Foreign investment funds guide

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Chapter 5: Foreign life assurance policies

Meaning of a foreign life policy

Your foreign life insurance policy (FLP) for an income year is a life insurance policy issued by an entity that was a non-resident at any time in that income year.

A life insurance policy is one which provides for the payment of benefits upon death, other than death by accident or specified sickness, or on the happening of a specified event which relates to the ending or continuing of a human life. A life insurance policy also includes an instrument which grants an annuity for a term dependent upon a human life. [SECTION 482]

The FIF measures do not apply to the following four categories of life policies:

• an Australian policy, provided that the entity which issued the policy was authorised under the Life Insurance Act 1945 to carry on life insurance business in Australia when it issued the policy
• those policies which provide for payment of benefits on death, or death or permanent disability only
• those policies issued before 1 July 1992 which cannot, after that date, be cancelled, surrendered or redeemed and for which the terms have not, after that date, been altered in any material way or
• a contract of reinsurance between a resident insurer and a non-resident reinsurer for life insurance policies which provide only life cover. [PARAGRAPHS 482(2)(e) and (f)]

You have an interest in a FLP if you have a legal title to the FLP. [SUBSECTION 483(3)]

Interest in a FLP subject to taxation

Your assessable income for an income year includes FIF income if you had an interest in a FLP at any time during a FLP's notional accounting period that ends in your income year and you were a resident at any time in that income year. [SUBSECTION 485(4)]

The measures do not apply to an interest in a FLP if you disposed of that interest before 30 June 1993. [SUBSECTION 485(5)]

Notional accounting period of a FLP

A notional accounting period of your FLP is a 12 month period ending 30 June each year. You may elect a different notional accounting period if a cash surrender value of your FLP is available in the same month of each year. This election is irreversible for as long as you hold an interest in that particular FLP. Your FLP's new notional accounting period will begin:

• on the first day of the month following the last day of the month in which the cash surrender value of your FLP is available in each year and
• in the month immediately prior to your electing a new notional accounting period in which the cash surrender value of your FLP is available each year. [SUBSECTIONS 487(3) and (7)]

EXAMPLE

The current notional accounting period of Judith's FLP is 1 July to 30 June each year. In November of each year a cash surrender value will be available for her FLP. In September 1997 she elects to use a different notional accounting period for her FLP. The new notional accounting period will begin on the first day of the month following November - that is, 1 December - and end 12 months later on 30 November each year.

However, the first new notional accounting period of Judith's FLP does not begin in the December following the election (December 1997) but begins in the December before the election is made (December 1996). Therefore the first new notional accounting period for Judith's FLP is 1 December 1996 to 30 November 1997.

The months between the start of her old notional accounting period (1 July 1996) to the start of her new notional accounting period (1 December 1996) is also a notional accounting period - that is, 1 July 1996 to 30 November 1996. [SECTION 487]

The FIF income for the period 1 July 1996 to 30 November 1996 will be returned in the 1996-97 income year. The FIF income for the period 1 December 1996 to 30 November 1997 will be included in the 1997-98 income year.

Methods of taxation applicable to FLPs

You must work out FIF income for an interest in a FLP using either:

• the deemed rate of return method or
• the cash surrender value method.

Choosing the taxation method

You would generally use the deemed rate of return method for your interest in a FLP. However, you may elect to use the cash surrender value method. [SUBSECTION 536(2)]

If you elect to use the cash surrender value method, you must also elect to use a notional accounting period for the FLP that coincides with the period for which the cash surrender values are available. [SECTION 487 and SUBSECTION 536(3)]

An election to apply the cash surrender value method is irrevocable. [SUBSECTIONS 487(3) and 536(5)]

Deemed rate of return method

The deemed rate of return method for FLPs is similar to the deemed rate of return method for FIFs. Four steps are used to work out your FIF income.

The following information will help you to complete Worksheet 4 Deemed rate of return method for FLPs.

Step 1 - Groups of interests

The first step is to decide whether you have one or more interests in the FLP during a notional accounting period.

If you acquired interests in the same FLP at different times during a notional accounting period, you must apply the deemed rate of return method separately for each interest for the period from when you acquired it. [SECTION 585]

Step 2 - Working out the opening value - box A

This step decides the opening value of the FLP.

If you had the interest in the FLP at the beginning of a notional accounting period, the opening value is the value on the day before the first day of the period.

Opening value where the deemed rate of return method has been applied in the previous year

If you used the deemed rate of return method in the immediately previous notional accounting period, work out the opening value as follows.

• Determine the deemed value of the FLP at the commencement of the previous notional accounting period.
• Add the FIF income of the FLP for its previous notional accounting period.
• Add the value of any premiums paid during the previous notional accounting period.
• Take away any distributions the FLP made in the previous notional accounting period. [SECTIONS 586 and 590]

Opening value where the interest is acquired during the notional accounting period

If you acquired the interest in the FLP during a notional accounting period, the opening value is its cost if you paid the full consideration. In any other case, the value is the amount of the first premium paid. [PARAGRAPH 586(b) and SECTION 591]

Please note:

• There are special rules for working out the opening value in the first operative year of the measures - that is, 1 January 1993 to 30 June 1993. [SECTION 588]
• There are also special rules when reverting to the deemed rate of return method following the application of the cash surrender method. [SUBSECTIONS 536(8) to (9)]

Step 3 - Working out the movement in the value of the FLP - box C

Once you have determined the opening deemed value, work out the FIF amount - that is, the movement in the value of the FLP - by applying the foolowing formula: [SECTION 592]

Opening value

X

Deemed rate of return

X

Number of days held 365

Opening value means the amount determined in Step 2.

Deemed rate of return means the basic statutory rate which is the same rate of interest as the 13 week Treasury Note or the Treasury Note yield less 4 per cent. This rate is published by the Commissioner of Taxation in the Commonwealth gazette for the subsequent six-month period. [SECTIONS 214A and 529]

If two or more rates apply in the relevant income year, use the weighted average of those rates.

Number of days held means the number of days in the notional accounting period in which you had the interests in the group.

Step 4 - Working out the amount to include in assessable income - box D

The final step in applying the deemed rate of return method is to convert the FIF amount to Australian currency.

Use the rate of exchange that applied at the end of the notional accounting period to convert each FIF amount in box C to FIF income in Australian currency. [SECTIONS 593 and 594]

The FIF income is included in your assessable income, subject to reduction by certain assessable distributions from the FLP. Chapter 6 Avoiding double taxation on page 25 has more information.

EXAMPLE

Lal acquires a FLP on 1 January 1997 for $HK250,000. For the first year, under the deemed rate of return method, he multiplies the opening value by the deemed rate of return as follows:

$HK250,000 x 10.5% x (181/365)

FIF income = $HK13,017

Lal includes the FIF income in his assessable income after converting it to Australian dollars using the exchange rate applicable on 30 June.

Cash surrender value method

Overview

The cash surrender value method of working out FIF income applies only to FLPs. This method decides whether any FIF income accrues to you from an interest in a FLP by taking into account changes over a 12-month period in the cash surrender value of your interest in the FLP.

Under the cash surrender value method, the amount of the FIF income is decided in two steps. The first step works out the movement in the cash surrender value of the FLP, generally between two annual reporting dates. The second step allows an adjustment for losses of prior years. The result of these calculations is the amount of foreign investment fund income that you must include in your assessable income.

The following information will help you to complete Worksheet 5 Cash surrender value method for FLPs.

Step 1 - Working out the movement in the cash surrender value - boxes A t o F

The movement in the cash surrender value of your interests in the FLP which have a cash surrender value at the end of the notional accounting period is worked out as follows. [SECTION 596]

Use the same currency in boxes B to G as you use for the cash surrender value in box A. [SUBSECTION 596(3)]

Box A

Insert the cash surrender value of your interests in the FLP on the last day of the notional accounting period.

Box B

Insert the value of distributions the FLP made to you during the notional accounting period for those interests held on the last day of the notional accounting period.

Boxes C and D

If you disposed of an interest in the FLP during the notional accounting period, insert:

• the amount you received for the disposal and
• the value of distributions the FLP made to you for that disposed interest.

Box E

Insert the opening cash surrender value of the interest at the commencement of the notional accounting period.

If you used the deemed rate of return method for the same interest in the immediately preceding notional accounting period, use the value determined by that method for the last day of that period.

Box F

Insert the amount you paid or gave for contributions to the interest in the FLP during the notional accounting period.

Box G

Take away the sum of E and F from the sum of A to D. This gives you the FIF amount.

• Gross FIF income

If the FIF amount is positive, it is your gross FIF income from the FLP. [SECTION 598]

• FIF loss

If the FIF amount is negative, a FIF loss has occurred. In certain circumstances, you may use this FIF loss to offset your assessable income in later income years. See chapter 6 Avoiding double taxation. [SECTIONS 533 and 599]

Step 2 - Working out the amount to include in assessable income

This step works out the amount of FIF income. [SECTION 600]

Box H

Insert the total of any unapplied previous FIF losses for your FLP. [SUBSECTION 600(2)]

If it is not already the case, convert the unapplied previous FIF loss to the same currency as the gross FIF income in box G. [SUBSECTION 600(8)]

Unapplied previous FIF losses

An unapplied previous FIF loss is the amount by which the undeducted amount of a foreign investment fund loss is more than the sum of any gross FIF income applying to your interest in a FLP. This is so even if the operative provision did not apply because of any of the exemptions listed on pages 14- 15. [SUBSECTION 600(5)]

In working out the unapplied previous FIF losses, the undeducted amount of a FIF loss is that part of a FIF loss that has not been allowed as a deduction from your assessable income in a previous income year. [SUBSECTION 600(6)]

Once you have used a FIF loss to work out if there was, for any notional accounting period, an unapplied previous FIF loss, you cannot use that loss again in later notional accounting periods. [SUBSECTION 600(7)]

Also, in determining the gross FIF income to use to work out the unapplied previous FIF losses, apply only that gross FIF income accruing after the notional accounting period in which you incurred the loss and before the current notional accounting period in which you have a gross FIF income. [SUBSECTION 600(5)]

Box I

Take away the amount in H from the amount in G. This will give you your FIF income.

Box J

Convert your FIF income to Australian dollars at the rate of exchange that applies at the end of the relevant notional accounting period. Insert the converted amount at J. [SUBSECTION 600 (8)]

The amount at J is your FIF income. Include it in your assessable income after allowing for a reduction for certain assessable distributions from the FLP. Read chapter 6 Avoiding double taxation for more information.

Boxes K, L and M

If any of the distributions referred to above are payments made by the entity which issued the FLP to you, use K, L and M to arrive at the amount to include in your assessable income.

You must read the next chapter , Avoiding double taxation , as the reduction of your FIF income cannot be more than the total of your FIF income for the current income year. [SECTIONS 530 and 603]

EXAMPLE

Increase in cash surrender value

The opening cash surrender value of an interest in a FLP, at 1 July, was $HK50,000 (E). At the end of the notional accounting period, 30 June, the closing value of the interest was $HK53,000 (A). There were no brought forward losses and no acquisitions, disposals or distributions (B, C, D and F) during the notional accounting period. The increase in cash surrender value, the FIF amount, is $HK3,000, worked out as follows:

$HK53,000 (A) + nil (B) + nil (C) + nil (D) - $HK50,000 (E) - nil (F)

= $HK 3,000

ATO references:
NO NAT 2130