beneficiary of the deceased participating policy holder's estate will be disregarded. [ Schedule 1, item 11, subsections 315-260(1) and (2) ]

Example 1.18

Further to Example 1.1.

William is a participating policy holder in Healthy Health's demutualisation, who is entitled to receive 300 shares. Unfortunately, William dies before Healthy Health issues its shares, and so Healthy Health issues the shares to Gary, the legal personal representative of William's estate.

Consequently, Gary is taken to have acquired 300 shares in Healthy Health on 17 October 2007, with a cost base of $7.

Under the terms of William's will, the 300 shares pass to Adele. Any capital gains arising to Gary from the 300 shares passing to Adele are disregarded.

Consequences for beneficiaries

1.100 A beneficiary of the deceased participating policy holder's estate who receives these shares or rights will be taken, for CGT purposes, to have acquired each of the shares or rights at the same time as the legal personal representative acquired them. [ Schedule 1, item 11, subsection 315-260(4) ]

1.101 The first element of the cost base (or reduced cost base) of each of the shares or rights that pass to a beneficiary of the deceased participating policy holder's estate will be equal to the share or right's cost base in the legal personal representative's hands. [ Schedule 1, item 11, subsection 315-260(3) ]

Example 1.19

Further to Example 1.18.

Adele receives the 300 shares in Healthy Health on 12 March 2008. Their market value on this day is $8.50 per share.

For CGT purposes, Adele is taken to have acquired the shares on 17 October 2007. Assuming Gary incurred no additional costs from the shares passing to Adele, the first element of the cost base of each share Adele receives is $7.

Exemption to the share tainting rules

Shares issued in the private health insurer

1.102 A private health insurer's share capital account will not become tainted if an amount is transferred to its share capital account in connection with its demutualisation. [ Schedule 1, item 10, subsection 197-37(1) ]

1.103 This exclusion will only apply to so much of the transferred amount that, together with any amounts that were previously transferred in connection with the demutualisation, does not exceed the total market value of the shares issued by the insurer to its participating policy holders and the trustee of the lost policy holders trust. [ Schedule 1, item 10, subsection 197-37(2) ]

Shares issued in a holding company

1.104 A company's share capital account will not become tainted if an amount is transferred to its account in connection with the demutualisation of a private health insurer and Division 315 applies to the insurer's demutualisation. [ Schedule 1, item 10, subsection 197-37(1) ]

1.105 If the company owns no other assets in addition to shares in the demutualised private health insurer, this exclusion will only apply to so much of the transferred amount that, together with any amounts that were previously transferred in connection with the demutualisation, does not exceed the total market value of the shares issued by the company to participating policy holders and the trustee of the lost policy holders trust. [ Schedule 1, item 10, subsection 197-37(2) and paragraph 197-37(3)(a) ]

1.106 If the company owns other assets in addition to shares in the demutualised private health insurer, this exclusion will only apply to so much of the transferred amount that, together with any amounts that were previously transferred in connection with the demutualisation, does not exceed the sum of the values calculated under subsection 315-160(2) of the ITAA 1997 for each share issued to participating policy holders and the trustee of the lost policy holders trust. [ Schedule 1, item 10, subsection 197-37(2) and paragraph 197-37(3)(b) ]

Cash payment made to participating policy holders

1.107 Rather than distribute its mutual surplus in the form of shares, a private health insurer may distribute its mutual surplus in the form of a cash payment.

1.108 A policy holder, former policy holder, other insured person or former insured person of a private health insurer who receives a cash payment under their insurer's demutualisation will not need to include any amount in their assessable income as a result of receiving that payment, provided the payment is made in connection with the individual having rights or other assets in the demutualising insurer varied or cancelled. [ Schedule 1, item 11, paragraphs 315-310(1)(b) and (2)(a) ]

Example 1.20

Further to Example 1.4.

John does not need to include the $500 he receives under Impressive Insurance's demutualisation in his assessable income.

1.109 Similarly if an entity receives the cash payment because of the death of a policy holder, former policy holder, other insured person or former insured person of the private health insurer, then that entity will not need to include an amount in their assessable income from that payment. [ Schedule 1, item 11, paragraphs 315-310(1)(b) and (2)(b) ]

Application and transitional provisions

1.110 These amendments will commence on Royal Assent.

1.111 These amendments apply to demutualisations that occur on or after 1 July 2007. This will ensure that private health insurers that demutualise prior to these amendments receiving Royal Assent may qualify for the relief. [ Schedule 1, item 12 ]

Consequential amendments

1.112 Amendments will be made to exclude private health insurers from the generic CGT demutualisation relief contained in Schedule 2H to the ITAA 1936. [ Schedule 1, items 1, 2, 4 and 6 ]

1.113 An amendment will be made to exclude Subdivision 126-E of the ITAA 1997 from applying in relation to a demutualisation that Division 315 of the ITAA 1997 applies to. [ Schedule 1, items 9 and 11, section 315-160 ]

1.114 A consequential amendment will be made to section 118-1 of the ITAA 1997 to direct readers to the CGT exemptions in Division 315. Division 118 of the ITAA 1997 sets out various exemptions for capital gains and losses. [ Schedule 1, item 8 ]

1.115 Consequential amendments will be made to the guide material in Subdivision 109-B of the ITAA 1997 to direct readers to the modified acquisition rules in Division 315. [ Schedule 1, item 5 ]

1.116 Consequential amendments will also be made to the guide material in Subdivision 112-B of the ITAA 1997 to direct readers to the modified cost base rules in Division 315. [ Schedule 1, item 7 ]

1.117 A consequential amendment will be made to section 11-55 of the ITAA 1997 to direct readers to the non-assessable non-exempt income provisions in Division 315. [ Schedule 1, item 3 ]