House of Representatives

Explanatory Memorandum

(Circulated by the authority of the Treasurer, the Hon J. B. Hockey MP)

Chapter 3 - CGT exemption for compensation and insurance

Outline of chapter

3.1 Schedule 3 to this Bill amends the Income Tax Assessment Act 1997 (ITAA 1997) to ensure that:

•

a capital gains tax (CGT) exemption is available to certain trustees and beneficiaries who receive compensation or damages;

•

a CGT exemption is available to trustees of complying superannuation entities for insurance policies relating to illness or injury; and

•

the CGT primary code rule applies to capital gains and capital losses that are disregarded by complying superannuation entities arising from injury and illness insurance policies, life insurance policies and annuity instruments.

3.2 All references in this Chapter are to the ITAA 1997 unless otherwise stated.

Context of amendments

3.3 This measure was one of the 92 announced but unenacted tax and superannuation measures that the Assistant Treasurer announced on 14 December 2013 would proceed.

3.4 It was intended that trustees or beneficiaries who receive compensation or damages in respect of certain events (such as an injury an individual suffers at work) or in respect of certain policies of insurance (such as illness, injury or death) not be subject to CGT. However, the express wording of the relevant provisions in the ITAA 1997 has created uncertainty about this treatment. This measure confirms the existing administrative treatment in respect of compensation and insurance policy receipts.

3.5 It was also intended that insurance policies held by complying superannuation funds for injuries and illnesses suffered by an individual not be subject to CGT. This measure ensures that the CGT exemption applies to amounts received under these types of policies.

Summary of new law

3.6 A CGT exemption is available in respect of compensation or damages received by:

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a trustee (other than a trustee of a complying superannuation entity) for a wrong or injury a beneficiary suffers in their occupation, or a wrong, injury or illness a beneficiary or their relative suffers personally; and

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a beneficiary that subsequently receives a distribution that is attributable to such compensation or damages from the trustee;

•

a taxpayer (other than a trustee of a complying superannuation entity) for a policy of insurance on the life of an individual or an annuity instrument if the taxpayer is the original owner of the policy or instrument; and

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a trustee of a complying superannuation entity for a policy of insurance for an individual's illness or injury.

3.7 The CGT primary code rule applies to capital gains and capital losses that are disregarded by complying superannuation entities arising from injury and illness insurance policies, life insurance policies and annuity instruments.

Comparison of key features of new law and current law

Detailed explanation of new law

Compensation or damages payments received by trustees (other than trustees of complying superannuation entities)

3.8 A capital gain or capital loss made by a trustee in relation to compensation or damages for any wrong or injury a beneficiary of the trust suffers in their occupation, or any wrong, injury or illness a beneficiary of the trust or their relative suffers personally, is disregarded. [Schedule 3, item 3, paragraph 118-37(1)(b)]

Example 3.1: Compensation received by trustee

Robert is the beneficiary of ABC trust, which was established after Robert fell off a roof whilst working for Roofing Inc and suffered serious injuries. Patrick, as trustee of ABC trust, seeks compensation on behalf of Robert from Roofing Inc's insurance company, and receives compensation for the accident.

The capital gain made by Patrick in relation to the compensation received is disregarded.

Compensation or damages payments received by beneficiaries

3.9 A capital gain or capital loss made by a beneficiary is also disregarded if the trustee of a trust then distributes money, property or other CGT assets to the beneficiary that are attributable to compensation or damages received by the trustee to which paragraph 3.8 applies. [Schedule 3, item 3, paragraph 118-37(1)(ba)]

Example 3.2: Trustee distribution of compensation to beneficiary

Following on from example 3.1 above, Robert recovers from his injuries, but requires substantial further medical and other support. Patrick, as trustee of ABC trust, distributes the compensation to Robert to assist in paying his hospital bills.

Any capital gain made by Robert in relation to the compensation received is disregarded.

Insurance policies and annuity instruments

Trustees and other taxpayers (other than the trustee of a complying superannuation entity)

3.10 A capital gain or capital loss made from a CGT event happening to an interest in a policy of insurance on the life of an individual or an annuity instrument is disregarded by the original owner of the policy or instrument (except if they are the trustee of a complying superannuation entity, see item 5 of the table in subsection 118-300(1) in relation to trustees of a complying superannuation entity for these types of interests). [Schedule 3, item 4, table item 3 in subsection 118-300(1)]

3.11 The amendment removes the reference to 'original beneficial owner' to ensure that taxpayers, such as trustees can claim the CGT exemption for compensation or damages received, where they hold the legal interest in the relevant insurance policy for a beneficiary.

Subsequent payment to a beneficiary

3.12 Where a trustee then makes a payment to a beneficiary in respect of the policy or instrument, any capital gain or capital loss made by the beneficiary is also disregarded. This exemption also applies where the payment is made to a legal personal representative, as defined in the ITAA 1997. For example, the exemption applies where the payment is made to the executor of an estate of an individual who has died. This ensures that the CGT exemption is not clawed back when proceeds are subsequently distributed to a beneficiary or their legal personal representative. [Schedule 3, item 6, subsection 118-300(1A)]

Example 3.3: Life insurance proceeds distributed to beneficiary

Gillian holds a life insurance policy from Insurance Co. Gillian passes away and Gillian's husband Tim, as executor of her estate, receives $100,000 from Insurance Co in respect of the policy. Tim, as executor of Gillian's estate pays $50,000 to Megan, a beneficiary of Gillian's estate. The payment to Megan is attributable to the amount received by Gillian's estate in respect of the life insurance policy.

Any capital gain made by Megan, as a beneficiary of Gillian's estate, is disregarded.

Trustees of complying superannuation entities

3.13 A capital gain or capital loss is disregarded if:

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it is made when a CGT event happens to an interest in a policy of insurance for an individual's illness or injury; and

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the capital gain or loss is made by the trustee of a complying superannuation entity for the income year in which the CGT event happened. [Schedule 3, item 5, table item 7 in subsection 118-300(1)]

3.14 The table in subsection 118-300(1) has been amended to ensure that the CGT exemption applies to policies of insurance that are not contingent on the duration of human life (item 5 of the table in subsection 118-300(1) applies to life insurance policies and annuity instruments) but are for an individual's illness or injury (for example, total and permanent disability).

Example 3.4: Insurance proceeds received for injury

Lake Super Fund holds total and permanent disability insurance for its members, through Insurance Co.

Tony, a member of Lake Super Fund, is injured at work and applies to be paid a total and permanent incapacity benefit from Lake Super Fund. Insurance Co is satisfied it must pay the insured amount to Lake Super Fund in respect of Tony's injury.

Any capital gain made by Lake Super Fund on the payment from Insurance Co is disregarded.

CGT primary code rule

3.15 Section 295-85 operates to ensure that gains and losses of complying superannuation entities are generally taxed under the CGT provisions rather than on revenue account (the CGT 'primary code rule'). The exceptions to this rule (see subsections 295-85(3) and (4)) enable certain capital gains and capital losses that are otherwise disregarded for the purposes of CGT, to be accounted for on revenue account.

3.16 Currently, one of the exceptions to the CGT primary code rule for complying superannuation entities is capital gains and capital losses in relation to insurance policies that are disregarded under section 118-300. Section 118-300 applies to insurance policies such as life insurance policies and annuity instruments.

3.17 Schedule 3 amends the table in subsection 118-300(1) to also include a policy of insurance for an individual's illness or injury as an additional policy type to which the CGT exemption applies (see paragraphs 3.13 and 3.14 above). [Schedule 3, item 5, table item 7 in subsection 118-300(1)]

3.18 An amendment is made to table item 10 of subsection 295-85(4) to modify one of the exceptions to the CGT primary code rule for complying superannuation entities. This ensures that capital gains and capital losses that are disregarded by complying superannuation entities under section 118-300 (for example, in respect of injury or illness insurance policies, life insurance policies and annuity instruments) are not subject to taxation treatment on revenue account.

Example 3.5: Application of CGT primary code rule to insurance proceeds for injury

Assuming the same facts as Example 3.4, the capital gain made by Lake Super Fund on the payment from Insurance Co under a total and permanent disability insurance policy for one of its members is disregarded.

The disregarded capital gain is subject to the CGT primary code rule. This ensures that the disregarded capital gain is not subject to treatment on revenue account.

3.19 However, disregarded capital gains and capital losses from general insurance policies for property (table item 2 in subsection 118-300(1)) continue to be subject to taxation treatment on revenue account. Such gains or losses should continue to be subject to revenue account treatment because of the potential for gains (or losses) of a revenue nature to arise, for example from landlord insurance policies held by complying superannuation entities. [Schedule 3, item 7, table item 10 in subsection 295-85(4)]

Adjustment for non-assessable component

3.20 CGT event E4 happens when the trustee of a trust makes a payment in respect of a taxpayer's interest in the trust and some or all of this payment is non-assessable income for taxation purposes (the 'non-assessable component').

3.21 When this occurs, the cost base and reduced cost base of the interest must be reduced by the amount of the non-assessable component. When the cost base reaches zero, any additional non-assessable component results in a capital gain.

3.22 A beneficiary that receives an amount from a trustee that is attributable to an amount for which the trustee received an exemption (under sections 118-37 and 118-300), may have a zero cost base for their interest in the trust because they have not purchased that interest. Therefore, a capital gain equal to the payment received will arise if CGT event E4 happens when they receive the non-assessable payment. This would effectively claw back the CGT exemption provided at the trustee level (see paragraphs 3.8 and 3.10 to 3.11 above).

3.23 To avoid this result, payments to which paragraph 118-37(1)(ba) and subsection 118-300(1A) (compensation or damages paid through a trust to a beneficiary) are excluded from the calculation in working out the non-assessable component. [Schedule 3, items 1 and 2, paragraphs 104-71(1)(da) and (db)]

Consequential amendments

3.24 As a result of the amendments to paragraphs 118-37(1)(a) and (b), Schedule 3 restructures paragraph 118-37(1)(a), without changing the operation of the provision. Paragraph 118-37(1)(a) provides that capital gains or capital losses arising from CGT events are disregarded if they relate directly to compensation or damages a person receives for:

•

any wrong or injury the person suffers in their occupation; or

•

any wrong, injury or illness they or their relative suffers personally.

[Schedule 3, item 3, paragraph 118-37(1)(a)]

Application and transitional provisions

Application

3.25 The amendments made by this Schedule apply in relation to CGT events happening in the 2005-06 and later income years. [Schedule 3, item 8]

3.26 The 2011-12 and 2012-13 Budgets announced that these amendments would apply from the 2005-06 income year and later income years. The amendments are consistent with the administrative practice of the Commissioner of Taxation (Commissioner) and ensure that taxpayers that could have benefited by relying on the Commissioner's administrative practice are not disadvantaged by this change.

Amendment of assessments

3.27 Section 170 of the Income Tax Assessment Act 1936 (ITAA 1936) limits the circumstances in which the amendment of an assessment may be made. Depending on the type of taxpayer, amendments may be made within either two or four years after the day on which the Commissioner gives notice of the assessment.

3.28 However, due to the retrospective application of the amendments made by Schedule 3, it is important that taxpayers are not denied the opportunity to give effect to the changes because of the operation of section 170. Accordingly, section 170 does not prevent the amendment of an assessment if:

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the assessment was made before Royal Assent of the Bill;

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the amendment is made for the purpose of giving effect to Schedule 3; and

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the amendment is made within two years after the day the Bill receives Royal Assent.

[Schedule 3, clause 4]

3.29 As the amendments apply to CGT events that occurred in the 2005-06 income year and later income years, the amendment period available to taxpayers will have expired in some cases. Accordingly the above provision ensures that taxpayers are given sufficient time to seek an amendment to previous assessments, if required, following the commencement of Schedule 3.

3.30 Section 170 also does not prevent the Commissioner amending an assessment if a taxpayer applies within the required period (two years after the day the Bill receives Royal Assent) (see section 170A of the ITAA 1936) but the Commissioner amends the assessment after this period. This ensures that the rights of a taxpayer to give effect to the amendments are not denied if the Commissioner does not make an amendment within the two year period provided a taxpayer's application for amendment is made within the required period.

3.31 The amendment period applicable for the purpose of giving effect to Schedule 3 does not apply to assessments made on or after Royal Assent of the Bill because in these cases taxpayers will be aware of the amendments and are able to take them into account in lodging returns.

STATEMENT OF COMPATIBILITY WITH HUMAN RIGHTS

Prepared in accordance with Part 3 of the Human Rights (Parliamentary Scrutiny) Act 2011 Tax and Superannuation Laws Amendment (2014 Measures No. 7) Bill 2014 - CGT exemption for compensation and insurance

3.32 This Schedule is compatible with the human rights and freedoms recognised or declared in the international instruments listed in section 3 of the Human Rights (Parliamentary Scrutiny) Act 2011.

Overview

3.33 Schedule 3 to this Bill amends the Income Tax Assessment Act 1997 to ensure that a capital gains tax (CGT) exemption is available to certain trustees and beneficiaries who receive compensation or damages.

3.34 It was intended that trustees or beneficiaries who receive compensation or damages in respect of certain events (such as an injury an individual suffers at work) or in respect of certain policies of insurance (such as illness, injury or death) not be subject to CGT. However, the express wording of the relevant provisions in the ITAA 1997 has created uncertainty about this treatment. This measure confirms the existing administrative treatment in respect of compensation and insurance policy receipts.

3.35 Schedule 3 also amends the CGT exemption to ensure that it is available to trustees of complying superannuation entities for insurance policies relating to illness or injury.

3.36 It was intended that insurance policies held by complying superannuation funds for injuries and illnesses suffered by an individual not be subject to CGT. This measure ensures that the CGT exemption applies to amounts received under these types of policies.

3.37 Schedule 3 also ensures that the CGT primary code rule applies to capital gains and capital losses that are disregarded by complying superannuation entities arising from injury and illness insurance policies, life insurance policies and annuity instruments. This ensures that such gains and losses are not subject to revenue account treatment.

3.38 This measure makes technical amendments to the taxation law and was one of the 92 announced but unenacted tax and superannuation measures that the Assistant Treasurer announced on 14 December 2013 would proceed.

Human rights implications

3.39 This Schedule does not engage any of the applicable rights or freedoms.

Conclusion

3.40 This Schedule is compatible with human rights as it does not raise any human rights issues.