Amendments to the life insurance taxation rules granting transitional relief

A number of changes have been made to the new rules for taxing life insurance business that were enacted as part of the Taxation (International Taxation, Life Insurance, and Remedial Matters) Act 2009.

The changes made by the Taxation (Trans-Tasman Savings Portability, KiwiSaver, and Remedial Matters) Act 2010 affect the scope of the grandparenting provisions applicable to life policies, particularly workplace group policies, sold before the start of the new taxation rules. Remedial amendments have also been made to ensure that the new rules achieve their intended policy effect.

Background

The Taxation (International Taxation, Life Insurance, and Remedial Matters) Act 2009 significantly changed the taxation rules applicable to life insurance business. The new rules are designed to tax the income from term life business so that life insurance companies pay tax on their profits, like any other New Zealand business.

The new rules also contained a comprehensive set of transitional provisions that preserve the previous income treatment of life insurance policies sold before the application date.

In response to submissions received on the Taxation (Annual Rates, Trans-Tasman Savings Portability, KiwiSaver, and Remedial Matters) Bill, the Finance and Expenditure Committee recommended a number of technical amendments to the new rules.

Key features

The main amendments to the new taxation rules for life insurance affect the scope of the transitional rules. Other changes have been made to correct technical problems identified with the new rules. The amendments are consistent with the policy intent of the new taxation rules for life insurance business.

Detailed analysis

Grandparenting of life policies

Section EY 30 provides that policies contracted under the previous rules are grandparented and subject to transitional rules for a specified period. The application of the previous life rules is therefore preserved, for a limited period, for term policies sold before the start of the new taxation rules for life insurance business. Several changes have been made to clarify the scope of the grandparenting rules.

Workplace group policies

A number of technical changes have been made to the definition of "workplace group policy" (section EY 30(15)).

• The definition now includes workplace group policies that are:
  • sponsored by trustees of superannuation schemes;
  • broker-administered pool schemes; or
  • group policies sponsored by industry associations.
• The definition also extends the scope of the life cover provided under a workplace group policy and now includes:
  • business owners or the directors of businesses; and
  • spouses, civil union partners and de facto partners of employees or members covered by the workplace group policy.
• The definition of "workplace group policy", in the context of policies sponsored by an employer, previously required that the policy was "compulsory" for the relevant class of employees. The context and application of the word "compulsory" was unclear. Section EY 30(15) has been changed so that the employer is required to offer the employee the opportunity to join the life insurance policy.
• The requirement about the payment of premiums has also been clarified and allows the life insurer and the employer to reach an agreement about who pays the premium.
• Voluntary top-ups in cover by individuals covered by the workplace group policies are included in with the scope of these changes.

Life policies with a mix of products

New section EY 30(1B) allows elements of a life policy that are capable of being sold separately to be given a different tax treatment if the grandparenting rules provide for a different treatment. For example, a life policy may contain both a level premium policy and a yearly renewable term (YRT) product. New section EY 30(1B) allows the life insurer to treat each life product which can be taken as a separate contract for life insurance, as a "policy" in its own right when calculating transitional relief. Any split or division of a life policy must be transparent to the policyholder, and the supporting policy documentation must clearly show that there is a separate price for each life product that forms part of the life insurance policy.

Previously, the transitional rules treated a life policy as the sum of all its parts. This meant that changes to a life policy that included a YRT product and a level premium product would not qualify for transitional relief if the YRT product ceased to meet the requirements in EY 30(2) or EY 30(5).

Multiple-life policies

Section EY 30(3) has been clarified to allow life insurers to "look though" to the underlying life insured and treat each life accordingly under the grandparenting rules. For example, a group policy that covers a husband and wife can be treated as two contracts for life cover. In the event that an increase in the individual's life cover results in a breach of section EY 30(3)(e), the other lives covered by the policy will remain unaffected unless they too breach section EY 30(3)(e).

Section EY 30(3) applies when the life insurer can look through the life policy to the individual lives covered. The word "can" in the context of section EY 30(3)(b) is directed at whether the life insurer's systems are able look through to the lives insured, taking into account the systems that are employed in the income year in which the transitional relief is claimed.

Life insurance policies

Section EY 30(2) has been redrafted following changes to the treatment of multiple-life policies in section EY 30(3). Changes to section EY 30(3) had the potential to limit transitional relief to multiple life policies if the life insurer's systems could not look through to the individual lives covered. Section EY 30(2) therefore acts a default rule. It is expected to apply to:

• single life policies;
• multiple-life polices (such as husband and wife policies) if the life cover for the individuals is not separately identified; and
• life policies that are not credit card repayment insurance and workplace group policies.

New section EY 30(2)(d) ensures that the redrafted section is limited to lives covered before the start of the new taxation rules for life insurance.

Level-premium policies

Section EY 30(5) has been amended to take into account CPI adjustments that may be made to level-premium policies if such adjustments are an agreed part of the life policy before the grandparenting start day. These adjustments will not cause level-premium life policies to lose transitional relief under section EY 30.

Life reinsurance of credit card repayment insurance and workplace group policies

Sections EY 30(11) and EY 30(14) have been amended so that transitional relief for life reinsurance of workplace group policies or credit card repayment insurance is based on whether the underlying product is also grandparented.

Increases in life cover during an income year

At the insurer's election, new section EY 30(5B) allows transitional relief for a life policy up to the date that it breaches the grandparenting rules. The deduction calculated under section EY 30(7) can now include part-year amounts - section EY 5(6).

For example, a life insurer compares the level of cover at the beginning of year 2 with the cover at the beginning of year 1. If the level of cover breaches the tolerances in the grandparenting rules, transitional relief will ordinarily end at the beginning of year 1 (section EY 30(10) - meaning of "Cover review period"), unless the life insurer is able to identify the point in time when the breach occurred during year 1.

Consequential changes have been made to sections EY 30(2)(c), EY 30(3)(e), EY 30(7) and EY 30(8) to allow for the transitional relief part-year calculation.

No restoration for life policies that lose grandparenting status

New section EY 30(5C) ensures that life policies that no longer qualify under the grandparenting rules are not restored in the next or subsequent cover review period(s).

Other matters

In addition to the changes to the grandparenting rules, the following sections have been amended to clarify their application.

• The application of sections CR 4 and DW 4 (outstanding claims reserve for general insurance contract) to life insurers has been clarified by inserting references to the definition of "premium" and "pay" in section YA 1. The term "general insurance contract" has also been removed and means that the treatment of insurance contracts set out in International Financial Reporting Standard 4 does not apply to general insurance contracts sold by life insurers. Instead, the reserving rules in section EY 24 apply.
• In section EY 5(4) the transfer of life reinsurance connected with the sale of life business is clarified.
• The provisions relating to the outstanding claims reserve (section EY 24(2)(a)(ii)), the premium smoothing reserve (section EY 25(2)(a)(ii)), the unearned premium reserve (section EY 26(2)(a)(ii)) and the capital guarantee reserve (section EY 27(2)(a)(ii)) have been amended to clarify how the opening balances for these reserves should be calculated for the first year in which the new rules apply.
• The definition of "savings product policy" in section YA 1 excludes situations when all or a portion of a premium connected with life risk is refunded to the policyholder. This should ensure that the return of such amounts does not result in the policy being treated as a "savings product policy".
• A grammatical error in section EY 30(4) has been corrected.

Application date

The changes apply from 1 July 2010. Life insurers have the option to apply the rules from the beginning of their income year, if that year includes 1 July 2010.