Product Ruling

PR 2013/24

Income tax: Challenger Guaranteed Annuity (Liquid Lifetime)

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No guarantee of commercial success

The Commissioner does not sanction or guarantee this product. Further, the Commissioner gives no assurance that the product is commercially viable, that charges are reasonable, appropriate or represent industry norms, or that projected returns will be achieved or are reasonably based.

Potential participants must form their own view about the commercial and financial viability of the product. The Commissioner recommends a financial (or other) adviser be consulted for such information.

This Product Ruling provides certainty for potential participants by confirming that the tax benefits set out in the Ruling part of this document are available, provided that the scheme is carried out in accordance with the information we have been given, and have described below in the Scheme part of this document. If the scheme is not carried out as described, participants lose the protection of this Product Ruling.

Terms of use of this Product Ruling

This Product Ruling has been given on the basis that the entity(s) that applied for the Product Ruling, and their associates, will abide by strict terms of use. Any failure to comply with the terms of use may lead to the withdrawal of this Product Ruling.

What this Ruling is about

1. This Product Ruling sets out the Commissioner's opinion on the way in which the relevant provisions identified in the Ruling section apply to the defined class of entities who take part in the scheme to which this Ruling relates. All legislative references in this Ruling are to the Income Tax Assessment Act 1936 (ITAA 1936) unless otherwise indicated.

2. In this Product Ruling the scheme is an investment in a Challenger Guaranteed Annuity (Liquid Lifetime) policy (Annuity) issued by Challenger Life Company Limited (Challenger) and offered under the Product Disclosure Statement dated 24 June 2013 (PDS).

3. This Product Ruling does not address:

(a)

the taxation consequences for an Annuity purchased by an entity other than an individual, or two individuals jointly;

(b)

the taxation consequences for an Annuity purchased using a 'roll-over superannuation benefit' as defined in section 306-10 of the Income Tax Assessment Act 1997 (ITAA 1997);

(c)

the taxation consequences for an Annuity purchased using a directed termination payment within the meaning of the Income Tax (Transitional Provisions) Act 1997 (IT(TP)A 1997);

(d)

the taxation consequences of acquiring, holding and disposing or redeeming the Annuity, other than as per paragraphs 16 to 31 of this Product Ruling;

(e)

the taxation consequences from disposing or otherwise ending the Annuity other than by way of commutation or upon death;

(f)

the taxation consequences for an Annuity purchased using personal injury compensation money, as per Division 54 of the ITAA 1997;

(g)

the taxation consequences for a reversionary who pays consideration for their reversionary entitlement;

(h)

a Holder's eligibility to claim the Senior Australians and pensioners tax offset;

(i)

the deductibility of the amount invested to purchase the Annuity;^[1]

(j)

the deductibility of adviser service fees; and

(k)

the taxation consequences of borrowing funds to purchase the Annuity, including the deductibility of interest on funds borrowed to purchase the Annuity.

Class of entities

4. This part of the Product Ruling specifies which entities can rely on the Ruling section of this Product Ruling and which entities cannot rely on the Ruling section.

5. The class of entities who can rely on the Ruling section of this Product Ruling consists of those entities that are Australian residents for taxation purposes and are any of the following:

(a)

an individual Holder (other than in the capacity of trustee of a trust estate) who purchases the Annuity described in paragraphs 16 to 31 of this Product Ruling on or after 1 July 2013 and on or before 30 June 2016;

(b)

each of two individual Holders (other than in the capacity of trustee of a trust estate), referred to as a joint owner for the purposes of this Ruling, who jointly purchases the Annuity described in paragraphs 16 to 31 of this Product Ruling on or after 1 July 2013 and on or before 30 June 2016;

(c)

the reversionary of an individual Holder referred to in paragraph 5(a) of this Ruling;

(d)

the estate of an individual Holder referred to in paragraph 5(a) of this Ruling, where the Holder dies within the withdrawal period and they have not elected a reversionary, or where their reversionary predeceases them;

(e)

the estate of the reversionary referred to in paragraph 5(c) of this Ruling, where both the relevant individual Holder and the reversionary die (in that order) within the withdrawal period;

(f)

the estate of a joint owner referred to in paragraph 5(b) of this Ruling, where that joint owner dies within the withdrawal period and was predeceased by the other joint owner.

6. The class of entities who can rely on the Ruling section of this Product Ruling does not include entities who:

(a)

purchase the Annuity before 1 July 2013 or after 30 June 2016;

(b)

purchase the Annuity and are neither an individual Holder nor an individual who purchases the Annuity as one of two joint owners;

(c)

purchase the Annuity using a roll-over superannuation benefit as defined in section 306-10 of the ITAA 1997; a directed termination payment within the meaning of the IT(TP)A 1997; or personal injury compensation money that is subject to Division 54 of the ITAA 1997; or

(d)

are a reversionary and who pay consideration for their reversionary entitlement.

Superannuation Industry (Supervision) Act 1993

7. This Product Ruling does not address the provisions of the Superannuation Industry (Supervision) Act 1993 (SISA). The Commissioner gives no assurance that the scheme is an appropriate investment for a superannuation fund. The trustees of superannuation funds are advised that no consideration has been given in this Product Ruling as to whether investment in this scheme may contravene the provisions of SISA.

Qualifications

8. The class of entities defined in this Product Ruling may rely on its contents provided the scheme actually carried out is carried out in accordance with the scheme described in paragraphs 16 to 31 of this Ruling.

9. If the scheme actually carried out is materially different from the scheme that is described in this Product Ruling, then:

•

this Product Ruling has no binding effect on the Commissioner because the scheme entered into is not the scheme on which the Commissioner has ruled; and

•

this Product Ruling may be withdrawn or modified.

Date of effect

10. This Product Ruling applies prospectively from 1 July 2013. It therefore applies only to the specified class of entities that enter into the scheme from 1 July 2013 until 30 June 2016, being its period of application. This Product Ruling will continue to apply to those entities even after its period of application has ended for the scheme entered into during the period of application.

11. However the Product Ruling only applies to the extent that there is no change in the scheme or in the entity's involvement in the scheme.

Changes in the law

12. Although this Product Ruling deals with the income tax laws enacted at the time it was issued, later amendments may impact on this Product Ruling. Any such changes will take precedence over the application of this Product Ruling and, to that extent, this Product Ruling will have no effect.

13. Entities who are considering participating in the scheme are advised to confirm with their taxation adviser that changes in the law have not affected this Product Ruling since it was issued.

Note to promoters and advisers

14. Product Rulings were introduced for the purpose of providing certainty about tax consequences for entities in schemes such as this. In keeping with that intention the Commissioner suggests that promoters and advisers ensure that participants are fully informed of any legislative changes after the Product Ruling has issued.

Ruling

15. Subject to paragraph 3 and the assumptions in paragraph 31 of this Ruling:

(a)

An Annuity purchased by a Holder referred to in paragraph 5(a) or 5(b) of this Ruling:

(i)

is not a 'qualifying security' as defined in subsection 159GP(1);

(ii)

is not a 'superannuation income stream' as defined in regulation 995-1.01 of the Income Tax Assessment Regulations 1997 (ITAR); and

(iii)

is an 'annuity' as defined in subsection 27H(4).

(b)

An Annuity purchased by a Holder referred to in paragraph 5(a) or 5(b) of this Ruling is not a financial arrangement to which Division 230 of the ITAA 1997 applies.

(c)

The regular payments made by Challenger to a Holder referred to in paragraph 5(a) or 5(b) of this Ruling, or to a reversionary referred to in paragraph 5(c) of this Ruling, as applicable, are assessable income under subsection 27H(1) to the extent that the regular payments exceed the 'deductible amount' in relation to the Annuity. The deductible amount is excluded from the assessable amount of the Annuity.

(d)

The annual deductible amount in relation to the regular payments derived by a Holder referred to in paragraph 5(a) or 5(b) of this Ruling, or by a reversionary referred to in paragraph 5(c) of this Ruling, as applicable, is ascertained (subject to subsection 27H(3)) in accordance with the formula set out in subsection 27H(2) on the basis that:

(i)

the 'relevant share' in relation to the Annuity is 1 (other than for joint owners, in which case it is their respective ownership proportion nominated at the time of purchase of the Annuity);

(ii)

the 'undeducted purchase price' of the Annuity is the initial investment amount paid to purchase the Annuity;

(iii)

the 'residual capital value' in relation to the Annuity is nil; and

(iv)

the 'relevant number' in relation to the Annuity is the life expectation factor of the Holder, or any other life insured under the Annuity (such as the reversionary or the other joint owner) who has a greater life expectation factor, determined on the commencement date of the Annuity in accordance with official Australian Life Tables.

(e)

Where the regular payments derived by a Holder referred to in paragraph 5(a) or 5(b) of this Ruling, or by a reversionary referred to in paragraph 5(c) of this Ruling, as applicable, are adjusted in line with movements in the CPI and are exceeded by the deductible amount ascertained in accordance with subsection 27H(2) for an income year in relation to those regular payments, the deductible amount for the year will be reduced by the Commissioner pursuant to subsection 27H(3) to the level of the regular payments.

(f)

The amount of any reduction in the deductible amount described in paragraph 15(e) of this Ruling can be applied to regular payments derived by a Holder referred to in paragraph 5(a) or 5(b) of this Ruling, or by a reversionary referred to in paragraph 5(c) of this Ruling, as applicable, in subsequent income years to the extent that those regular payments would otherwise exceed the deductible amount in those years.

(g)

Any capital gain made by a Holder referred to in paragraph 5(a) or 5(b) of this Ruling, or by a reversionary referred to in paragraph 5(c) of this Ruling, as applicable, resulting from the regular payments made by Challenger is disregarded under section 118-300 of the ITAA 1997, and is not otherwise assessable as ordinary or statutory income under the Income Tax Assessment Act.

(h)

Any capital gain made by a Holder referred to in paragraph 5(a) or 5(b) of this Ruling, or by a reversionary referred to in paragraph 5(c) of this Ruling, as applicable, resulting from the payment of the withdrawal value by Challenger to them upon commutation is disregarded under section 118-300 of the ITAA 1997. The payment of the withdrawal value in these circumstances is, however, included in the assessable income of such Holders to the extent that it exceeds a capital component calculated as the undeducted purchase price (as per paragraph 15(d)(ii) of this Ruling) less any deductible amounts previously applied to the regular payments from the Annuity, but not reduced to less than $0.

(i)

Any capital gain made by a deceased estate referred to in paragraph 5(d), 5(e) or 5(f) of this Ruling resulting from the payment of the withdrawal value by Challenger to them, as applicable, upon death is disregarded under section 118-300 of the ITAA 1997. The payment of the withdrawal value in these circumstances is, however, included in the assessable income of such deceased estates to the extent that it exceeds a capital component calculated as the undeducted purchase price (as per paragraph 15(d)(ii) of this Ruling) less any deductible amounts previously applied to the regular payments from the Annuity, but not reduced to less than $0.

(j)

Provided the scheme ruled on is entered into and carried out as described in this Ruling, the anti-avoidance provisions in Part IVA will not apply to the entities referred to in paragraph 5 of this Ruling.

Scheme

16. The scheme that is the subject of this Ruling is identified and described in the following documents:

•

application for a Product Ruling as constituted by documents and information received on 15 October 2013, 25 October 2013 and 12 November 2013;

•

Challenger Guaranteed Annuity (Liquid Lifetime) Policy Document dated 24 June 2013;

•

Challenger Guaranteed Annuity (Liquid Lifetime) Product Disclosure Statement dated 24 June 2013; and

•

Investor Certificate.

Note: certain information has been provided on a commercial-in-confidence basis and will not be disclosed or released under Freedom of Information legislation.

17. For the purposes of describing the scheme to which this Ruling applies, there are no other agreements, whether formal or informal, and whether or not legally enforceable, which an entity referred to in paragraph 5 of this Ruling, or any associate of such entity, will be a party to, which are a part of the scheme.

18. All Australian Securities and Investments Commission (ASIC) requirements are, or will be, complied with for the term of the agreements.

Overview

19. The Annuity is a 'life policy' for the purposes of the Life Insurance Act 1995 (as per paragraph 9(1)(c) of that Act) which therefore satisfies the definition of a 'life insurance policy' under subsection 995-1(1) of the ITAA 1997, and is offered by Challenger in Australia to individuals, companies and trusts (including superannuation entities).

20. Individuals who purchase the Annuity can do so alone or, where the Annuity is not purchased using a roll-over superannuation benefit, jointly with another person. To purchase the Annuity, Holders are required to execute and lodge the Application Form attached to the PDS with Challenger, together with an initial investment amount of at least $10,000 to buy the Annuity. No additional fees or charges are payable to Challenger by the Holders.

21. Upon acceptance of a valid application, the Holder is issued with the Policy Document (a legal contract between the Holder and Challenger) and an Investor Certificate by Challenger, setting out the relevant terms and conditions.

22. In exchange for the initial investment amount, the Annuity provides regular payments for the Holder's lifetime (or the lifetime of the Holder and another person, as applicable) at an agreed frequency (monthly, quarterly, half-yearly or yearly, as chosen at the time the Annuity is purchased). Joint owners can split the regular payments in whatever proportions they nominate at the time the Annuity is purchased (with a maximum of 95% to one owner and 5% to the other).

23. The amount of the regular payments is determined at the time the Annuity is purchased and will depend on a number of factors, including the amount of the initial investment, prevailing market rates and the Holder's life expectancy (and the life expectancy of any reversionary or joint owner) at the time of purchase. The amount of the regular payments payable by Challenger under the Annuity is also affected by the choices the Holder makes with respect to a number of options offered under the Annuity (discussed in the following paragraphs).

24. The Holder can choose to have their regular payments fixed such that they will not change over the term of the Annuity; adjusted partially in line with annual movements in the Consumer Price Index (CPI) (that is, increased in line with any increase in the CPI in excess of 2% and decreased in line with any decrease in the CPI); or adjusted fully in line with the annual movements in the CPI.

25. At the time the Annuity is purchased, the Holder can also elect that, on their death, the regular payments continue to be made (subject to any reduction by either 25% or 50% if the benefit reduction option is chosen) to a nominated person known as the reversionary for the duration of the reversionary's life. Similarly, where a Holder who is a joint owner dies, their regular payments will be made to the surviving joint owner for their life, together with the regular payments the surviving joint owner is receiving at that time (subject to any reduction by either 25% or 50% if the benefit reduction option is chosen). If a benefit reduction option has been chosen, the regular payments the reversionary receives or the additional regular payments the surviving joint owner receives, as the case may be, will be reduced by that percentage.

26. The Annuity has a withdrawal period of 15 years from its commencement date during which time the Annuity has a withdrawal value, payable by Challenger as a lump sum if during this period the Holder (or the reversionary, as applicable) chooses to end their Annuity early; the Holder dies without a reversionary; or both the Holder and their reversionary or surviving joint owner die. After the end of the withdrawal period, the Annuity ceases to have a withdrawal value.

27. Unless they choose not to, the Holder (or the reversionary, as applicable) has the right to withdraw voluntarily from the Annuity (commute) within the withdrawal period and be paid the withdrawal value from Challenger. If the Holder (or the reversionary) commutes their Annuity at the end of the withdrawal period, the withdrawal value will be a guaranteed percentage of their initial investment. A partial commutation of the Annuity is not permitted.

28. Challenger will pay the withdrawal value to the Holder's estate where the Holder dies within the withdrawal period and:

•

they have not elected an eligible reversionary and do not have a surviving joint owner; or

•

they have elected an eligible reversionary but the reversionary has predeceased the Holder.

29. Where the Holder dies within the withdrawal period and their reversionary or surviving joint owner in receipt of the Holder's regular payments then also dies within the withdrawal period, Challenger will pay the withdrawal value (subject to any reduction by either 25% or 50% if the benefit reduction option is chosen) to the estate of the reversionary or surviving joint owner, as applicable.

30. Calculation of the withdrawal value by Challenger will be in accordance with the terms of the Annuity and subject to a minimum level prescribed under the Life Insurance Act 1995 and prudential standards enforced by the Australian Prudential Regulation Authority.

Assumptions

31. This Ruling is made on the basis of the following assumptions:

(a)

each of the entities referred to in paragraphs 5(a), 5(b) and 5(c) of this Ruling are individual Australian residents for taxation purposes and are not taxation residents of a country with which Australia has concluded a double tax treaty;

(b)

each of the entities referred to in paragraphs 5(d), 5(e) and 5(f) of this Ruling are Australian resident trust estates as defined in subsection 95(2) and are not resident trust estates of a country with which Australia has concluded a double tax treaty;

(c)

the entities referred to in paragraphs 5(a) and 5(b) of this Ruling will not purchase the Annuity using a roll-over superannuation benefit as defined in section 306-10 of the ITAA 1997; a directed termination payment within the meaning of the IT(TP)A 1997; or using personal injury compensation money that is subject to Division 54 of the ITAA 1997;

(d)

all Holders are the original Holders who purchased the annuity from Challenger for their own benefit;

(e)

the entities referred to in paragraph 5(c) of this Ruling will not pay consideration for their reversionary entitlement;

(f)

no portion of the amount invested to purchase the Annuity is deductible;

(g)

all dealings between any of the entities referred to in paragraph 5 of this Ruling and Challenger will be at arm's length; and

(h)

the scheme will be executed in the manner described in the Scheme section of this Ruling and the scheme documentation referred to in paragraph 16 of this Ruling.

Commissioner of Taxation
18 December 2013

Appendix 1 - Explanation

Subsection 27H(4) - annuity

32. Subsection 27H(4) defines an 'annuity' to mean:

an annuity, a pension paid from a foreign superannuation fund (within the meaning of the Income Tax Assessment Act 1997) or a pension paid from a scheme mentioned in paragraph 290-5(c) of that Act, but does not include:

(a)

an annuity that is a qualifying security for the purposes of Division 16E; or

(b)

a superannuation income stream (within the meaning of the Income Tax Assessment Act 1997).

33. This definition encompasses an annuity on ordinary concepts, as contemplated within various judicial authorities and discussed in Taxation Ruling IT 2480. An annuity on ordinary concepts is a contract under which a principal sum is converted into an income stream^[2] of payments that are at least annual, fixed or variable in a way that is calculable, and which will continue to be paid for a fixed or determinable period.

34. The Holder's initial investment amount is applied to purchase the regular payments payable by Challenger under the terms of the Annuity, a contract between the Holder and Challenger. Those regular payments are a series of periodic payments (payable at least yearly), either fixed at the time of purchase or variable in a way calculated by reference to CPI movements under the terms set out at the time of purchase (as per paragraph 24 of this Ruling), and (unless commuted earlier for the withdrawal value) continue for the life of the relevant Holder or reversionary, as the case may be. The Holder's ability to commute does not of itself result in the Annuity failing to be accepted as an annuity contract (paragraph 25 of IT 2480).

35. An Annuity purchased by an individual Holder referred to in paragraph 5(a) or 5(b) of this Ruling therefore constitutes an annuity on ordinary concepts and, subject to the exclusions in paragraphs (a) and (b) of the definition (considered below at paragraphs 36 to 41 of this Ruling), constitutes an annuity as defined in subsection 27H(4).

Division 16E - qualifying security

36. A 'qualifying security' is defined in subsection 159GP(1). For the purposes of determining whether an arrangement is a qualifying security, that arrangement must be a security, also defined in subsection 159GP(1) to mean:

(a)

stock, a bond, debenture, certificate of entitlement, bill of exchange, promissory note or other security;

(b)

a deposit at bank or other financial institution;

(c)

a secured or unsecured loan; or

(d)

any other contract, whether or not in writing, under which a person is liable to pay an amount or amounts, whether or not the liability is secured.

37. The Annuity is not considered to have sufficient debt like obligations to be a contract to which paragraph (d) of the definition of security in subsection 159GP(1) applies, nor does it fall within paragraphs (a), (b) or (c) of that definition. Therefore, the Annuity does not meet the definition of security under subsection 159GP(1) and, as such, is not a qualifying security for the purposes of Division 16E.

38. Additionally, an annuity will not be a qualifying security for the purposes of subsection 159GP(1) where it is an 'ineligible annuity', a term also defined in subsection 159GP(1) to mean an annuity issued by a life assurance company to or for the benefit of a natural person other than in the capacity of trustee of a trust estate. An Annuity issued by Challenger to a Holder referred to in paragraph 5(a) or 5(b) of this Ruling (that is, a natural person other than in the capacity of trustee of a trust estate) is an ineligible annuity.

Superannuation income stream

39. A 'superannuation income stream' has the meaning given by the ITAR (subsection 307-70(2) of the ITAA 1997). Subregulation 995-1.01(1) of the ITAR defines superannuation income stream in relation to an annuity commenced after 19 September 2007 to mean an income stream that is taken to be an annuity for the purposes of the SISA in accordance with subregulation 1.05(1) of the Superannuation Industry (Supervision) Regulations 1994 (SISR).

40. Subregulation 1.05(1) of the SISR provides a number of requirements that must be met for a benefit provided by a life insurance company to be taken to be an annuity for the purposes of the SISA. One of those requirements in respect of a benefit purchased on or after 1 July 2007 is that it is purchased with the whole or part of a roll-over superannuation benefit as defined in section 306-10 of the ITAA 1997, or the whole or part of a directed termination payment within the meaning of the IT(TP)A 1997.

41. As per paragraph 31(c) of this Ruling, it is assumed for the purposes of this Ruling that a Holder referred to in paragraph 5(a) or 5(b) of this Ruling will not purchase the Annuity using either a roll-over superannuation benefit as defined in section 306-10 of the ITAA 1997 or a directed termination payment within the meaning of the IT(TP)A 1997. As such, the Annuity is not a superannuation income stream for such Holders.

Division 230 - taxation of financial arrangements

42. Division 230 of the ITAA 1997 sets out the tax treatment of gains or losses from a 'financial arrangement'. Generally, a financial arrangement is a cash settlable legal or equitable right to receive a financial benefit, or obligation to provide such benefit, or a combination of one or more such rights and/or obligations (subsection 230-45(1) of the ITAA 1997). A right to receive or obligation to provide a financial benefit can be 'cash settlable' under subsection 230-45(2) of the ITAA 1997 if the benefit is money, or if it is a right the taxpayer intends to satisfy or settle by receiving money, or if it is an obligation that the taxpayer intends to satisfy or settle by providing money.

43. The Annuity constitutes a financial arrangement for the purposes of Division 230 of the ITAA 1997 on the basis that the entities referred to in paragraph 5 of this Ruling have cash settlable rights to receive a financial benefit in the form of the regular payments and/or the withdrawal value, as applicable, and on the basis that the Holder has a cash settlable obligation to provide a financial benefit in the form of the initial investment amount.

44. Subject to exceptions under Subdivision 230-H, gains made from a financial arrangement are included in assessable income under subsection 230-15(1) of the ITAA 1997 and are not (to any extent) to be included in assessable income pursuant to any other taxing provision of the Income Tax Assessment Act (subsection 230-20(4) of the ITAA 1997), including section 27H.

45. However, where the rights and/or obligations under an arrangement are the subject of an exception under section 230-460 of the ITAA 1997, Division 230 of the ITAA 1997 does not apply in relation to gains or losses from a financial arrangement for any income year (subsection 230-460(1) of the ITAA 1997). Subsection 230-460(5) of the ITAA 1997 provides a specific exception as follows:

A right or obligation under a *life insurance policy is the subject of an exception unless:

(a)

you are not a *life insurance company that is the insurer under the policy; and

(b)

the policy is an annuity that is a *qualifying security.

46. As the Annuity is a life insurance policy (as defined in subsection 995-1(1) of the ITAA 1997) that is not a qualifying security (as defined in subsection 159GP(1) and discussed at paragraphs 36 to 38 of this Ruling), the exception in subsection 230-460(5) applies and Division 230 of the ITAA 1997 does not apply to any gains or losses derived from an Annuity purchased by a Holder referred to in paragraph 5(a) or 5(b) of this Ruling.

Section 27H - assessability of regular payments

47. Paragraph 27H(1)(a) includes in the assessable income of a taxpayer of a year of income the amount of any annuity derived by the taxpayer during that year excluding, in the case of an annuity that has been purchased, any amount that is the deductible amount in relation to the annuity in relation to the year of income. The regular payments made by Challenger to a Holder referred to in paragraph 5(a) or 5(b) of this Ruling, or to a reversionary referred to in paragraph 5(c) of this Ruling, as applicable, are therefore assessable income under subsection 27H(1) to the extent that the regular payments exceed the deductible amount in relation to the Annuity.

48. The deductible amount is excluded from the assessable amount of the annuity and is tax free to the recipient because it represents the return to them of the amount paid to acquire the annuity. Subsection 27H(2) provides for the calculation of the deductible amount in relation to an annuity derived by a taxpayer during a year of income, subject to subsections 27H(3) and (3A), in accordance with the following formula:

[A * (B - C)] / D


where:

A is the relevant share in relation to the annuity in relation to the taxpayer in relation to the year of income.

B is the amount of the undeducted purchase price of the annuity.

C is:

(a)

if there is a residual capital value in relation to the annuity and that residual capital value is specified in the agreement by virtue of which the annuity is payable or is capable of being ascertained from the terms of that agreement at the time when the annuity is first derived - that residual capital value; or

(b)

in any other case - nil; and

D is the relevant number in relation to the annuity.

49. The relevant share in relation to the Annuity (component A) for a Holder or reversionary entitled to the entirety of the regular payments, referred to in paragraph 5(a) and 5(c) of this Ruling respectively, is 1. The relevant share in relation to the Annuity for a Holder referred to in paragraph 5(b) of this Ruling is a fraction corresponding with their respective share in the Annuity as nominated at the time of purchase.

50. The undeducted purchase price in relation to an Annuity (component B) that is purchased by a Holder referred to in paragraph 5(a) or 5(b) of this Ruling is the whole of the purchase price of the Annuity (the initial investment amount), reduced by any portion of the initial investment amount that is an allowable deduction. As per paragraph 31(f) of this Ruling, it is assumed for the purposes of this Ruling that no portion of the initial investment amount is deductible.

51. The residual capital value in relation to an annuity is defined in subsection 27H(4) to mean the capital amount payable on the termination of the annuity. As the terms of the Annuity do not provide for any residual capital value in relation to the Annuity, it (component C) is nil.

52. Where an annuity is payable during the lifetime of a person and not thereafter, the relevant number in relation to that annuity in relation to a year of income is defined in subsection 27H(4) to mean the life expectation factor of the person. The relevant number in relation to the Annuity (component D) is therefore the life expectation factor of the Holder, or any other life insured under the Annuity (such as the reversionary or the other joint owner) who has a greater life expectation factor.^[3] The life expectation factor in relation to a person in relation to an annuity is defined in subsection 27H(4) to mean the number of years in the complete expectation of life of the person as ascertained by reference to the prescribed Life Tables^[4] at the time at the beginning of the period to which the first payment of the annuity relates.

53. Where the Commissioner considers that the deductible amount ascertained in accordance with the formula in subsection 27H(2) is inappropriate, having regard to the terms and conditions applying to the annuity and to any other relevant matters, he may, subject to subsection 27H(3A), determine the deductible amount that applies pursuant to subsection 27H(3). In making a determination pursuant to subsection 27H(3), the Commissioner may have regard to the terms and conditions applying to the annuity, to a certificate supplied by an actuary and to any other matters considered relevant.

54. Paragraphs 16 to 24 of Taxation Ruling IT 2157 provide some guidelines as to the exercise of the discretion under subsection 27H(3). Applying those guidelines to the Annuity, the Commissioner may exercise the discretion under subsection 27H(3) where:

•

the regular payments are not payable for the whole of an income year, in which case the deductible amount ascertained under subsection 27H(2) will be inappropriate and reduced proportionately based on the part of the year during which the regular payments are not paid;

•

the regular payments payable to a Holder until their death is greater than the regular payments paid to the reversionary as a consequence of having chosen the benefit reduction option, in which case the deductible amount ascertained under subsection 27H(2) will be inappropriate and will be allocated in greater proportions to the regular payments payable to the Holder than to the reversionary; and

•

the quantum of the regular payments may vary as a consequence of them being subject to movements in the CPI.

55. In the case of an increasing or indexed annuity, the Commissioner will only alter the deductible amount pursuant to subsection 27H(3) where the deductible amount ascertained in accordance with the formula under subsection 27H(2) for a full year exceeds the minimum annual amount proposed to be paid under the annuity contract. Therefore, where the regular payments under the Annuity are adjusted in line with movements in the CPI and the deductible amount ascertained under subsection 27H(2) for a full year exceeds the regular payments to be paid by Challenger under the Annuity to a Holder referred to in paragraph 5(a) or 5(b) of this Ruling, or to a reversionary referred to in paragraph 5(c) of this Ruling, as applicable, the Commissioner will alter that deductible amount pursuant to subsection 27H(3).

56. The deductible amount excluded in accordance with subsection 27H(3) under the circumstances set out in paragraph 55 above is to be so much of the deductible amount ascertained in accordance with the formula under subsection 27H(2) as does not exceed the annuity payment (in this case, the regular payments for the relevant year). The balance of the deductible amount ascertained in accordance with the formula under subsection 27H(2) is to be carried forward and excluded (along with the following year's deductible amount ascertained in accordance with the formula under subsection 27H(2)) from the following year's annuity payment (paragraph 21, IT 2157). As such, this amount will be used to reduce the portion of the regular payments assessable in the following year.

57. As the Annuity cannot be partly commuted, subsection 27H(3A) cannot have any application on the determination of the deductible amount in relation to the Annuity.

Capital gain or loss from payments under the Annuity disregarded

58. Under subsection 108-5(1) of the ITAA 1997 a CGT asset is any kind of property or a legal or equitable right that is not property. The contractual rights of the entities referred to in paragraph 5 of this Ruling under the Annuity are legally enforceable rights and therefore a CGT asset according to the definition in subsection 108-5(1) of the ITAA 1997. Generally, the discharge or satisfaction of contractual rights give rise to a CGT event C2 (paragraph 104-25(1)(b) of the ITAA 1997).

59. Section 118-300 of the ITAA 1997 exempts certain capital gains and losses made in respect of a policy of insurance on the life of an individual or an annuity instrument. An annuity instrument is defined broadly in subsection 995-1(1) of the ITAA 1997 to mean an instrument that secures the grant of an annuity (whether dependent on the life of an individual or not).

Section 118-300 - regular payments

60. Item 3 of the table in subsection 118-300(1) of the ITAA 1997 provides that a capital gain or capital loss made from a CGT event happening in relation to a CGT asset that is an interest in rights under a life insurance policy or an annuity instrument is disregarded where that CGT event happens to the original owner of the policy or instrument (other than the trustee of a complying superannuation entity).

61. [Omitted.]

62. As an individual to whom the Annuity is first issued, a Holder referred to in paragraph 5(a) or 5(b) of this Ruling is regarded as an original owner of a policy of insurance on the life of an individual or an annuity instrument. Pursuant to item 3 in the table in subsection 118-300(1) of the ITAA 1997, any capital gain or capital loss the Holder makes under section 104-25 of the ITAA 1997 from the receipt of regular payments by Challenger under the Annuity is therefore disregarded.

63. Item 4 of the table in subsection 118-300(1) of the ITAA 1997 provides that a capital gain or capital loss made from a CGT event happening in relation to a CGT asset that is an interest in rights under a life insurance policy or an annuity instrument is disregarded where that CGT event happens to an entity that acquired the interest in the policy or instrument for no consideration.

64. As per paragraph 31(e) of this Ruling, a person referred to as the reversionary in paragraph 5(c) of this Ruling acquires, on the death of a Holder referred to in paragraph 5(a) of this Ruling, an interest in the Annuity for no consideration. Pursuant to item 4 in the table in subsection 118-300(1) of the ITAA 1997, any capital gain or capital loss the reversionary makes under section 104-25 of the ITAA 1997 from the receipt of regular payments by Challenger under the Annuity is therefore disregarded.

Section 118-300 - payment of withdrawal value

65. As a Holder referred to in paragraph 5(a) or 5(b) of this Ruling is regarded as an original owner of a policy of insurance on the life of an individual or an annuity instrument, pursuant to item 3 in the table in subsection 118-300(1) of the ITAA 1997, they will disregard any capital gain or capital loss they make under section 104-25 of the ITAA 1997 from the receipt of the withdrawal value from Challenger upon commutation of the Annuity.

66. A reversionary referred to in paragraph 5(c) of this Ruling acquires, on the death of a Holder referred to in paragraph 5(a) of this Ruling, an interest in the Annuity for no consideration and will therefore, pursuant to item 4 in the table in subsection 118-300(1) of the ITAA 1997, disregard any capital gain or capital loss they make under section 104-25 of the ITAA 1997 from the receipt of the withdrawal value from Challenger upon commutation of the Annuity.

67. A deceased estate referred to in paragraph 5(d), 5(e) or 5(f) of this Ruling acquires, on the death of a Holder referred to in paragraph 5(a) or 5(b) of this Ruling, or the death of a reversionary referred to in paragraph 5(c) of this Ruling, as applicable, an interest in the Annuity for no consideration and will therefore, pursuant to item 4 in the table in subsection 118-300(1) of the ITAA 1997, disregard any capital gain or capital loss they make under section 104-25 of the ITAA 1997 from the receipt of the withdrawal value from Challenger upon the relevant death.

Assessability of withdrawal value

68. The receipt of the withdrawal value from Challenger by a Holder referred to in paragraph 5(a) or 5(b) of this Ruling upon commutation of the Annuity, or a deceased estate referred to in paragraph 5(d), 5(e) or 5(f) of this Ruling on the death of a Holder referred to in paragraph 5(a) or 5(b) of this Ruling, or the death of a reversionary referred to in paragraph 5(c) of this Ruling, as applicable, is assessable income to the extent that it does not comprise a repayment of capital. The capital component of the withdrawal value in these circumstances is the undeducted purchase price of the Annuity less any deductible amounts previously applied to the regular payments from the Annuity, but not reduced to less than $0.

69. Any amount referred to in paragraph 68 of this Ruling which is included in the assessable income of a deceased estate shall, pursuant to subsection 101A(1) be deemed to be income to which no beneficiary is presently entitled.

Part IVA - anti-avoidance

70. Provided that the scheme ruled on is entered into and carried out as disclosed in this Ruling, it is accepted that the scheme is an ordinary commercial transaction and Part IVA will not apply.

Appendix 2 - Detailed contents list

71. The following is a detailed contents list for this Ruling:

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References

ATO references:
NO 1-55WSIYH

Related Rulings/Determinations:

IT 2157
IT 2480
TR 2013/5

Subject References:
capital gains tax
income tax
producing assessable Income
product rulings
public rulings
qualifying securities
securities
taxation administration
taxation of financial arrangements

Legislative References:
ITAA 1936 27H
ITAA 1936 27H(1)
ITAA 1936 27H(1)(a)
ITAA 1936 27H(2)
ITAA 1936 27H(3)
ITAA 1936 27H(3A)
ITAA 1936 27H(4)
ITAA 1936 95(2)
ITAA 1936 101A(1)
ITAA 1936 Pt III Div 16E
ITAA 1936 159GP(1)
ITAA 1936 Pt IVA
ITR 1936 9(d)
ITAA 1997 Div 54
ITAA 1997 104-25
ITAA 1997 104-25(1)(b)
ITAA 1997 108-5(1)
ITAA 1997 118-300
ITAA 1997 118-300(1)
ITAA 1997 Div 230
ITAA 1997 230-15(1)
ITAA 1997 230-20(4)
ITAA 1997 230-45(1)
ITAA 1997 230-45(2)
ITAA 1997 Subdiv 230-H
ITAA 1997 230-460
ITAA 1997 230-460(1)
ITAA 1997 230-460(5)
ITAA 1997 306-10
ITAA 1997 307-70(2)
ITAA 1997 995-1(1)
ITAR 1997
ITAR 1997 995-1.01
ITAR 1997 995-1.01(1)
IT(TP)A 1997
SISA 1993
SISR 1994 1.05(1)
TAA 1953
Life Insurance Act 1995 9(1)(c)