CONSOLIDATION (CHAPTER 26)

AFSA favours the simplicity of Option 2, on the availability of carry-forward losses.

Loss claims should continue to be reduced by net exempt income, but where net exempt income excludes premium income, to be consistent with the exclusion of investment deposit receipts in loss availability calculations of other investment institutions.

TAXATION OF LIFE INSURERS (CHAPTER 34)

AFSA strongly favours Option 3 to determine taxable income.

To be consistent with the tax treatment of complying superannuation and normal business of a corporate entity, AFSA believes it to be both consistent and equitable to apply capital gains tax calculations (at an entity level) on relevant investment assets in respect of its eligible insurance business.

To be consistent with the treatment of other financial products, business tax reform (albeit in indirect taxation) should remove existing stamp duty charges (currently charged by the states) on life assurance policies.

To be consistent with the treatment of franked dividends which are paid out of already-taxed entity profits to non-residents, AFSA believes that reversionary bonuses should remain outside the normal operation of non-resident withholding tax – except where the Commissioner specifically directs a resident life insurer to deduct such tax.

AFSA favours a single tax rate change from the existing 33% eligible insurance business rate to a new uniform company rate (we agree with the target 30%) from 30^th June, 2000 or whenever the new company rate comes into force.

To facilitate the transfer of benefit fund deferred annuity business to a separate and standalone complying superannuation fund, AFSA seeks rollover relief on asset transfers and a mechanism to provide solvency reserve support to capital guaranteed products.

To facilitate the transfer of benefit fund superannuation business to a separate and standalone complying superannuation fund, AFSA seeks rollover relief on asset transfers and a mechanism to provide solvency reserve support to capital guaranteed products.

AFSA seeks the retention of current rules relating to the use of franking credits in calculating bonuses for existing policies.

AFSA seeks the availability of the inter-corporate dividend rebate in an imputation regime for new policies, to avoid the possibility of double taxation.

Franking credit allocation between shareholders and policyholders should be on a regulatory basis.

EXEMPTIONS

AFSA seeks retention of effective exemption on the following non-life and other products.

Income bonds.

Funeral bonds.

Scholarship funds.

THE TAXATION OF POLICYHOLDERS

EXISTING POLICIES (CHAPTER 35)

AFSA prefers and supports the adoption of full grandfathering, retaining the existing rules for existing policies.

AFSA also proposes a means of allowing existing low income policyholders to access the new rebate system (available on new policies).

AFSA favours and supports a single non-phased Section 160AAB rebate at the new company rate – but introduced one year after the new company rate applies, consistent with past changes in this area

NEW POLICIES (CHAPTER 35)

AFSA favours the flexibility and choices provided in Option 1.

Section 67AAA(2) provision on the denial of deductibility, for interest expenses incurred in the purchase of a Friendly Society "insurance bond", should be repealed.

CGT treatment should be available on any realised growth component.

Policy fees which are assessable to the life insurer should be deductible to the policyholder in the same year, to avoid "blackhole expenditure" outcome.

It is noted that the distribution of tax-preferred trust income may or may not continue in a new tax system.

If it were to continue, it would seem both consistent and equitable to extend its availability to assessable bonus/growth returns on a policy of life assurance.

POOLED SUPERANNUATION TRUSTS (CHAPTER 36)

AFSA favours retention of PSTs as a superannuation entity with 15% tax rate.

CONSOLIDATION OF CARRY-FORD LOSSES (CHAPTER 26)

AFSA favours Option 2 which would allow carry-forward losses to be brought into a consolidated group subject to a modified Same Business Test (SBT).

AFSA favours Option 2 because of its simplicity. It would remove the constraints imposed by the existing loss transfer rules. Its proposal of a modified SBT relaxes the current law despite the cap on the usage of losses designed to limit the cost to revenue.

AFSA also considers that loss claims should continue to be reduced by net exempt income, but where net exempt income excludes premium income to be consistent with the exclusion of investment deposit receipts in loss availability calculations of other investment institutions.

AFSA’s strong preference is for Option 3, using a combination of approaches to establishing taxable income for risk business (Option 1) and investment business (Option 2).

Risk business taxable income would be established via the formula:

Taxable income = Premiums + Management Fees + Investment Income + Other Income – Outlays.

Investment business taxable income would be established via the formula:

Taxable Income = Management Fees + Investment Income + Underwriting Profit/Loss + Other Income – Outlays.

Friendly societies would have no difficulty coping with this two-tiered system. Premiums should be readily split between risk and investment. Friendly Societies already operate under a system of multiple taxation rates and have systems in place able to cope. They already account for multiple streams of income and expenditure and accordingly strongly favour Option 3.

CAPITAL GAINS TAX, STAMP DUTY AND WITHHOLDING TAX

To be consistent with the tax treatment of complying superannuation and normal business of a corporate entity, AFSA believes it to be both consistent and equitable to apply capital gains tax calculations (at an entity level) on relevant investment assets in respect of its eligible insurance business.

To be consistent with the treatment of other financial products, business tax reform (albeit in indirect taxation) should remove existing stamp duty charges (currently charged by the states) on life assurance policies.

To be consistent with the treatment of franked dividends which are paid out of already-taxed entity profits to non-residents, AFSA believes that reversionary bonuses should remain outside the normal operation of non-resident withholding tax – except where the Commissioner specifically directs a resident life insurer to deduct such tax.

RATE CHANGE

AFSA accepts that Friendly Society eligible insurance business will be taxed at the new uniform entity rate as ultimately established. It strongly favours the 30 per cent rate regarded as desirable by the Government.

The current Friendly Society rate of 33 per cent is ensured under legislation until 30^th June, 1999, and the Government has proposed that this date will be extended until the new entity rate is introduced. Whatever the starting date of the new uniform entity rate, AFSA urges that there be only one change in rate from 33 per cent to the new rate and not an up-down movement, which might occur, entailed in a shift to the current company tax rate (36%) followed by a reduction to the new uniform entity rate (recommended to be 30%) when established. This would totally confuse the market and would be contrary to the spirit behind the legislation freezing the current rate until the completion of the inquiry and the implementation of its recommendations.

DEFERRED ANNUITIES

AFSA acknowledges that the effect of applying the entity rate of tax to deferred annuities would be to cause their immediate demise.

Existing policy holders would be greatly disadvantaged by the changed arrangements if Friendly Societies were unable to transfer their deferred annuity business to other forms of retirement saving without penalty.

AFSA therefore asks that, in order to facilitate the equitable transfer of deferred annuity business to a complying superannuation fund, rollover relief be provided for asset transfers and that a mechanism be provided for solvency reserve support to existing capital-guaranteed deferred annuity products.

SOCIETY FUND SUPERANNUATION

Similarly, to facilitate the equitable transfer of Friendly Society benefit fund superannuation business to a separate and stand-alone complying superannuation fund, AFSA seeks rollover relief on asset transfers and a mechanism to provide solvency reserve support for existing capital-guaranteed superannuation products.

FRANKING CREDITS

The adoption of a new taxing regime for life insurers and their policyholders will require adjustments to the franking credit system.

AFSA favours a status quo situation for existing policies i.e. full grandfathering and consequently seeks retention of the current rules for existing policies.

Under the current system Friendly Societies are able to use franking credits internally. Under the new regime these credits will be passed on to the investor.

This raises the question of double taxation. A Friendly Society investing in a company which, having paid tax, provides franking credits, would then be required to pay tax again on that income.

Accordingly, AFSA considers that an inter-corporate dividend rebate should be incorporated in any imputation regime for new policies.

With respect to the allocation of franking credits between shareholders and policyholders, AFSA believes that a system using the same basis that tax is allocated for regulatory purposes would be appropriate.

EXEMPTIONS

NON-LIFE INCOME BONDS

In July 1996, the Government introduced the social security extended deeming system, simplifying the treatment of pensioner investments in relation to income/asset tests. A single deeming regime has since applied to the financial assets of all means-tested pensioners and other social security/veterans beneficiaries.

Unfortunately, this did not take into account the different methods of taxation applied to non-taxed and pre-paid tax investments. Investors seeking to obtain at least the deeming rate of return were prone to the perception that pre-paid investments i.e. Friendly Society capital guaranteed bonds, could not match the untaxed bank, building society or unit trust equivalents.

This clearly disadvantaged Friendly Societies who sought, with Government approval, to gain parity by introducing "income bonds". These were non-life investments whose proceeds were immediately taxed in the hands of the investors.

Such income bonds were required to be capital guaranteed and to be held solely by Friendly Societies.

See Attachment 3 – Income Bonds: How they operate

AFSA contends that, to maintain this fair and level playing field, Friendly Society income bonds should be treated in the same manner as other widely-held collective investments i.e. unit trusts.

To facilitate uniform entity taxation, effective investor exemption may be achieved by assessing entity income and by providing a deduction for the income component allocated each year to investor accounts.

FUNERAL BONDS

Friendly Societies have for some time been providers of funeral bonds to the elderly.

The bonds, exempt from taxation under Section 50-20 of the Income Tax Assessment Act 1997, operate under the strict requirement that the proceeds (and capital) are used for the sole purpose of meeting funeral expenses.

Tens of thousands of elderly Australians have invested more than $500 million in these special purpose bonds.

Neither the capital nor proceeds can be accessed until death and the exemption was approved in recognition of the voluntary quarantining of savings for an inevitable event and for no other. Social Security and Veterans Affairs legislation already recognizes these restricting conditions for income/assets test exemption.

See Attachment 2 - Funeral Bonds: How they operate

In referring to the non-life aspect of Friendly Society business, Chapter 34.5 refers to the uncertainty of its taxation treatment.

AFSA urges the immediate removal of such uncertainty. Removal of the exemption would surely involve a breach of faith with a great many elderly Australians. AFSA also believes that the imposition of a new tax on investments available solely for expenses associated with death would not be in keeping with Government philosophy.

Accordingly, AFSA seeks the retention of such exemption.

To facilitate uniform entity taxation, effective investor exemption may be achieved by assessing entity income and by providing a deduction for the income component allocated each year to investor accounts.

Additionally, at the investor level, death benefit payments should continue to be exempt. This may be achieved by maintaining Section 26AH rules for funeral bonds issued from 1 July 2000 – in other words, by not establishing any "new policy" class.

SCHOLARSHIP FUNDS

Friendly Societies operate under Section 50-20 of the Income Tax Assessment Act 1997 (the "1997 Act"). Under this section, Friendly Societies are tax-exempt so long as they are not run for the profit or gain of their members. The life insurance business of Friendly Societies is separately taxed under Division 8A of the Income Tax Assessment Act 1936.

Only one Friendly Society currently operates scholarship funds under Section 50-20 of the 1997 Act. The proceeds do not flow to members but to secondary and tertiary students to assist them in their educational pursuits. To our knowledge there is no other similar product offered in Australia.

See Attachment 1 – Scholarship Funds – How they operate.

Some 180,000 Australian families (300,000 children) are contributors to scholarship funds which total around $500 million in savings. Contributions average about $10 a week and are often constituted by the diversion of child endowment by parents.

The scholarship proceeds are confined to and shared by the nominated children and cannot be used for purposes other than specified education expenses. Members (contributors) cannot benefit and the proceeds are effectively quarantined from all other uses.

The funds are not life insurance policies and have no element of contingency based on the life of a contributing member or dependant. Consequently, they are completely separate from life policies and other benefit funds provided and operated by Friendly Societies and whose proceeds are taxable.

The function and underlying principle of these funds was incorporated by Governments in the rewritten Friendly Societies Act of 1997.

Consequently, AFSA would view the removal of such exemption as a breach of faith with a great many Australian families who are prepared to sacrifice current expenditure to save for their children’s education and future.

AFSA could understand that their interpretation of such removal would include:-

• The imposition of a tax on education;
• a penalty on long-term saving; and
• a blow to schools and universities already under financial pressures.

Because of the genuine nature of the funds quarantined as they are from other purposes, and their widespread use by so many Australians, AFSA strongly urges the retention of effective tax exemption for this product.

THE TAXATION OF POLICYHOLDERS

EXISTING POLICIES (CHAPTER 35)

AFSA considers the advantages of retaining the existing rules for existing policies outweigh the disadvantages.

Accordingly, AFSA agrees with the proposed retention of the present method of assessing investors under Sections 26AH (inter alia without imputation gross-ups), 160AAB (at a single fixed rate) and Section 160ZZI (CGT exemption).

A full "grandfathering" of these policies would entail no change in the contract entered into by the provider and the policyholder. Additionally, it would confirm that a policyholder who held an existing life insurance investment policy for more than 10 years would have no present taxation obligation to fulfil.

However, AFSA can envisage low income policyholders with existing policies, (even beyond 10 years) seeking to take advantage of the new rebate system, available on new policies. In such circumstances, a taxing event could mean a net refund as the rebate may exceed their tax obligation.

To meet this reasonable desire, we envisage that a further contribution of amounts in excess of the current 125 per cent rule would readily achieve the reclassification of an "existing policy" to a "new policy".

This would, in effect, offer a simple non-disposal alternative without attracting undue tax and transfer costs (arising from a disposal event), thus helping achieve fairness to those on lower incomes, without introducing the complexities and breaches of undertakings which might be attributed to options 2 or 3.

SECTION 160AAB REBATE RATE

With respect to the prospective change in the company rate of tax (entity rate), AFSA comes down on the side of simplicity. We would prefer the rebate rate to be that of the company rate and that there be no phasing in of a stepped rate. As a consequence, the company rate of rebate should apply to bonuses paid after 30^th June, 2001 or whenever that rate comes into force.

The introduction of any lower rebate (as a result of a lower entity tax rate) should be lagged by one year – consistent with past changes, and in recognition that bonuses received generally relate to income earned at the entity level the previous year.

NEW POLICIES (CHAPTER 35)

TAXATION (OPTION 1)

AFSA is attracted to Option 1. It provides a flexibility not before available to policyholders.

Attachment 4 sets out our proposed operation of Option 1.

Option 1 provides clear choices for the policyholder who then ultimately becomes responsible for his/her taxation obligation, in the same manner as other investment products which are not taxed at source.

A very strong advantage is the element of fairness providing scope for low marginal rate policyholders to attract net credits and, potentially, refunds of excess credits.

Option 1 further enables imputation credits to be accessed annually should the policyholder choose to be assessed annually.

Having carefully considered all three Options, AFSA favours the built-in flexibility and equity of Option 1.

INTEREST DEDUCTIBILITY

Existing law provides that no deduction can be made where there is no certainty of assessable income.

New policies, under the proposed taxation regime, will always be certain of providing assessable income – either year to year or at maturity.

In these circumstances AFSA believes that the Section 67AAA(2) provision on denial of deductibility of interest expenses incurred on borrowings to fund the purchase of a Friendly Society "insurance bond" should be repealed.

CAPITAL GAINS TAX TREATMENT (INVESTOR LEVEL)

Under the new regime, Friendly Societies may have the capacity to structure a bond which may contain unrealised growth.

No tax would occur at the entity or investor level until the growth was later realised.

Societies could then provide bonuses which would

• contain a rate applying to realised growth; plus
• an element which would be treated as unrealised growth.

In this event, AFSA believes that CGT treatment should be available on the later realised growth component.

POLICY FEES

Under current laws, fees incurred by a policyholder qualify for an income deduction provided that they are not of a capital, private of domestic nature.

Under the new regime, AFSA considers that policy fees which are assessable to the life insurer should be deductible to the policy holder in the same year.

This would avoid "blackhole expenditure", an outcome which seem unreasonable.

TAX-PREFERRED INCOME

It is noted that the distribution of tax-preferred trust income may or may not continue in a new tax system.

If it were to continue, it would seem both consistent and equitable to extend its availability to assessable bonus/growth returns on a policy of life assurance.

POOLED SUPERANNUATION TRUSTS (CHAPTER 36)

While AFSA understands that the current taxation treatment of PSTs would be inconsistent with the redesigned imputation system applying to other entities, it believes that PSTs are a valuable link in the retirement saving chain.

The pooling system has enabled many small and medium sizes superannuation funds to take advantage of the skills, economies of size, etc of PSTs.

Furthermore, they contribute to the all important element of competition in the retirement savings field – an aim which would lose its vitality if left finally to a few conglomerates.

Consequently, AFSA strongly favours the retention of Pooled Superannuation Trusts as superannuation entities and, as such, believes they should be taxed at the concessional superannuation rate of 15 per cent.