Life Insurance Tax Reform

The Finance and Expenditure Committee (FEC) reported back to Parliament on the Taxation (International Taxation, Life Insurance, and Remedial Matters) Bill (the Bill) on 30 June 2009. The Bill introduces a fundamentally new taxation framework for life insurance businesses.

As expected, the key aspects of the reform generally remain unchanged. However, the FEC has recommended a number of technical amendments to the draft legislation. These amendments are intended to make the legislation clearer and more flexible.

A summary of the original proposals is available on our website. We summarise the key changes recommended by Officials and the FEC below.

Application date

As originally drafted, the new regime was intended to apply for income years starting on or after 1 April 2009. However, following consultation with industry representatives, the FEC has recommended that the new rules apply to all life insurers from 1 July 2010. Insurers will have the option to elect into the rules from the start of the income year which includes 1 July 2010.

From a practical perspective, a “hard” application date of 1 July 2010 means that life insurers with a balance date other than 30 June will be required to prepare two income tax calculations in the year the rules come into effect. For example, a life insurer with a 31 December balance date would be required to prepare a tax calculation covering the period from 1 January 2010 to 30 June 2010 (under the old rules) and another covering the period from 1 July 2010 to 31 December 2010 (under the new rules). However, the legislation expressly notes that the part year calculation obligations do not create any part-year return obligations. The part-year calculations will result in one income tax liability for one income tax year. However, some uncertainty around timing issues will be inevitable as a judgement call will be required in order to determine which part year certain items of income and expenditure should be allocated.

Officials believe that delaying the application date of the rules to 1 July 2010 will give life insurers sufficient time to develop adequate compliance systems in response to the new taxation framework.

Transitional provisions

The Bill includes a number of transitional provisions which will apply when life insurers transfer from the current life tax regime into the new rules. The transitional provisions cover:

• grandfathering of existing policies entered into prior to the commencement of the new regime;
• deemed realisation of policyholder investments on entry into the new rules; and
• the treatment of tax balances (including tax losses and payments) carried into the new rules.

Grandfathering of existing policies

Under the original drafting of the legislation, policies entered into prior to the commencement of the new regime would be grandfathered as follows:

Life insurers may elect to opt out of the transitional rules for a class of policies, although such an election will be irrevocable. Transitional periods will automatically cease for polices if in any income year the amount of insurance cover increases by more than the greater of:

• 10% of the previous year's insurance cover; and
• the percentage change in the consumer price index for the previous income year.

Key changes recommended by the FEC in relation to the grandfathering rules include:

• Grandfathering periods will apply from 1 July 2010 and apply to policies entered into prior to that date. Where a life insurer adopts the new rules early, the grandfathering period for new business will commence from the date the new rules apply. The life insurer may elect to apply the new rules for new business from this date as well.
• In applying the test for changes in policies, life insurers may make a one-off election in the first year of applying the new rules to determine the policy review date for each class of policy.
• The grandfathering rules will apply to employer-sponsored group life policies (provided that certain criteria are met).
• The 10% cover limit will not apply to the grandfathering of credit card repayment insurance policies. These policies will be grandfathered for a maximum of 5 years, provided that the policy was in place upon entering the new rules and the substantial and material terms of the policy do not change during the grandfathering period.
• The grandfathering rules have been clarified to ensure that reinstated policies will be grandfathered, provided that the policy is reinstated within 90 days of lapsing and the insurer does not treat the reinstated policy as a new contract.

Deemed sale and reacquisition on entry into the new regime

The FEC has recommended that PIE investments (other than those in portfolio-listed companies) be excluded from the deemed sale and reacquisition of investments at market value for the purpose of determining policyholder reserves on entry into the new regime. This will prevent tax liabilities on PIE investments from arising on entry into the new rules when no tax liability would have arisen on the acquisition and disposal of PIE interests in other situations.

Tax balances

The FEC has recommended that the legislation be amended to ensure that overpayments of tax under the current rules may be carried forward into the new rules and used to satisfy both shareholder-base and policyholder-base tax liabilities.

Other miscellaneous amendments

The Bill includes a number of other minor technical and drafting amendments to the legislation. These include:

• clarification that all direct and indirect expenditure incurred by the life insurer is deductible in the shareholder base;
• allowing life insurers to apportion income and expenditure between the shareholder and policyholder bases on a basis that is “equitable and reasonable”;
• clarification of the legislation to ensure that life insurers are entitled to claim a deduction for movements in the outstanding claims reserve (OCR) in respect of non-life products. This ensures that the tax treatment of the OCR is consistent as between life and non-life policies offered by life insurers and general policies of general insurers;
• amendments to the definition of “life reinsurance” to clarify that general reinsurance policies are excluded from the new rules;
• amendments to the definition of “actuarially determined”. Under the amended definition, an amount will be “actuarially determined” if it has been determined using relevant actuarial standards. The requirements to provide actuarial certification and calculation details have been removed.

Changes from earlier drafts

The Bill has clarified a number of items in the earlier draft. These include:

• refinements to the operation of Premium Smoothing Reserve;
• providing a low compliance alternative for participating policies;
• providing consistent treatment of non-life reserves held by life insurers (e.g. disability income)