SENATE

Explanatory Memorandum

(Circulated by authority of the Treasurer, the Hon Peter Costello, MP)

Chapter 2 Rebatable annuities

Overview

2.1 The amendments contained in Part 2 of Schedule 1 of the Bill amend the definition of 'qualifying annuity' in subsection 27A(1) of the Income Tax Assessment Act 1936 (the Act) to:

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ensure that, subject to certain exceptions for some annuities purchased on or before 9 December 1987, only annuities purchased wholly with rolled-over amounts are treated as eligible termination payments (ETPs) on commutation or termination;

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prevent the conversion of ordinary (non-ETP) annuities to rebatable annuities and pensions.

Summary of the amendments

Purpose of the amendments

2.2 The purpose of the amendments is to ensure that:

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subject to exceptions for certain annuities purchased on or before9 December 1987, only annuities purchased entirely with amounts accumulated within the superannuation system receive concessional taxation treatment as ETPs on commutation or termination;

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ordinary (non-ETP) annuities can not be converted to rebatable ETP annuities and superannuation pensions;

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the existing treatment of certain annuities which were purchased on or before 9 December 1987 with a mix of ETP and non-ETP amounts is maintained, so that they continue to be treated as ETPs on commutation or termination.

Date of effect

2.3 The amendments apply to annuities commuted or terminated on or after 15 June 1996.

Background to the legislation

2.4 Amendments to the Act were made in 1994 (contained in the Taxation Laws Amendment (Superannuation) Act 1992 ) to allow annuities already within the superannuation system to be treated as ETPs and further rolled-over on commutation or termination.

2.5 Prior to the 1994 amendments, amounts received on the commutation or termination of a qualifying annuity were included in the definition of an ETP. However the amount to be treated as an ETP was reduced by the unused undeducted purchase price (UUPP) of the annuity. As the UUPP of an ordinary (non-ETP) annuity equalled the entire amount received on commutation or termination, the effect of this was that no amount received on the commutation or termination of such an annuity was an ETP.

2.6 A qualifying annuity is defined in subsection 27A(1) of the Act to mean:

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an annuity purchased after 12 January 1987 that is an eligible annuity or the subject of an eligible policy;

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an annuity purchased on or before 12 January 1987 that is an eligible annuity as defined before that date;

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an immediate annuity purchased on or before 9 December 1987.

2.7 The 1994 amendments provided for the UUPP of a qualifying annuity to be treated as an ETP by removing the exclusion of UUPP from the definition of an ETP in paragraph 27A(1)(g) of the Act, and including UUPP in the definition of undeducted contributions in subsection 27A(1) of the Act. Undeducted contributions are a component of an ETP and can be rolled-over.

2.8 The amendments had the unintended consequence of allowing ordinary (non-ETP) annuities which are the subject of eligible policies to be treated as ETPs on commutation or termination. As ETPs these annuities were eligible to be rolled-over into the superannuation system and used to purchase rebatable annuities and pensions.

2.9 The ability to convert ordinary (non-ETP) annuities to rebatable annuities and pensions was not the intention of the amending legislation and is inconsistent with past and present Government policy in this area.

2.10 Rebates for ETP annuities and superannuation pensions purchased wholly with rolled-over amounts are available under section 159SU and section 159SM of the Act. The rebate was brought in to compensate for the impact of tax on contributions to superannuation funds. The rebate is clearly intended to apply only to pensions and annuities purchased with superannuation amounts. Amounts received on the commutation or termination of an ordinary (non-ETP) annuity are not superannuation amounts and should therefore not be treated as an ETP or be eligible for the rebate.

2.11 An exception to this approach is the treatment of immediate annuities purchased on or before 9 December 1987, with a mixture of ETP and non-ETP amounts. Prior to legislative amendment contained in the Taxation Laws Amendment Act (1988), which had effect from 1987, immediate annuities purchased only partly with an ETP amount could be treated as an ETP on commutation or termination.

2.12 For reasons of equity these annuities have continued to be treated as ETPs on commutation or termination. This treatment is to be maintained by the amendment.

Explanation of the amendments

2.13 The Bill amends the definition of 'qualifying annuity' contained in subsection 27A(1) of the Act. The amount received on commutation or termination of an annuity is an ETP if the annuity is a qualifying annuity as defined in subsection 27A(1). The amount received as an ETP can be rolled-over to purchase an ETP annuity or superannuation pension that may be eligible for a rebate. The definition of 'qualifying annuity' is therefore amended to ensure that only annuities which have been purchased wholly, or in some cases partly, with rolled-over amounts will satisfy the definition of 'qualifying annuity'.

2.14 The amendments apply to annuities commuted or terminated on or after 15 June 1996 [item 9] . That is, the amendments will apply to any amount received in relation to a commutation or termination of an annuity received on or after 15 June 1996. Amounts received on the termination of an annuity are known as the 'residual capital value' of an annuity and are covered by these amendments.

2.15 References in the amendments to rolled-over amounts also include a rolled-over amount. The amendments apply to annuities purchased with a single rolled-over amount and to annuities purchased with two or more rolled-over amounts.

2.16 Paragraph (a) of the definition of 'qualifying annuity' is amended to require that the annuity be purchased wholly with rolled-over amounts [item 7] . This has the effect of ensuring that annuities purchased after 12 January 1987 and commuted or terminated on or after 15 June 1996, will only satisfy the definition of qualifying annuity and hence the definition of ETP if they were purchased wholly with rolled-over amounts.

2.17 The definition of 'eligible annuity' was amended with effect from 12 January 1987 to ensure that for an annuity to be an 'eligible annuity' it must satisfy certain conditions. One of these conditions is that the annuity must be one whose purchase price consists wholly of a rolled-over amount or rolled-over amounts. The effect of the current amendment then, is to ensure that an annuity which is the subject of an eligible policy within the meaning of Division 8 or 8A is similarly required to have been purchased wholly with rolled-over amounts.

2.18 Paragraph (b) of the definition of 'qualifying annuity' is amended to require that the annuity be purchased wholly or partly with rolled-over amounts [item 7] . This has the effect of ensuring that annuities purchased before 12 January 1987 and commuted or terminated on or after 15 June 1996, will satisfy the definition of qualifying annuity and hence the definition of ETP if they were purchased either wholly or partly with rolled-over amounts.

2.19 The definition of 'eligible annuity' prior to the 12 January 1987 amendment, other than in the case of a deferred annuity (see definition of roll-over annuity in subsection 27A(1)), did not contain the condition that the purchase price consist wholly of a rolled-over amount or rolled-over amounts. Thus, prior to 12 January 1987 an annuity would have satisfied the definition of an 'eligible annuity' if it was purchased wholly or partly with a rolled-over amounts.

2.20 This amendment to paragraph (b) of the definition maintains the previous treatment of annuities purchased on or before 12 January 1987, which will continue to be treated as qualifying annuities and hence as ETPs when they were purchased either wholly or partly with rolled-over amounts.

2.21 Paragraph (c) of the definition of 'qualifying annuity' is amended to require that the annuity be purchased wholly or partly with rolled-over amounts [item 8] . This has the effect of ensuring that immediate annuities purchased on or before 9 December 1987 and commuted or terminated on or after 15 June 1996, will satisfy the definition of qualifying annuity and hence the definition of ETP if they were purchased either wholly or partly with rolled-over amounts.

2.22 This amendment to paragraph (c) of the definition maintains the previous treatment of immediate annuities purchased on or before 9 December 1987, which will continue to be treated as qualifying annuities and hence as ETPs when purchased only partly with rolled-over amounts.

2.23 The amendment to paragraph (c) of the definition augments the amendment to paragraph (a) in that the paragraph (c) amendment will apply to immediate annuities purchased before 9 December 1987 and which do not satisfy the definition of 'eligible annuity'. The amendment to paragraph (a) of the definition applies to immediate annuities which do satisfy the 'eligible annuity' definition.

2.24 Immediate annuities purchased after 9 December 1987 and commuted or terminated on or after 15 June 1996 will only satisfy the definition of qualifying annuity and hence the definition of ETP if they were purchased wholly with rolled-over amounts.