Amendments to the life insurance taxation rules

Sections EY 15, EY 17, EY 18, EY 19, EY 21, EY 22, EY 30 and YA 1 of the Income Tax Act 2007

Several changes have been made to the new rules for taxing life insurance business. The changes made by the Taxation (Consequential Rate Alignment and Remedial Matters) Act 2009 affect the scope of the grandparenting provisions applicable to life insurance policies sold before 1 July 2010. 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 (Consequential Rate Alignment and Remedial Matters) Bill, the Finance and Expenditure Committee recommended a number of technical amendments be made the new rules.

Key features

The main amendments to the new taxation rules for life insurance affect the scope of the transitional rules. Other technical 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.

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.

Detailed analysis

Grandparenting of term life products (section EY 30(2), (4), (5), (11), (14) and (15))

Section EY 30 allows life insurance policies sold under the previous rules to be grandparented and subject to transitional rules for a period of up to five years. 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:

Group life policies - workplace group policies: Changes have been made that allow employee lives insured after 1 July 2010 to be grandparented if the life cover arises from a compulsory group life policy provided by an employer. Previously, the new rules for workplace group policies (referred to as "employer-sponsored group policies") required life insurers to "look through" the group life policy to the individual lives covered and limited the benefits associated with grandparenting to lives insured before the application date. Because group life policies insure a portfolio of lives, the requirement to "look through" was not considered practical or feasible because of information constraints and related systems costs.

Changes have therefore been made which remove the need to distinguish between employee members of a compulsory workplace group scheme that joined before the application date and those that joined afterwards.

The maximum grandparenting period for these policies has, however, been reduced from five years to three years.

The new definition of "workplace group policy" in section EY 30(15) also ensures that policies sold to trade unions to cover their members are similarly treated.

Credit card repayment insurance: Life policies that provide for the repayment of a credit card balance which are sold directly to cardholders may now be grandparented as a result of amendments to the definition "credit card repayment insurance". Previously, credit card repayment insurance could only be grandparented if the cover was provided under a master policy and the general public was excluded.

Table 1 summarises the operation of the grandparenting rules, including the changes made by the Taxation (Consequential Rate Alignment and Remedial Matters) Act. This table replaces the earlier table printed on page 55 of Tax Information Bulletin Vol 21, No 8, Part II.

Table 1: Operation of grandparenting rules

Premium payback policies

Changes have been made to the new rules for premium payback policies. Premium payback policies are life policies which pay a portion of premiums back to policyholders who hold their policies for a set minimum period. The definition of "savings product policy" in section YA 1 has been amended to exclude life policies if the surrender value arises wholly from a "premium payback amount" (as defined in section YA 1). Under the new rules, if the policy is not treated as a savings product it cannot have policyholder base income and the transitional rules therefore have effect.

These amendments ensure that these policies can be grandparented, if sold before the application date, and that any premium return feature does not give rise to the life insurer having policyholder base income.

Drafting matters

A number of amendments have been made clarify certain aspects of the new life insurance rules:

• Section EY 17(3) has been changed to provide context to the application of the term "policyholder unvested liabilities" by referring to the value of any assets used to support such liabilities. The term "policyholder unvested liabilities" is defined in section YA 1.
• Sections EY 18 and EY 22 have been changed to ensure that "net transfers" are ignored when calculating allowable deductions allocated to the policyholder base. The change prevents double-counting as amounts relating to net transfers can be positive or negative and are allocated when determining policyholder base income under section EY 17 or shareholder base income under section EY 21.
• Sections EY 17(2) and EY 21(2) have been changed by giving context to the term "shareholders" as it is used in these sections. The sections now refer to "shareholder's retained earnings".
• Sections EY 15(5), EY 17(2), EY 19(2) and EY 21(2) have been changed to ensure drafting consistency with the rest of the Income Tax Act 2007.