Further remedial changes to the taxation rules for life business

Sections EY 24, EY 30 and YA 1 of the Income Tax Act 2007

Technical changes have been made to the recently enacted reforms for taxing life insurance business.

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 changed the basis of taxing life insurance business and contained a comprehensive set of transitional provisions that preserved the previous income tax treatment of life insurance policies sold before the application date.

Since the enactment of the Taxation (International Taxation, Life Insurance, and Remedial Matters) Act 2009, subsequent taxation bills have amended aspects of the transitional rules to remove uncertainties and deal with practical problems identified by life insurers.

In response to submissions received on the Taxation (GST and Remedial Matters) Bill, the Finance and Expenditure Committee recommended a number of technical amendments to the life insurance taxation rules.

Key features

The changes include:

• Section EY 30(3)(e) has been amended and simplifies the application of the transitional rule for life reinsurance contracts sold before the start of the new taxation rules. Transitional relief should apply to life reinsurance contracts in place before the start date of the new life insurance rules to the extent that any life insurance policy covered by the life reinsurance contract is:
  • also grandparented (this assumes the life reinsurer is able to use the information provided to it by the cedant life insurer about the underlying life policy); or
  • would be grandparented but for the seller of the life policy not being a "life insurer" for income tax purposes, for example, this can occur if the seller of the life policy fully reinsures.
  The revision to section EY 30(3)(e) allows life reinsurers to grandparent existing reinsurance contracts to the extent that the underlying life policy is also grandparented and there are no material changes in the terms of the life reinsurance contract.
• Section EY 30(8) has been amended and removes references to the Outstanding Claims Reserve and the Capital Guarantee Reserve from the transitional relief formula in section EY 30(7). The change ensures that the formula produces an amount which effectively taxes grandparented life insurance policies on a basis similar to the one that existed under the old life insurance taxation rules.
• Section EY 24(2)(a)(ii) clarifies the method for calculating the opening balance of the Outstanding Claims Reserve for the first income year that the new life insurance rules have application. The change recognises that historically individual life insurers have for tax purposes used different accounting methods when calculating the opening balance of the Outstanding Claims Reserve for their mortality profit calculations. The example used in the section is for illustrative purposes and uses the acronym "IBNR" (which is commonly used by insurers for claims incurred but not reported) instead of the defined terms in section EY 24 for outstanding claims reserve.
• Section YA 1 has been amended by narrowing the definition of "profit participation policy" to ensure that life reinsurance policies, multiple life policies, and workplace group policies are taxed as non-participating life insurance policies. Life reinsurance and group policies share the characteristics of pure risk policies and should not be treated as traditional profit participation policies when they contain no savings element.

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.