Supplementary Explanatory Memorandum
Amendments to be moved on behalf of the Government (Circulated by authority of the Treasurer, the Hon Peter Costello, MP)Chapter 4 - Insurance
Outline of Chapter
4.1 This Chapter discusses the amendments that are made in relation to the treatment of general insurance for GST purposes. Amendments are made to ITCAB 2 in relation to:
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- changing the current treatment of settlements; and
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- removing the transitional notification requirement insureds currently have.
Summary
4.2 The amendments:
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- remove the insured's GST liability on settlements;
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- remove the insurer's input tax credit entitlement on settlements;
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- provide for insurers to have an adjustment on settlements. That adjustment being equivalent to the difference between what would have been their input tax credit and what would have been the insured's GST liability;
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- remove the requirement that insureds notify the Commissioner if they wish to claim input tax credits on the acquisition of insurance policies in the first 3 years of GST; and
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- have little revenue impact. The amendments reduce compliance costs for all registered entities that have insurance policies and also for insurers.
Detailed explanation of amendments
4.3 The ITCAB 2 as introduced to Parliament proposes amending Division 78 of the GST Act to simplify the application of GST to workers' compensation and compulsory third party insurance. Those amendments retained the underlying policy for the application of GST to insurance whilst simplifying the administration of that policy. After consultation with the general insurance industry after the introduction of those amendments to Parliament, the application of GST to the rest of general insurance is to be similarly simplified.
4.4 The supply of insurance premiums would still be treated under the other rules of GST, that is, taxable if section 9-5 applies, GST-free if any of Division 38 applies, etc. Input tax credits for the acquisition of premiums will also remain subject to the other rules in Division 11, etc. It will be the GST treatment of the settlement of a claim under an insurance policy that is treated differently.
Current treatment under Division 78 of the GST Act
4.5 For insurance settlements Division 78 currently generally applies as follows:
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- insurers receive an input tax credit on the settlement if the supply of the policy was a taxable supply; and
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- insureds have a GST liability to the extent they were entitled to an input tax credit for the acquisition of the policy.
4.6 Amendment 49 preserves this model for the treatment of insurance but reduces the compliance costs for all concerned. This is achieved by providing that insurers have an adjustment on settlements rather than insureds having a GST liability and insurers having an input tax credit. The settlement of an insurance claim will not be consideration for a supply made by the insured [new section 78-45] . Nor will it be consideration for an acquisition made by the insurer [new section 78-20] .
4.7 The amendments amend the ITCAB 2 to amend the GST Act to remove Subdivisions 78-A and 78-B and replace them with new Subdivisions dealing with the GST treatment of insurance settlements for insurers and insureds. The ITCAB 2 already proposed amendments to the GST Act in relation to insurance. Other amendments are made to the ITCAB 2 as the current amendments affect some of those existing amendments.
4.8 Insurers will only have a deceasing adjustment on settlements that relate to the taxable part of a policy. Where the supply of a policy is solely GST-free or input taxed, there will be no decreasing adjustment on settlement. [New section 78-10]
Premium partly or fully subject to GST
4.9 Where the supply of the policy was fully taxable, the insurer could have a decreasing adjustment on any settlement under the policy [new subsection 78-10(2)] . If the supply of the policy was partly taxable and partly not taxable (i.e. GST-free or input taxed), the insurer will have a decreasing adjustment to the extent the settlement relates to the taxable part of the policy [new subsection 78-15(3)] .
4.10 The insurer will only have a decreasing adjustment if there was no input tax credit or a partial input tax credit available on the acquisition of the policy.
Example 4.1
Big Global Corp Ltd (BGC) takes out an insurance policy. The supply of the policy is 60% taxable and 40% GST-free. BGC was entitled to a input tax credit to the extent of 30% of the policy. A settlement of $88,000 is made relating to the GST-free part of the policy.
BGC is entitled to a 30% input tax credit on the insurance policy under Division 11 and BGC has no GST liability on settlement of the claim. [New section 78-45]
The insurer has a GST liability on the supply of the insurance policy under Division 9. The insurer has no decreasing adjustment as the settlement relates to the non taxable part of the policy. [New subsection 78-10(2)]
Full input tax credit entitlement on the premium
4.11 The insurer will not have a decreasing adjustment if there was a full input tax credit available on the acquisition for the policy. [New subsection 78-15(1)]
Example 4.2
A registered business, Angela's Automatic Carwash (AAC), acquires an insurance policy fully for a creditable purpose. The GST inclusive price of the policy is $385. AAC causes personal injuries to a customer when the automatic carwash malfunctions. The damages are $50,000.
AAC is entitled to a $35 input tax credit on the insurance policy under Division 11 of the GST Act. It has no GST liability on settlement of the claim [new section 78-45] .
The insurer has a $35 GST liability on the supply of the insurance policy under Division 9 of the GST Act. The settlement under the policy is not treated as consideration for an acquisition made by the insurer [new section 78-20] . In this instance the insurer does not have a decreasing adjustment because AAC was entitled to a full input tax credit on the premium.
The total settlement will be the $50,000 paid to the injured customer. The cost of the claim to the insurer is $50,000.
Amount of decreasing adjustment
No credit entitlement on the premium
4.12 If there was no entitlement to an input tax credit on the premium, the amount of the decreasing adjustment that the insurer has is 1/11 of the 'settlement amount'. [New subsection 78-10(3)] In this instance, the 'settlement amount' will be the same amount of money the insurer pays in settlement of the claim. [New subsection 78-10(5)]
Example 4.3
Continuing example 4.2, AAC has chosen to cancel its registration because its annual turnover was below $50,000. It still runs the carwash. It acquires an insurance policy which has a GST inclusive price of $385. The carwash malfunctions again. This time the damages are $16,500.
AAC is not entitled to an input tax credit for the GST paid on the policy because it is not registered (paragraph 11-5(d) of the GST Act). There is no GST liability on the settlement because AAC is not registered (section 9-5 of the GST Act).
The insurer has a $35 GST liability on the supply of the insurance policy under Division 9 of the GST Act. The settlement under the policy is not consideration for a creditable acquisition made by the insurer [new section 78-20] . New subsection 78-10(3) will apply to allow a decreasing adjustment of 1/11 of the settlement, which is 1/11 of $16,500. The insurer will account for a decreasing adjustment of $1,500 in the relevant tax period.
The net cost of the claim to the insurer is the $16,500 settlement less the $1,500 decreasing adjustment, which is $15,000.
4.13 If there was an entitlement to a partial input tax credit on the premium, the amount of the decreasing adjustment will be 1/11 of the settlement amount multiplied by the extent to which there was no input tax credit entitlement on the premium. [New subsection 78-15(2)]
4.14 The 'settlement amount' will be the amount of money the insurer provides as settlement, multiplied by 11 and then divided by 11 less the extent of credit on the premium. [New subsection 78-15(4)]
Example 4.4
Continuing example 4.3 above, AAC registers again. It has diversified its business and now runs the car wash and makes supplies of long term commercial residential accommodation at a caravan park. It has chosen to have its supplies of long term commercial accommodation input taxed. It acquires an insurance policy that covers it for liabilities arising out of the car wash and the caravan park for a GST inclusive cost of $770. AAC is entitled to an input tax credit on the premium to the extent of 60%. The carwash malfunctions yet again. This time the damages are $5,200.
AAC is entitled to an input tax credit on the insurance policy of $42 (1/11 x 770 x 60%) under Division 11. It has no GST liability on settlement of the claim [new section 78-45] .
The insurer has a $70 GST liability on the supply of the insurance policy under Division 9. The settlement under the policy is not treated as consideration for an acquisition made by the insurer [new section 78-20] . New subsection 78-10(4) will apply to allow a decreasing adjustment equal to 1/11 of the settlement amount multiplied by 40%. The settlement amount will be:
($5,200 *11) / (11 - 0.6) = $5,500.
The decreasing adjustment will be:
1/11 of $5,500 * 40% = $200.
The net cost of the claim to the insurer is the $5,200 settlement less the decreasing adjustment of $200, which is $5,000.
4.15 This 'grossing up' of the amount of settlement ensures that insurers have the same claims cost under the adjustment as they would have under the current Division 78.
4.16 From examples 4.2 to 4.4, it can be seen that the insurer will need to know the extent of input tax credit entitlement on the premium. Under the current Division 78, insurers would generally have needed this information so that they could determine the premium to charge for the policy. That is, the amount of premium depended on the potential amount of settlement, which depended on the extent of the insured's GST liability on a settlement, which depended upon the insured's extent of input tax credit on the premium.
4.17 However, under the adjustment mechanism, the insurer will be relying on the information from the insured in order to determine its adjustment entitlement. For this reason, if the insurer is not correctly informed of the extent of input tax credit entitlement on the acquisition of the policy, the entity that was entitled to the input tax credit on the premium will have a GST liability on a settlement. That entity will have a GST liability to the extent it did not inform the insurer of its credit entitlement [new section 78-50] . Private consumers have no credit entitlement. They do not have a GST liability on settlement.
Example 4.5
Robert is registered and makes both taxable and input taxed supplies. Robert acquires an insurance policy 70% for a creditable purpose and pays a GST inclusive premium of $330. He informs his insurer that his credit on the acquisition of the policy was 100%. A settlement of $16,500 is later made under the policy.
The insurer has a $30 GST liability on the supply of the insurance policy under Division 9. The settlement under the policy is not treated as consideration for an acquisition made by the insurer [new section 78-20] . The insurer bases its adjustment on the extent of credit Robert informed them of. In this instance, the insurer believes that no decreasing adjustment arises because Robert was entitled to a full input tax credit on the premium.
Robert is entitled to a $21 input tax credit on the insurance policy under Division 11. On settlement, Robert will have a GST liability of $450 [new section 78-50] . That is, 30% (100% less 70%) of 1/11 of $16,500.
4.18 Currently, adjustment events can arise in relation to the input tax credits or GST liability that arises in relation to settlements. For example, if a settlement is made, but later investigation reveals that the claim was fraudulent, and the settlement is recovered, the insurer (and the insured if registered) will have an adjustment. Under an adjustment approach, there is no longer an input tax credit or an amount of GST in relation to which an adjustment event can arise. New section 78-35 ensures that adjustment events can arise in relation to the adjustment that an insurer will have on a settlement.
4.19 New section 78-35 provides that if an insurer has made a claim in exercising its rights of subrogation and a third party makes a payment, a supply or both in settlement of that claim, that supply or payment is not consideration for a supply made by the insurer. The effect of this is that the insurer will not have a GST liability on the supply or payment. Amendment 50 amends item 41 ( new section 78-75 ) to provide that the third party making the payment or supply will not have made a creditable acquisition. It will not be entitled to an input tax credit on the payment or supply.
4.20 Instead, settling claims made in exercise of rights of subrogation will be treated as an adjustment event.
Example 4.6
An insurer makes a settlement of $11,000. There was no input tax credit on the premium. It receives a decreasing adjustment of $1,000. It later, in exercise of its right of subrogation, recovers $6,600 from a third party. This means that in effect the net settlement the insurer paid has been reduced to $4,400 ($11,000 $6,600). The insurer's decreasing adjustment on that amount of settlement would be $400.
The insurer will have an increasing adjustment of $600 due to the adjustment event. This leaves it with a net decreasing adjustment on the settlement of $400.
Supplies by insurers in settlement of claims
4.21 It is common in certain types of insurance for the insurer to acquire goods or services and supply it to the insured in settlement of a claim. For example, if an entity's business premises burn down, it is common for the insurer to pay the builder directly for the cost of rebuilding. If the insurer has acquired the services of the builder under a contract for the builder to supply building services to the insurer, it would be a creditable acquisition in the hands of the insurer. The insurer would be entitled to an input tax credit under Division 11 for that acquisition. If it then supplies those services to the insured in settlement of the claim, that supply by the insurer could be a taxable supply under Division9. If the claim had been settled in money it would not be a taxable supply. The treatment of the claim settlement should be no different if it is a supply of goods or services. For this reason, new section 78-25 provides that a supply an insurer makes in settling a claim is not a taxable supply.
Acquisitions of goods by insurers in settling claims
4.22 If an insurer acquires goods or services for the purpose of settling a claim, that acquisition will generally be a creditable acquisition under the general rules. If the insurer then supplies those goods to an insured as settlement of the claim, that supply would generally be a taxable supply under the general rules. As discussed at paragraph 4.21 that supply is treated as not being a taxable supply. As the insurer will have been entitled to an input tax credit on the acquisition of the goods or services, the amount of settlement that the decreasing adjustment is calculated on excludes the amount of the supply of those goods or services [new subsection 78-10(5)] .
4.23 However, the insurer does not have a decreasing adjustment if the supply of the policy was not a taxable supply. Therefore, the insurer is not entitled to an input tax credit on the acquisition of goods if the insurer acquires them to make a supply in settlement of a claim that is made under such a policy. [New section 78-30]
Goods supplied to insurer in course of settling a claim
4.24 If you supply goods to an insurer under an insurance policy in the course of settling a claim, such as supplying a car wreck after an accident, the supply is not a taxable supply. This also means that the acquisition by the insurer of those goods is not a creditable acquisition. If part of the supply is not a supply of goods to an insurer under an insurance policy in the course of settling a claim, you will be liable for GST on that part of the supply. [New section 7-60]
4.25 Excesses paid to the insurer are excluded from the calculation of the decreasing adjustment [new subsection 78-10(5)] . The payment of an excess by an insured to an insurer is also not treated as consideration for a supply. Otherwise, under the general rules the insured could be liable to 1/11 of the excess as GST and the insurer could be entitled to 1/11 of the excess as an input tax credit. [New section 78-55]
Statutory compensation schemes
4.26 Some statutory compensation schemes do not fall within the definition of insurance in subsection 78-5(4) and therefore are not covered by Division 78. Other statutory compensation schemes are insurance and are covered by Division 78. For example, some workers' compensation schemes are within the definition of insurance and others are not. The Government's intention is to treat such statutory compensation schemes similarly.
4.27 Amendment 55 inserts new subdivision 78-E to deal with statutory compensation schemes.
4.28 New section 78-100 ensures that any payments towards or under a 'statutory compensation scheme' and any settlement of a claim for compensation under such a scheme are treated in the same manner as payments for an insurance policy and a settlement of a claim under an insurance policy. 'Statutory compensation scheme' is defined in new section 78-105 . Note that the scheme has to be specified in the regulations or of the type specified in the regulations to be brought within the operation of Division78. For example, a particular workers' compensation scheme could be specified in the regulations and thereby brought within the operation of Division 78.
4.29 In some situations a settlement under a compensation scheme can arise even where an entity that was responsible for making payments to the scheme did not do so. For example, under some workers' compensation schemes an employee can be entitled to compensation even if the employer did not make the payments into the scheme it was liable to make. New subparagraph 78-100(2)(c)(ii) ensures that the compensation is treated the same whether or not the employer met their liability to make payments into the scheme. It does so by providing that even if an entity did not make payments into a statutory compensation scheme but it was liable to do so, it is treated as the entity insured for the purposes of Division 78.
Effect of judgments and court orders on GST and insurance
4.30 In some circumstances when there is a court ordered settlement there will be a different treatment for GST purposes than if the settlement had been reached without the intervention of the court. New section 78-110 ensures that if there is a judgment or order of the court in relation to an insurance claim the outcome for GST purposes is the same as if the settlement had been made without the intervention of the court.
4.31 New section 78-110 also applies in relation to claims made by insurers in exercising their rights of subrogation (see paragraph 4.19 for a discussion of subrogation). That is, if the outcome of such a claim is determined by a judgment or order of the court it will be treated in the same way as if the outcome had been reached through an out of court settlement.
Exclusion of certain insurance schemes
4.32 There may be certain government schemes of insurance or compensation to which it is not appropriate to apply Division 78. For this reason, new section 78-115 is inserted to provide that Division 78 does not apply to types of insurance or compensation specified in the regulations. The insurance or compensation scheme has to be one established by a law of the Commonwealth, State or Territory. For example, it may not be appropriate to treat a loss making statutory insurance scheme as insurance under Division 78.
4.33 The GST on the supply of an insurance policy, or the supply of membership or participation in a statutory scheme, will be calculated as if an amount equivalent to stamp duty were excluded from the price of the supply. For example, if the total premium for a policy was $185, with stamp duty of $20, GST would be 1/11 of $165, which is $15. [New sections 78-5 and 78-95] The price for other purposes of the GST Act, such as the tax invoicing provisions, will remain stamp duty inclusive.
Consequential amendments
4.34 Amendment 76 (item 61C) replaces the definition of 'insurance policy' in the Dictionary in section 195-1 of the GST Act.
4.35 Amendment 70 and 86 omit the items proposing to insert definitions of 'compulsory third party scheme' and 'workers compensation scheme' into the Dictionary in section 195-1 of the GST Act. With the wider application of the adjustment mechanism these definitions are no longer needed.
4.36 Amendments 14, 52 to 54, 80, 82 and 83 make consequential cross referencing amendments.
4.37 Amendments 72 and 81 make other minor amendments consequential upon the changes outlined above.
4.38 Amendments 45 and 46 (items 30B and 30C) make amendments to ensure that the associate provisions do not apply where the transaction is a settlement of an insurance claim.
Transitional provisions
4.39 Section 22 of the GST Transition Act currently provides which settlements the GST treatment of insurance applies to. Amendment 101 amends section 22 to take account of the change in the treatment of insurance. The insurer will not have an adjustment under Division 78 if the event to which the settlement relates occurred before 1July 2000 or, if the time of the event is not certain, the claim was made before 1July 2000.
4.40 The removal of the GST liability on the settlement that the insured currently has under Division 78 means that there is no longer any need for the notification under section 23 of the GST Transition Act. The notification under section 23 was required to enable insureds time to ensure that their insurance policies were rewritten to take account of their GST liability on a settlement. As the amendments remove that GST liability, there is no need for the notification under section 23. Amendment 102 (item 12) repeals section 23 of the GST Transition Act.
Compulsory third party insurance
4.41 Amendment 102 also inserts a new section 23 . New section 23 provides a special transitional rule for compulsory third party insurance.
4.42 You are not entitled to input tax credits on the acquisition of compulsory third party insurance for the first 3 years of the GST. The effect of this is that the insurer will be entitled to a decreasing adjustment equal to 1/11 of the amount of the settlement. See paragraph 4.12 for a discussion of calculating the decreasing adjustment on a settlement. This will allow time for compulsory third party insurance to be repriced to take account of the GST.
4.43 The regulations will specify the compulsory third party schemes, or kinds of schemes, to which new section 23 applies.
Informing insurers of input tax credit entitlement
4.44 As discussed at paragraph 4.17, insureds will generally need to inform insurers of the extent to which they are entitled to input tax credit on premiums, when or before the policy is supplied. As policies have already been supplied, insureds will not have been able to inform insurers of their input tax credit entitlement.
4.45 Amendment 103 inserts new section 23A for policies that span 1July 2000 so that insureds will have until 30June 2000 to inform insurers of the extent to which they are entitled to an input tax credit for the premium they have paid.
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