senate

Explanatory Memorandum

(Circulated by the authority of the Treasurerthe Hon John Dawkins, M.P.)This Memorandum takes account of amendments made by the House of Representatives to the Bill as introduced.

Chapter 4 DEDUCTIONS ALLOWABLE TO LIFE ASSURANCE COMPANIES

Overview

4.1 The formulas by which some deductions are calculated and apportioned between the various classes of income of a life assurance company will be amended to exclude the section 275 deemed income component. The subsection 116CF(2) apportionment formula will be amended to include sections 111A and 111AA premium amounts [Clause 19] .

Summary of amendments

Formulas which calculate deductions

4.2 Sections 111C and 113 contain formulas to determine the extent to which some deductions or expenditures are allowable to a life assurance company.

4.3 The amendments will exclude amounts transferred to life assurance companies under paragraph 275(2)(a) of the Act from the formulas set out in section 111C and subsection 113(2). The amendments apply to amounts transferred under agreements entered into after 31 May 1993.

Formula which apportions allowable deductions to the various classes of income of life assurance companies

4.4 Deductions which are allowable to a life assurance company and which do not relate exclusively to a particular class of assessable income derived by the life assurance company are apportioned to the various classes of assessable income by a formula in subsection 116CF(2). This provision is to be amended in two respects.

4.5 The first amendment will exclude amounts transferred under paragraph 275(2)(a) from the subsection 116CF(2) formula.

4.6 The second amendment will include superannuation premiums to which section 111A applies, and the investment component of life assurance premiums to which section 111AA applies, in the subsection 116CF(2) formula.

4.7 These amendments will apply to relevant premiums received after 31 May 1993 or to amounts transferred under agreements entered into after that date.

Background to the legislation

4.8 Life assurance companies, unlike most other taxpayers, have separate classes of assessable income arising from the various types of business in which they are engaged. There are four classes of income, each taxed at a different rate. The relevant classes and rates of tax are:

•

Non-complying superannuation class - assessable at 47%

•

Complying superannuation and rollover annuity class - assessable at 15%

•

Accident disability/residual life assurance class - assessable at 39%

•

Non fund class:

-

non-mutual company - assessable at 33%

-

mutual company - assessable at 39%

4.9 These unique factors make it necessary to allocate or apportion deductions to the particular class of assessable income so that the overall tax liability of the company may be determined. This calculation and apportionment of some deductions is achieved through formulas in the tax law.

Reduction of deductions not exclusively related to producing assessable income

4.10 Section 111C reduces certain deductions that would otherwise be allowable to a life assurance company. The reduction made by the formula in this section excludes that part of the deduction that is attributable to deriving exempt income of a life assurance company and, for this purpose, most premium income is treated as assessable income.

4.11 The formula in section 111C is;

Deduction * Assessable income/Total income


4.12 "Assessable income" is the total assessable income of the company. "Total income" is total assessable income plus all exempt income.

4.13 Section 111C does not operate to reduce deductions that are either;

(a)

allowable under subsection 51(1) or section 113; or

(b)

expenses that relate exclusively to the assessable income of a life assurance company.

4.14 Deductions that come within section 111C are those that are allowable under specific provisions of the tax law and that do not come within (a) or (b) above; for example, deductions for gifts under section 78 or subscriptions under section 73.

Expenditure incurred in the general management of the business of a life assurance company

4.15 General management expenses of a life assurance company are not incurred in relation to a specific class of assessable income or exempt income. In these circumstances, it may often be very difficult for a life assurance company to calculate the extent to which much of this expenditure would be deductible.

4.16 Section 113 of the Act provides the means by which a deduction may be calculated for the general management expenses of a life assurance company.

4.17 A life assurance company may elect that its deduction for general management expenses be calculated on the basis set out in subsection 113(1). In that case, the deduction is calculated by reference to the extent that the expenditure was incurred in gaining or producing assessable income. This basis operates in a similar fashion to subsection 51(1). The premium income to which sections 111A and 111AA apply is deemed to be assessable income for the purposes of determining the deduction allowable under subsection 113(1).

4.18 Unless a life assurance company makes the election in subsection 113(1), expenditure incurred in the general management of a life assurance company is deductible only to the extent allowed by the formula in subsection 113(2), that is:

General management expenditure * Assessable income/Total income


4.19 "Assessable income" is the total assessable income of the company (which includes premium income to which sections 111A and 111AA apply). "Total income" is all the income derived by a life assurance company including exempt income.

4.20 Expenses that are of a capital nature, are exclusively incurred in gaining assessable income or are exclusively incurred in gaining exempt income are not general management expenses for the purposes of section 113.

Allocation of deductions

4.21 If a deduction relates exclusively to a particular class of assessable income that deduction is allocated and allowed against that class of assessable income under subsection 116CF(1).

4.22 Where a deduction does not relate exclusively to a particular class of assessable income, subsection 116CF(2) provides a formula for allocating that deduction among the various classes of assessable income.

4.23 The formula in subsection 116CF(2) that allocates deductions is:

Residual current deductions * Income of class/Total income


4.24 "Residual current deductions" is the total of expense deductions not dealt with by subsection 116CF(1). "Income of class" is the assessable income of the relevant class (excluding capital gains) and "Total income" is the total assessable income (excluding capital gains) of all classes of assessable income of the company.

Anomalies in the operation of the formulas

4.25 Some anomalies in the operation and effect of these formulas have now been identified.

4.26 One anomaly is caused by the inclusion in the relevant formulas of amounts deemed to be income under section 275 of the Act. Section 275 allows the contributions tax liability of a complying superannuation fund or of a complying approved deposit fund to be transferred to a life assurance company. This transfer facility was instituted for the administrative ease of small superannuation funds. The transfer is achieved by excluding an agreed amount from the assessable income of the relevant fund and including that amount in the assessable income of the life assurance company. These amounts then form part of the assessable income of a life assurance company for the purposes of the formulas in section 111C, subsection 113(2) and subsection 116CF(2).

4.27 Representatives of the life assurance industry have indicated that virtually no expenses are incurred in relation to section 275 transfers. Their inclusion in the formulas distorts the calculation and apportionment of deductions so that more is directed to the lower taxed superannuation class of assessable income of life assurance companies. This leads to a reduction in the tax value of the deductions of life assurance companies. The amendments seek to overcome this anomaly by excluding section 275 transfer amounts from the formulas.

4.28 Another anomaly arises from including superannuation premiums and the investment component of life assurance premiums in the section 111C and subsection 113(2) formulas but not including these amounts in the subsection 116CF(2) formula. Including these premiums in the first two formulas results in a greater proportion of expenditure being deductible to a life assurance company (and this is the intended result). However, in apportioning the increased deductions according to the subsection 116CF(2) formula no account is taken of the superannuation premiums or the investment component of life assurance premiums. Generally, premium receipts from superannuation policies significantly exceed receipts from ordinary life policies. By omitting these premiums from the formula, a larger proportion of "residual current deductions" is allocated to a more highly taxed class of assessable income. This leads to an unintended increase in the tax value of the deductions allowable to a life assurance company. The amendments seek to correct this anomaly.

Explanation of the amendments

4.29 The proposed amendments will provide that amounts transferred under paragraph 275(2)(a) of the Act are not included in the formulas which determine deductions under section 111C and subsection 113(2) and allocate those deductions to the various classes of assessable income under subsection 116CF(2) [ Clauses 20, 21 and 22] .

4.30 Excluding paragraph 275(2)(a) amounts from these formulas puts a life assurance company in the same position it would have been in had it not accepted a section 275 transfer.

4.31 The amendments to exclude the paragraph 275(2)(a) transferred amounts apply only to amounts that were agreed to be transferred after the date on which the proposed amendments were announced - that is, after 31 May 1993 [Clause 23] .

4.32 The amendments will include superannuation premiums to which section 111A applies, and the investment component of life assurance premiums to which section 111AA applies, in the formula in subsection 116CF(2). This measure will ensure that the "residual current deductions" are apportioned more correctly across the classes of assessable income of a life assurance company [ Clause 22] .

4.33 The amendments to include the superannuation premiums and the investment component of life assurance premiums in the subsection 116CF(2) formula will apply to premiums received after the date on which the proposed amendments were announced - after 31 May 1993 [Clause 23] .