House of Representatives

Explanatory Memorandum

Circulated By the Authority of the Treasurer, the Hon Wayne Swan MP)

Chapter 3 - Exempt annuity business of life insurance companies

Outline of chapter

3.1 Schedule 3 to this Bill amends the Income Tax Assessment Act 1997 (ITAA 1997) to clarify the circumstances in which income derived by life insurance companies in respect of immediate annuity business qualifies as non-assessable non-exempt income.

Context of amendments

3.2 The income derived by life insurance companies in respect of immediate annuity business is non-assessable non-exempt income. Immediate annuity business is business that supports life insurance policies that provide for an annuity that is currently payable. This includes immediate annuity policies that are purchased with rolled-over superannuation benefits.

3.3 The rationale for exempting life insurance companies in relation to immediate annuity business is to prevent double taxation. That is, as the policyholder is taxable on the annuity income received, the life insurance company is exempt from tax.

3.4 The exemption for immediate annuity business applies only to income that relates to immediate annuities that meet certain conditions (the annuity conditions). The purpose of the annuity conditions is to prevent the excessive deferral of tax on income derived by life insurance companies that relates to immediate annuity policies.

3.5 The annuity conditions were transferred from the Income Tax Assessment Act 1936 (ITAA 1936) to the ITAA 1997 in 2000. The intention of the rewrite was to replicate the annuity conditions. However, concerns have been raised that anomalies arise because of modifications to the wording of the annuity conditions as a result of that rewrite.

3.6 These concerns were compounded when the annuity conditions were modified to reflect the Simplified Superannuation changes, which commenced from the 2007-08 income year. One of those changes was to make superannuation income streams exempt from tax in most cases. Superannuation income streams are regulated under the Superannuation Industry (Supervision) Act 1993 . In these circumstances, it is not appropriate to continue to apply the annuity conditions to immediate annuity policies that provide for superannuation income streams.

Summary of new law

3.7 The amendments will clarify the circumstances in which income derived by life insurance companies in respect of immediate annuity business qualifies as non-assessable non-exempt income.

3.8 First, from 1 July 2000, the amendments will ensure that the annuity conditions in the ITAA 1997 are consistent with the former annuity conditions in the ITAA 1936. To achieve this, the annuity conditions have been rewritten to make the law clearer and to clarify the circumstances in which the annuity conditions apply.

3.9 Second, from the 2007-08 income year, the amendments:

•

ensure that the annuity conditions do not apply to immediate annuity policies that provide for superannuation income streams; and

•

modify the annuity conditions to update terminology as a consequence of the Simplified Superannuation changes.

Comparison of key features of new law and current law

Detailed explanation of new law

3.10 The income derived by life insurance companies in respect of immediate annuity policies that satisfy the annuity conditions is non-assessable non-exempt income.

3.11 The annuity conditions apply, broadly, to:

•

an annuity purchased with a rolled-over superannuation benefit before 10 December 1987; and

•

any annuity (including an annuity that provides for a superannuation income stream) purchased after 9 December 1987.

3.12 The amendments:

•

from 1 July 2000, clarify the operation of the annuity conditions; and

•

from the 2007-08 income year:

-

ensure that the annuity conditions do not apply to immediate annuity policies that provide for superannuation income streams; and

-

modify the annuity conditions to update terminology as a consequence of the Simplified Superannuation changes.

Clarify the operation of the annuity conditions (from 1 July 2000)

3.13 The annuity conditions are being rewritten, with effect from 1 July 2000, to clarify their operation and ensure that they are consistent with the former annuity conditions in the ITAA 1936.

3.14 These changes are a rewrite of the former annuity conditions in the ITAA 1936. Changes to the wording or style used in the rewritten provisions are not intended to change the law as it operated prior to 1 July 2000.

Annuity condition 1

3.15 The first annuity condition applies if there is a residual capital value in relation to an immediate annuity. [Schedule 3, items 1 and 2, subparagraphs 320-246(1)(e)(ii) and (iii) and item 1 in the table in subsection 320-246(3)]

3.16 The term 'residual capital value' was formerly defined in section 27A of the ITAA 1936 to mean, broadly, the amount that is payable under an annuity contract when the annuity contract is terminated or comes to an end.

3.17 The condition is that the contract under which the annuity is payable does not permit the residual capital value to exceed the annuity's purchase price. [Schedule 3, item 2, item 1 in the table in subsection 320-246(3)]

Annuity condition 2

3.18 The second annuity condition applies if the contract under which the annuity is payable provides that the annuity is payable until the end of a term of years certain - that is, broadly, for the fixed term. [Schedule 3, items 1 and 2, subparagraphs 320-246(1)(e)(ii) and (iii) and item 2 in the table in subsection 320-246(3)]

3.19 The condition is that the contract does not permit the total of the amounts paid for the annuity's commutation (whether in whole or in part) to exceed the annuity's reduced purchase price. [Schedule 3, item 2, item 2 in the table in subsection 320-246(3)]

3.20 A commutation is essentially the process of converting an annuity into a lump sum.

3.21 The term 'reduced purchase price' was formerly defined in section 27A of the ITAA 1936 to mean, broadly, the purchase price of the annuity to the extent that it has not been treated for income tax purposes as having been effectively returned to the policyholder in annuity payments that have been paid.

Annuity condition 3

3.22 The third annuity condition applies if the contract under which the annuity is payable:

•

provides that the annuity is payable until the later of:

-

the death of a person (or of the death of the last of two or more persons to die); or

-

the end of a term of years certain ; and

•

permits one or more commutation payments to become payable before the end of a term of years certain for the annuity's commutation (whether in whole or in part).

[Schedule 3, items 1 and 2, subparagraphs 320-246(1)(e)(ii) and (iii) and item 3 in the table in subsection 320-246(3)]

3.23 The condition is that the contract does not permit the total of the commutation payments that may become payable before the end of the term of years certain (broadly, before the end of the fixed term period of the annuity) to exceed the annuity's reduced purchase price. [Schedule 3, item 2, item 3 in the table in subsection 320-246(3)]

Annuity condition 4

3.24 The fourth annuity condition applies to all immediate annuity contracts which are subject to the annuity conditions. [Schedule 3, items 1 and 2, subparagraphs 320-246(1)(e)(ii) and (iii) and item 4 in the table in subsection 320-246(3)]

3.25 The condition is that there is no unreasonable deferral of the payments of the immediate annuity, having regard to:

•

to the extent to which the payments depend on the returns of the investment of the assets of the life insurance company paying the annuity - when the payments are made and when those returns are derived;

•

to the extent to which the payments do not depend on those returns - the relative sizes of the annual totals of the payments from year to year; and

•

any other relevant factors.

[Schedule 3, item 2, item 4 in the table in subsection 320-246(3)]

Annuity conditions do not apply to superannuation income streams (from the 2007-08 income year)

3.26 The purpose of the annuity conditions is to prevent the excessive deferral of tax on income derived by life insurance companies that relates to immediate annuity policies.

3.27 As a result of the Simplified Superannuation changes, superannuation income streams are exempt from tax in most cases. Superannuation income streams are regulated under the Superannuation Industry (Supervision) Act 1993 .

3.28 In these circumstances the annuity conditions will cease to apply to immediate annuity policies that provide for superannuation income streams.

3.29 Therefore, with effect from the 2007-08 income year, an exempt life insurance policy will include, so far as is relevant, a life insurance policy that provides for an immediate annuity that:

•

was purchased on or before 9 December 1987;

•

is a superannuation income stream; or

•

satisfies the relevant approved annuity conditions.

[Schedule 3, items 4 and 5, paragraph 320-246(1)(e)]

Update terminology to reflect the Simplified Superannuation changes (from the 2007-08 income year)

3.30 A number of terms which are used in the annuity conditions were modified when the Simplified Superannuation changes were introduced.

3.31 Therefore, with effect from the 2007-08 income year, the annuity conditions are modified to reflect these changes in terminology. That is:

•

in item 1 in the table in subsection 320-246(3), the reference to section 27A of the ITAA 1936 is changed to section 27H of the ITAA 1936; and

•

in items 2 and 3 in the table in subsection 320-246(3), the references to reduced purchase price (within the meaning of section 27A of the ITAA 1936) are changed to purchase price (within the meaning of section 27H of the ITAA 1936), reduced by the sum of the deductible amounts excluded from assessable income under that section.

[Schedule 3, items 6 to 8, subsection 320-246(3)]

Application and transitional provisions

Amendments which apply from 1 July 2000

3.32 The amendments to rewrite the annuity conditions to clarify their operation and ensure that they are consistent with the former annuity conditions in the ITAA 1936 commence from 1 July 2000 - that is, from the commencement of the new taxation regime for taxing life insurance companies.

3.33 These amendments are beneficial to life insurance companies that conduct immediate annuity business and to immediate annuity policyholders as they address concerns that unintended anomalies could arise under the current wording of the annuity conditions. During the consultation process on these amendments, key stakeholders sought for the amendments to commence from 1 July 2000 primarily to reduce compliance costs.

Amendments which apply from the 2007-08 income year

Annuity conditions do not apply to superannuation income streams

3.34 The amendments to ensure that the annuity conditions do not apply to immediate annuity policies that provide for superannuation income streams apply from the 2007-08 income year - that is, from the commencement of the Simplified Superannuation changes. [Schedule 3, item 11]

3.35 These amendments are beneficial to life insurance companies that conduct immediate annuity business and to policyholders who receive superannuation income streams as they remove an additional layer of rules that need to be complied with.

Update terminology to reflect the Simplified Superannuation changes

3.36 The amendments to modify the annuity conditions to update terminology as a consequence of the Simplified Superannuation changes apply from the 2007-08 income year - that is, from the commencement of the Simplified Superannuation changes. [Schedule 3, item 11]

3.37 These amendments are of a minor technical nature to ensure that the income tax law operates effectively.

Consequential amendments

3.38 Consequential amendments will repeal the following amendments:

•

a technical correction that was made in 2006 to paragraph 320-246(5)(a);

•

amendments that were made in 2007 as part of the Simplified Superannuation changes to:

-

modify paragraph 320-246(1)(e) (including an amendment that inserted subparagraph 320-246(1)(e)(iv));

-

modify paragraph 320-246(4)(a); and

-

insert section 320-246 in the Income Tax (Transitional Provisions) Act 1997 .

[Schedule 3, items 3, 9 and 10]