Remedial changes to the taxation of insurance business
(Clauses 2(6) and (13), 32 and 33, 36, 37B, 44 to 54, 87, 100 to 101 and 103(44) to (46 and (54))
The bill contains a number of technical remedial changes to the tax treatment of general and life insurance business conducted in New Zealand.
Issue: Reserves – deductions for claims under non-participation policies
Submissions
(Matter raised by officials)
Further technical revision to section DR 4(1) is required to ensure that deductions do not arise for any savings returns to the policyholder that might be included in a claim.
Comment
Clause 33(1) of the bill amends section DR 4 of the Income Act 2007 and improves the Act’s internal linkages relating to the rules about deductions for life-risk claims paid under a life insurance policy including reserving amounts (described in sections EY 20 and EY 23). The change ensures that deductions are defined in the context of non-participation policies.
To further ensure that deductions for claims allowed under section DR 4 of the Income Tax Act 2007 are limited to non-participation policies, officials recommend a further technical change by specifying the deduction for a claim does not arise if the life insurance policy is a profit participation policy or the expenditure or loss is in connection with an annuity.
Recommendation
That the submission be accepted, and that section DR 4 be amended by specifying that a deduction does not arise in respect of a claim under a profit-participation policy or an annuity.
Issue: Reserves – setting an opening balance for reserves when general and life insurance business is transferred from non-residents to New Zealand insurers
Submissions
(Matter raised by officials)
The rules for calculating the opening balance for reserve connected with business that is transferred from a non-resident to a New Zealand resident insurer needs to take into account the actuarial assumptions used by the non-resident.
Comment
Clauses 36 and 44 respectively amend sections DW 4 and EY 5 of the Income Tax Act 2007 and set out a method for calculating the opening balance of reserves for insurance business that is transferred by a non-resident insurer to a New Zealand resident insurer. The amendment is intended to remove a risk that insurance business could be transferred from a jurisdiction that does not have similar commercial or tax regulatory environment to New Zealand with the result that deduction entitlements or taxable income could be over-or- understated.
The proposed amendment requires New Zealand resident insurers to restate the closing balance of the transferred reserve as if the relevant insurance policies had been sold in New Zealand. The change focuses on the requirements of the reserve by reference to IFRS 4 but does not specify the assumptions that are used to support the calculation. This omission could, at worst, allow an overstated deduction to result, if for example, a New Zealand-resident insurer were to unduly suppress a risk margin on transfer but later revise the actuarial assumptions supporting the reserve to create a deduction in New Zealand. A further risk is that the amounts required by financial reporting and the judgement exercised by accountants under those standards can depart from the assumptions and methods required and used by an actuary.
To prevent this situation from arising, officials recommend that the proposed amendments make particular reference to the rules in the Income Tax Act (rather than IRFS 4) in connection with the assumptions and methods that support the calculation of the various reserves when the transferor is a non-resident. For general insurers this will involve calculating the outstanding claims reserve by reference to a statutory formula that requires an actuarial determination of the insurer’s incurred (but not reported) claims, reported claims and an appropriate risk margin.. Life insurers will need to make reference to sections EY 23 to 27. Consequential changes are also required to sections ED 3 and EY 5 to deal with part-year transfers.
Recommendation
That the submissions be accepted, and that sections DW 4(4B) and EY 5(4B) be amended by adding the additional requirement that the opening balance be calculated using actuarial assumptions and methods set out in Income Tax Act 2007.
Issue: Policyholder base income – allocation of income
Submissions
(Matter raised by officials)
Improvements recommended to assist reader comprehension about the application and effect of the allocation rules for investment income derived by non-participation policies.
Comment
Clause 45 amends section EY 15 to clarify its relationship with section EY 19. Section EY 15 defines the income that should be allocated to the policyholder base. Section EY 15(2) specifies that policyholder income is limited to the amount provided for in the formula set out in that section. Any excess income becomes shareholder base income under section EY 19. The purpose of the amendment is to specify when investment income is allocated between the shareholder base and the policyholder base.
The effect of the proposed amendment is unclear as it is currently expressed. Officials recommend that the amendment be redrafted. To support the operation of the allocation rule in section EY 15(2), it is also recommended that the definition of “investment income” in section EY 15(1) be amended so that it includes income that arises from the operation of the Income Tax Act 2007. The change does not extend the scope of the policyholder base but clarifies that income created by the Income Tax Act from investments can also be apportioned between the policyholder and shareholder bases. Under current law, income deemed to arise under the Income Tax Act from investments is arguably treated as policyholder income only.
Consequential changes are also recommended to sections EY 16(2), the deduction rules for non-participation policies, to reflect the clarified relationship between sections EY 15 and EY 19.
Recommendation
That the submission be accepted, and that section EY 15(2) be amended so that the reference to section EY 19 be removed. Section EY 15(1) be amended by clarifying that the term “investment income” also includes income from investments that arises through the operation of the Income Tax Act 2007.
Issue: Profit participation policies – discounting future entitlements to income
Submissions
(Financial Services Council, Matter raised by officials)
The changes proposed to sections EY 17 and EY 21 of the Income Tax Act 2007 should also apply to sections EY 28 and EY 29. (Financial Services Council)
The amendments to section EY 17 and EY 21 should be reworded to assist comprehension of the sections. (Matter raised by officials)
Comment
Clauses 46 and 49 amend sections EY 17 and EY 21 of the Income Tax Act 2007 to ensure that any claim the shareholder base has on future income derived on investment income is correctly valued. The change involves replacing the current discount factor which requires a risk-free rate, with a discount rate that is actuarially determined. The discount rate used should be the same as the one used by a life insurer for financial reporting purposes. The relevant discount rate is net of tax. The amendments in the bill ensure that the Income Tax Act allocates the correct amount of future income to the shareholder base.
The Financial Services Council has asked that the proposed amendment also apply to sections EY 28 and EY 29 which deal with “other profit”. “Other profit” is income or expenditure that arises when there are changes in actual cashflows when contrasted against expected cashflows connected with the assets created by profit participation policies. The submission seeks a change to the way the Income Tax Act values policy liabilities in sections EY 28 and EY 29.
Following discussions with the Financial Services Council, officials consider that the matter relates to the way the Income Tax Act 2007 expresses the concept of future amounts which are used to calculate a life insurer’s exposure to policy liabilities and contractual claim over future earnings from managing policyholder assets. The discussions have also pointed to wider legislative matters affecting the calculation of “other profit” in sections EY 28 and EY 29. Officials are currently reviewing the operation of the rules for calculating “other profit”, and the Financial Services Council’s submission will be considered as part of it.
As such, officials do not recommend making the change suggested by the Financial Services Council at this time, but will consider the matter for a future taxation bill.
Officials do consider, however, that there is benefit in altering the amendment affecting the definition of “present value (actuarial net)” in the bill. Rather than prescribe the manner of discounting, which carries the risk of mandating requirements that would normally not be used by life insurers, officials recommend changes to clauses 46 and 49 in connection with the amendments to sections EY 17 and EY 21 to specify that future amounts be recognised net of tax.
A further change is recommended in sections EY 17(2)(c) and EY 21(2)(c) that would substitute the words “future bonus declarations” with “portions of future profits”. Life insurers do not receive bonus declarations from managing policyholder assets – they receive a share of future profits.
Recommendation
That the submissions be declined in part. Sections EY 17 and EY 21 be amended so that future amounts are calculated net of tax. In sections EY 17(2)(c) and EY 21(2)(c) replace the words “future bonus declarations” with the phrase “portion of future profits”.