Senate

Explanatory Memorandum

(Circulated by the authority of the Treasurer the Hon Ralph Willis, M.P.)

CHAPTER 5 - ELIGIBLE INVESTMENT INCOME OF REGISTERED ORGANISATIONS

Overview

5.1 The amendment will include in the assessable income of registered organisations income derived from certain assets.

Summary of the amendments

Purpose of the amendment

5.2 The proposed amendment will include in the assessable income of a registered organisation income derived from certain assets. The purpose of the amendment is to ensure that the provisions of Division 8A of the Income Tax Assessment Act 1936 (the Act) are not circumvented by the holding of assets separate from the eligible insurance business of the organisation (for instance by the establishment of a separate fund) as a result of the High Court decision in Independent Order of Odd Fellows of Victoria v FC of T (91 ATC 5032; (1991) 22 ATR 783) (the IOOF case) . [Clause 61]

Date of effect

5.3 The amendment will apply to income derived on or after 1July1994 by a registered organisation from eligible investment assets. [Clause64]

Background to the legislation

5.4 'Registered organisation' is defined in subsection 116E(1) to mean a trade union, a friendly society or an employees' association, which is exempt from tax under either paragraph 23(f) (as a trade union or employees' association) or subparagraph 23(g)(i) (as a friendly society).

5.5 Section 116F states that Division 8A overrides all other provisions of the Act in determining the assessable income of a registered organisation. Accordingly, section 116G sets out classes of assessable income of registered organisations; assessable income of registered organisations is limited to income falling within these classes. The classes of assessable income are non-complying superannuation, complying superannuation/roll-over annuity and eligible insurance business.

5.6 The amount of assessable income of a registered organisation to be included in each class is determined by section 116GD. The amount of assessable income in the eligible insurance business (EIB) class comprises assessable income allocated under certain sections relating to the disposal of relevant assets and any other EIB assessable income (subsection 116GD(2)).

5.7 The terms 'eligible insurance business', 'EIB assessable income' and 'EIB asset' are defined in subsection 116E(1). 'Eligible insurance business' means the business of, or relating to, the issuing of, or the undertaking of liability under, eligible insurance policies. 'EIB assessable income' means so much of the total income (other than premiums) of the organisation as is derived from eligible insurance business of the organisation. 'EIB asset' means an asset that relates to the eligible insurance business.

5.8 In the IOOF case , the High Court examined the definition of 'eligible insurance business' in subsection 116E(1). In that case, the taxpayer, a friendly society, had transferred monies from the 'benefits fund' into which premiums were paid, into a 'tax provision repository fund' to cover any tax liability arising from its eligible insurance business. The High Court held that investment income derived from the fund which was specifically established to meet income tax obligations was not income derived from eligible insurance business and, therefore, was exempt. This was because the investment of monies in the 'tax provision repository fund' was not relevantly related to the issuing of or the undertaking of liability under eligible insurance policies.

5.9 The Court said that although the eligible insurance business of the friendly society included all the activities relating to the issuing of and undertaking of liabilities under eligible insurance policies, including making provisions for tax liabilities and making investments in the course of carrying on eligible insurance business, it did not include the investment of moneys held in a separate fund and which could be applied for purposes other than eligible insurance business purposes. It followed that the investment income derived from the 'tax provision repository fund' was not income from eligible insurance business.

5.10 As a result of the IOOF case , the provisions of Division 8A could be circumvented by holding assets separate from the eligible insurance business of the organisation, for instance by establishing a separate investment fund the income from which, on the basis of that case, may not be derived from the business of or in relation to the issuing of or undertaking of liability under eligible insurance policies.

5.11 To overcome that result, it is necessary to broaden the definition of EIB assessable income to include all income derived from certain specified assets.

Explanation of the amendments

5.12 These amendments are necessary to ensure that all income derived by a registered organisation relating to eligible insurance business, such as income derived by a friendly society from the investment of premiums held separately from its benefits fund, is subject to income tax.

5.13 A new definition of 'EIB assessable income' is inserted to replace the existing one in subsection 116E(1). The new definition includes income derived from eligible insurance business (ie income that was previously included in EIB assessable income) as well as income derived from 'eligible investment assets'. Such assets would include money, equities, real estate, or any other assets. [Clause 62]

5.14 A definition of 'eligible investment asset' is inserted in subsection 116E(1). It means:

(a)

premiums derived in carrying on eligible insurance business or other amounts derived in carrying on eligible insurance business (regardless of whether such premiums or other amounts are transferred from one fund into another). This would include the earnings or surplus of a friendly society's benefits fund, whether held in that fund or not.

(b)

income or profits derived from eligible investment assets, for instance, interest derived on premiums or on the surplus of a friendly society's benefits fund, whether held in such fund or not .

(c)

assets purchased with amounts included in (a), (b) above or in (c). This paragraph would cover the situation of assets such as equities or real estate purchased with premiums or interest derived on premiums and whether held in a friendly society's benefits fund or transferred from the benefits fund into another fund.

[Clause 62]

5.15 The definition applies to eligible investment assets whether held in the original fund into which they were paid or credited, or whether they were transferred out of that fund, including if they were transferred into another fund or into a series of funds. For example, it would include assets (such as premiums or assets acquired with those premiums, or income derived thereon) transferred by a friendly society from its benefits fund, whether transferred into another fund or through a series of funds.

5.16 The effect of the amendment is that income derived from eligible investment assets is included in EIB assessable income regardless of how such income is used (eg whether the income is capitalised or reinvested, used to pay expenses relating to insurance business, used to pay bonuses to policyholders or members, etc). Thus investment income derived from a fund specifically established to meet tax obligations in circumstances similar to those examined by the High Court in the IOOF case will come within the new definition of 'EIB assessable income'.

5.17 That effect is achieved by the amendment regardless of the number of funds which may be interposed between the fund in which the premiums or other amount derived in carrying on the eligible insurance business are initially placed and the fund in which the EIB assessable income is derived.

5.18 A new definition of 'EIB asset' has been substituted. The new definition covers not only an asset relating to eligible insurance business but also an eligible investment asset. [Clause 62]

5.19 As a result of these changes, an amendment is needed to subsection 116GA(4). The provision currently refers to the business of the classes of income. The reference to 'the business of' is being deleted because of the inclusion of eligible investment assets in the definitions. [Clause 63]