The University of Sydney-    Classic Texts in Australian and International Taxation Law

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27. Chapter 21 Income Taxation in Relation to Superannuation and Life Insurance

^note

21.1. Life insurance and superannuation, whilst they have many differences, also possess some important similarities. On one level they are, apart from the purchase of houses, the only common forms of contractual long-term savings in Australia and these savings provide a very significant pool of long-term investment capital. On another level, life insurance and superannuation give financial protection to the individual and those dependent upon him in the event of death or retirement. To this extent they provide benefits that society has come to regard as desirable.

21.2. For these reasons the Committee believes that, generally, life insurance and superannuation should not be dealt with in isolation from each other and that the tax treatment of one should be consistent with the tax treatment of the other. This is not to say, however, that the basis of taxing both should necessarily be identical, for important differences between the two must be recognised.

21.3. For convenience, this chapter is divided into three sections. The case for special treatment is briefly considered in Section I. This is followed, in Section II, by a close examination of superannuation and retiring allowances in terms both of the present legislation and possible lines of reform. Section III is addressed to life insurance.

I. The Case for Special Treatment

21.4. The Committee has, in Chapter 3, expressed the view that neutrality should be the general aim when economic efficiency is at issue and that, as far as possible, considerations of tax liability ought not to be allowed to influence the manner in which a person conducts his affairs. But in so far as certain inherent features of the tax system tend to make for non-neutrality in the overall operation of that system, some deliberately contrived offsetting correction may be warranted.

21.5. One such feature, of particular relevance in the context of the present chapter, concerns the taxing of income. As already pointed out in Chapter 3, a tax on income falls on the component saved as well as on the component immediately consumed; and when income is subsequently earned on the component saved, that too bears tax. In the result, the effective rate of return on saving is less than it otherwise would be and the balance of advantage between consuming income immediately and saving it to consume later is shifted towards the former. Bias of this kind against saving is an inherent feature of income tax: it could be wholly eliminated only by abandoning income tax altogether and substituting an expenditure tax along the lines suggested by Lord Kaldor. The Committee is not prepared to go this far; though if greater reliance is placed on indirect taxes and less on income tax, which is the Committee's proposed long-run objective, the general bias against saving will in time diminish. In the meanwhile, however, special provisions in the income tax law must be relied upon to correct the bias.

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21.6. Traditionally the law, in its special provisions, has gone beyond merely correcting the bias against saving. These provisions clearly reflect a policy of promoting long-term saving in the private sector. The policy reflects notions of thrift intended, among other things, to relieve the State of some of the heavy financial burden of providing for old age. It also reflects the need to foster a healthy capital market. The Committee does not see its role as enabling it to question the policy of promoting long-term saving, even were it minded to do so. It is concerned, nevertheless, to make an assessment of the existing law, or any alternative law, directed to promoting saving and to judge its effectiveness to this end as well as its fairness.

21.7. Clearly superannuation and life insurance are structured so that they can offer the assurance that saving undertaken through them is long term. In this respect they are the avenues of private saving most deserving of tax assistance.

21.8. While the Committee can thus see some justification for an approach that will result in the deferral of tax and some relief from tax on such long-term saving, it can find little justification in theory for a system that permits exemption from tax altogether. If contributions to superannuation funds are to be an allowable deduction at the time they are made, and the income of such funds is to be exempt from tax, then the virtual exemption from tax of the whole benefit payable at retirement is debatable. If some relief from tax is to be given in relation to life insurance premiums, and it is not practicable to tax the policy proceeds, the levying of some tax on the investment income earned by the premiums is seen to be appropriate.

21.9. Finally, and most importantly, it must be borne in mind that the matters with which the Committee is here dealing involve long-term commitments entered into by taxpayers on the basis of the existing taxation structure. It would be unfair to such persons if a significantly different taxation structure were to be introduced without adequate and reasonable transitional arrangements. Having regard to the importance of life insurance and superannuation funds in the Australian capital markets, it would be an unwise step to make recommendations likely to force such institutions abruptly to slacken the pace of new investment or even to liquidate a large portion of their existing holdings. The deleterious effect of such action on the Australian economy would outweigh any gains in equity in the treatment of taxpayers that recommendations of this kind might bring.

II. Superannuation, Retiring Allowances and Related Matters

Background and Present Legislation

21.10. Figures released by the Australian Bureau of Statistics indicate that, as at February 1974, of the civilian work force approximately 1.65 million, or 28.7 per cent, were covered by a superannuation or pension-type scheme. The total number of such schemes in operation is not known but is very large, as are the variety and scope of the benefits provided.

21.11. It is important to recognise that most schemes have been established voluntarily by employers to provide for the needs of their employees who retire or the needs of the dependants of those who die while in employment. Any reform of the law directed to the curtailment of abuses in this area should not be such as to discourage employers from continuing to provide for these needs.

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21.12. The Committee is also mindful of the effect of inflation on superannuation schemes, particularly of the benefit promise type. If wages and salaries continue to rise at current rates, considerable strain will be felt by many funds in meeting objectives and that strain will be reflected in the contributions required to be made by, or on behalf of, employees.

Taxation of Lump-sum Payments on Retirement

21.13. Section 26 (d) of the Income Tax Assessment Act includes in the assessable income of a taxpayer:

‘(d) five per centum of the capital amount of any allowance, gratuity or compensation where that amount is paid in a lump sum in consequence of the retirement from, or the termination of, any office or employment, and whether so paid voluntarily, by agreement or by compulsion of law …’.

21.14. Section 26 (e) of the Act includes in the assessable income of a taxpayer:

‘(e) the value to the taxpayer of all allowances, gratuities, compensations, benefits, bonuses and premiums allowed, given or granted to him in respect of, or for or in relation directly or indirectly to, any employment of or services rendered by him, whether so allowed, given or granted in money, goods, land, meals, sustenance, the use of premises or quarters or otherwise:

Provided that this paragraph shall not apply to any allowance, gratuity or compensation which is included in the last preceding paragraph …’.

21.15. The effect of section 26 (d), when taken in conjunction with the proviso to section 26 (e), is twofold. Firstly, it includes in assessable income 5 per cent of lump sums that would otherwise be regarded as wholly capital receipts. Examples of such receipts are payments from the trustees of a superannuation fund and compensation for loss of office. Secondly, it includes in assessable income only 5 per cent of lump sums that would otherwise be regarded as assessable in full under either general law principles or under the specific provisions of the first part of section 26 (e). Examples of this latter type of receipt are retiring allowances paid directly by an employer to a retiring employee (including such items as accrued long-service leave and holiday pay) and payments made under a service contract that provides for payment of a lump sum at the satisfactory conclusion of the contract.

21.16. The principle inherent in section 26 (d) of assessing only 5 per cent of a lump sum received on retirement has been followed ever since income tax was first levied by the Australian Government in 1915. The choice of the figure of 5 per cent was plainly arbitrary and reflected in part the inequity of taxing such a sum wholly in the year of receipt when it may have arisen from employment stretching over many years.

21.17. There are no limitations on the amount of any receipt to which section 26 (d) is applicable, nor is there any restriction on the number of occasions on which it may be applied. Thus it is open to a taxpayer who is employed by one of a number of related companies to resign and move to another company within the group and collect a substantial retiring allowance from the first employer which will be assessable only as to 5 per cent. Instances of this happening have been brought to the attention of the Committee where the amounts involved, and the consequent cost to the Revenue, have been extremely large.

21.18. Some control over the application of section 26 (d) in the case of a private company is provided by section 109 of the Act:

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‘109. So much of a sum paid or credited by a private company to a person who is or has been a shareholder or director of the company or a relative of a shareholder or director, being, or purporting to be—

• (a) …
• (b) an allowance, gratuity or compensation in consequence of the retirement of that person from an office or employment held by him in that company, or upon the termination of any such office or employment,

as exceeds an amount which, in the opinion of the Commissioner, is reasonable, shall not be an allowable deduction and shall … be deemed to be a dividend paid by the company on the last day of the year of income of the company in which the sum is paid or credited.’

21.19. However, the Commissioner cannot make use of this section if the person receiving the retiring allowance is not within the class of persons prescribed in the section or if the company concerned is a public company.

21.20. Section 26 (d) was examined in the early 1950s by the Spooner Committee which recommended that the operation of the section be limited by restricting the concessional basis of taxation to so much of the retiring allowance as might be regarded as reasonable, having regard to remuneration and length of service. In effect the formula for assessment of retiring allowances and payments from superannuation funds proposed by that Committee was that the amount taxable on the concessional basis be limited to the equivalent of one year's salary for every eight years of service and should not, in any case, be allowed to exceed $30,000. The Spooner Committee further recommended that any payments received by an employee as consideration for entering into a restrictive covenant should be assessable in full, but, somewhat anomalously, recommended that any amounts received by an employee as compensation or damages for the termination of his employment should continue to be assessable only as to 5 per cent and without any limit on the amount received.

21.21. The Government decided to adopt the Spooner Committee's recommendations in principle and proceeded to implement a less generous version of the proposal. The Government's intention was that the amount subject to the 5 per cent basis of taxation be limited to one year's salary for every twenty years of service, with an upper limit of $20,000.

21.22. A Bill that would have given effect to this intention was introduced into the House of Representatives in 1952, but aroused much opposition. The principal ground of objection was that reputable private superannuation schemes had been operating for many years on the assumption that senior executives would be paid lump-sum amounts on retirement which would be substantially in excess of the amounts provided in the formula. If the excess were to be taxed in full, the application of the progressive graduated rate of tax to very large amounts received in a single year of income could result in most of the lump sum being lost in tax. It was contended that this would defeat the legitimate expectations of taxpayers who had been contributing to superannuation funds over a long period on the assumption that they would receive a lump sum on retirement, 95 per cent of which would be tax free.

21.23. As a result of these objections, the clause relating to retirement allowances was deleted from the Bill.

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21.24. The Ligertwood Committee, though aware of the previous Committee's recommendations on the matter, did not mention section 26 (d) in its 1961 report—probably because of what had transpired previously.

Deductibility of Retiring Allowances Paid by Employers

21.25. Amounts paid directly by an employer to a terminating employee, or to the dependants of a deceased employee, are at present an allowable deduction to the employer under either section 51 (1) of the Act, which provides that:

‘51 (1) All losses and outgoings to the extent to which they are incurred in gaining or producing the assessable income, or are necessarily incurred in carrying on a business for the purpose of gaining or producing such income, shall be allowable deductions except to the extent to which they are losses or outgoings of capital, or of a capital, private or domestic nature, or are incurred in relation to the gaining or production of exempt income’,

or under section 78 (1) (c), which provides that:

‘78 (1) The following shall … be allowable deductions:

• (a) …
• (b) …
• (c) Sums which are not otherwise allowable deductions and are paid by the taxpayer during the year of income as pensions, gratuities or retiring allowances to persons who are or have been employees or dependants of employees, to the extent to which, in the opinion of the Commissioner, those sums are paid in good faith in consideration of the past services of the employees in any business operations which were carried on by the taxpayer for the purpose of gaining or producing assessable income.’

21.26. Certain lump sums paid to terminating employees have always been considered to be allowable deductions under section 51 (1). These include accrued holiday and long-service leave pay and certain payments made under service contracts. To the extent that other payments were regarded as being deductible it had been the practice of the Commissioner—in line with what was thought to be the intention of the legislature evinced from the words in section 78 (1) (c)—to apply similar standards of reasonableness in determining the amount of the deduction as those now applied in determining the maximum benefit that may be provided by a tax-exempt superannuation fund under section 23F (2) (h) of the Act.

21.27. However, it has lately become clear that the Commissioner is unable to resist claims that section 51 (1) authorises the full deduction of retiring allowances paid by public companies where it can be established that the payments are made for one or more of the following reasons:

• (a) as a matter of commercial expediency in order to establish harmonious relationships between the management and staff;
• (b) as a means of ensuring greater efficiency; or
• (c) as a means of inducing executives to press themselves to the limit by giving them the prospect of being treated generously on their retirement.

Once the company has established that the payment was made for one or more of these reasons—and in practice it is not difficult to establish this—then the quantum of the lump-sum payment is for the company itself to determine and it must be allowed a deduction for the full amount. Instances of amounts of up to $250,000 being paid by


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public companies to retiring executives and deducted under section 51 (1) have been brought to the notice of the Committee. In some of these cases the executives have also received very large amounts from the companies’ superannuation funds and also under service contracts. The amounts received by the executives are reported to have been assessable only as to 5 per cent in their hands.

21.28. It is to be noted that the foregoing applies not only to employees of public companies, but also to arm's length employees of private companies. However, section 109 of the Act imposes an effective limit on the deduction that can be claimed for a retiring allowance paid to a person who is or has been a shareholder or director of a private company or a relative of a shareholder or director. In addition, section 65 gives the Commissioner power to disallow a deduction for a retiring allowance paid by a non-corporate employer to a relative to the extent that the retiring allowance is excessive.

21.29. Even if the deduction is claimed under section 78 (1) (c), the Commissioner may be unable to challenge the amount of the payment. If the payment is made by a public company and approval for the payment has been granted by the shareholders in general meeting, then the Commissioner would be hard-pressed to superimpose his opinion as to the reason for, or the amount of, the payment.

Deductibility of Contributions to Superannuation Funds

21.30. Contributions by an individual to a superannuation fund for the benefit of himself or his spouse or child are a concessional deduction under section 82H of the Act. Such contributions when aggregated with life insurance premiums and payments to friendly societies are subject to a maximum deduction of $1,200.

21.31. Concessional treatment of personal contributions to superannuation funds can be traced back to the first time income tax was levied by the Australian Government in 1915. From that year until 1935 superannuation contributions were a concessional deduction subject initially to a maximum of $100, but from 1922 a maximum of $200 applied. From 1936 to 1941 superannuation contributions and life insurance premiums were amalgamated with an overall maximum deduction of $200. From 1942 to 1951 concessional rebates of tax were substituted for concessional deductions against income and the maximum amount on which a rebate was allowed remained at $200, raised in 1950 to $300. Concessional deductions were reintroduced in 1951 and the maximum deduction increased to $400. This maximum was increased to $600 in 1957, $800 in 1960 and to the present level of $1,200 in 1968.

21.32. In 1973 section 82H was amended to restrict the availability of the deduction for personal superannuation contributions to cases where the contribution was made to a fund that had been approved by the Commissioner for the purpose of total or partial exemption from tax of the income of the fund. This was done in order to prevent abuses of section 82H whereby funds that were superannuation funds in name only were being set up by individual taxpayers who would make contributions to the fund, claim a deduction and then terminate the fund and withdraw their contributions.

21.33. Deductibility of contributions by employers to superannuation funds for the benefit of their employees is governed by the provisions of sections 82AAA-82AAR of the Act. These sections, some of which are exceedingly complex, were inserted in 1964 and 1965 largely as a result of the Report of the Ligertwood Committee. That Committee detailed abuses which had developed as a result of the then section 66


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(governing deductibility of contributions by employers) and section 79 (governing deductibility of contributions by persons other than employers).

21.34. In summary, the provisions of sections 82AAA-82AAR provide for the deductibility of amounts set aside or paid as or to a fund by an employer for the purpose of making provision for superannuation benefits for an eligible employee or his dependants (section 82AAC). It is to be noted that the deduction is available regardless of whether or not the fund concerned is one that complies with the requirements necessary for partial or total exemption from tax of the fund's income.

21.35. By section 82AAE the amount of the deduction available in respect of each employee is limited in any year to the greater of $400 or 5 per cent of the employee's remuneration in that year. However, this limitation is of little practical significance since the Commissioner is given power to allow the deduction of a greater amount if he considers that there are special circumstances justifying such greater deduction. The Commissioner exercises this power in such a way that, since 1970, the amount which will be allowed as a deduction is the amount (or rate of contribution) which, when aggregated with the contributions, if any, being made by the employee, will produce an end-benefit that is ‘reasonable’ for the purposes of section 23F (2) (h) (see later). These amounts will often be extremely large, particularly where the maximum permissible benefit is being funded over a relatively short period for an executive close to retirement. Deductions in excess of the employee's annual salary are not unusual in these circumstances.

21.36. Self-employed persons are disadvantaged by comparison with employees since they are restricted to claiming a deduction for personal superannuation contributions under section 82H which imposes a limit of $1,200 on deductions for superannuation contributions and life insurance premiums. Employees may receive the benefit both of the section 82H deduction and of contributions made on their behalf to a superannuation fund by their employer. The Ligertwood Committee recommended that self-employed persons be allowed an additional deduction, over and above the section 82H deduction, of $400 per annum for contributions to superannuation funds set up to cater specifically for the self-employed. However, this recommendation has never been implemented.

Taxation of Income of Superannuation Funds

21.37. There are a number of provisions in the Act governing the total or partial exemption from tax of the income of superannuation funds.

21.38. Section 23 (jaa) exempts from tax the income of a superannuation fund established by:

‘(i) an Act, a State Act or an Ordinance of a Territory of the Commonwealth; or

(ii) a municipal corporation, other local governing body or public authority constituted by or under an Act, a State Act, or an Ordinance of a Territory of the Commonwealth’.

No conditions are prescribed for the exemption of the income of such a fund.

21.39. Section 23 (ja), which was inserted in the Act in 1952, exempts from tax the income of a superannuation fund established for the benefit of self-employed persons where:

• (a) the number of members of the fund is not less than twenty; and
• 
  
  
    ― 356 ―
  (b) ‘the terms and conditions applicable to the fund … have been approved by the Commissioner, having regard to the classes of persons who are eligible for membership, the reasonableness of the benefits provided for, the amount of the fund in relation to those benefits and such other matters as the Commissioner thinks fit’.

The Commissioner has set out guidelines for the approval of funds under section 23 (ja) and these include a restriction on the maximum permissible benefit to $100,000 and a limitation on the maximum contribution which a member may make in any one year, ranging from $1,200 where the member is under forty years of age up to $2,800 where the member is over fifty-five. In addition, such a fund must comply with the provisions of section 121C in regard to the maintenance of a minimum proportion of its assets in public sector securities in order to qualify for exemption. At least 30 per cent of the increase in the assets of the fund since 1 March 1961 (at cost price) must be invested in public sector securities, with at least 20 per cent being invested in Australian Government securities—the so-called ‘30/20 ratio’.

21.40. Section 23 (jb) exempts the interest and dividend income derived in Australia by a foreign superannuation fund. No conditions are prescribed for this exemption.

21.41. Section 23F governs the exemption of the income of ‘conventional’ private sector superannuation funds set up by employers for the benefit of their employees. This section was inserted in the Act in 1964 and amended in 1965 and was largely the result of recommendations contained in the Report of the Ligertwood Committee. That Committee had found that the earlier provision—section 23 (j) (the predecessor of which dates back to 1915)—which simply exempted the income of such funds, was being seriously abused. In particular such funds were being used as recipients for private company dividends that would otherwise have borne tax in the hands of shareholders (who were of course members of the superannuation fund as well). The present section 23F closely parallels sections 82AAA-82AAR in many respects, including the complexity of its provisions.

21.42. The main requirements for approval of a superannuation fund under section 23F and the exemption from tax of its income under section 121C are:

• (a) The fund must be established and maintained solely for the provision of superannuation benefits for employees in the event of their retirement or in other circumstances of a kind approved by the Commissioner, or the provision of benefits for the dependants of employees in the event of death.
• (b) The employer(s) must contribute to the fund and, broadly speaking, only employees and employers may contribute.
• (c) Benefits forgone by an employee who leaves the service of the employer before retirement must be either applied towards providing benefits for the members (or their dependants) or dealt with in some other manner approved by the Commissioner.
• (d) The benefits to be provided by the fund for an employee or his dependants must not be excessive having regard to his remuneration and length of service, to benefits which he or his dependants have received or may receive from another fund to which section 23F applies, and to such other matters as the Commissioner considers relevant. This is commonly referred to as the
  
  
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  ‘reasonable benefits’ test. The criteria that have been adopted for determining reasonable benefits are discussed below.
• (e) The amount of the fund must not be substantially in excess of the amount required to provide the benefits, having regard to the future contributions that will be made to the fund and its earning rate.
• (f) Rights of members to benefits must be fully secured and members must be notified of the existence of a right to receive benefits.
• (g) That part of the income of the fund comprising private company dividends will not be exempt, and will be currently liable to tax at a rate of 50 per cent, unless the Commissioner is satisfied that it would be reasonable to exempt such dividend. Broadly speaking, the dividend must have the character of an arm's length transaction to qualify for exemption.
• (h) The fund must also satisfy the 30/20 ratio, outlined in paragraph 21.39, in relation to its investments.

21.43. The concept of ‘reasonable benefits’ is quite central to the operation of section 23F and, as pointed out in paragraph 21.35, the Commissioner now, as a matter of practice, applies the standards of reasonableness determined for the purposes of section 23F in stipulating the maximum deduction allowed for contributions to a fund by an employer under section 82AAE, and also, where this is possible, to retiring allowances paid by an employer and claimed as a deduction under section 78 (1) (c). The standards of reasonableness have been increased at various times since they were first introduced in 1965 and the present position, in very general terms, is that a benefit will be considered ‘reasonable’ in the following circumstances:

• (a) In the case of a lump sum, if it does not exceed the lesser of $100,000 or seven times the average annual remuneration of the employee in the three years preceding retirement. In cases where seven times the average annual remuneration at retirement exceeds $100,000, the Commissioner is normally prepared to approve a higher figure—up to approximately $300,000 in the case of very highly-paid executives—but the multiple of average annual remuneration that will be approved will decline progressively from seven as the amount increases. Thus a benefit of $250,000 may be approved in a particular case but this may represent only three or four times the average annual remuneration of the executive over the three years preceding his retirement.
• (b) In the case of a fund providing pension benefits on retirement, the pension must not exceed 70 per cent of the employee's average remuneration over the three years preceding his retirement. No dollar limit is set on the pension, providing the same method of calculating pension entitlement is applicable to substantially all the members of the fund.
• (c) In the case of a fund providing benefits in part pension, part lump-sum form, a combination of methods (a) and (b) is used.

The above criteria apply, without any further limitations, to employees of private companies. In the case of non-arm's length employees of private companies (directors, shareholders and their relatives), the same tests apply with the two following exceptions:

• (a) Where section 109 of the Act has been applied to reduce the amount of the employee's remuneration which may be claimed as a deduction, the
  
  
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  remuneration so reduced will be used as the basis for calculating the maximum benefit permitted.
• (b) Where the employee concerned will have had less than twenty years’ service with the company at retirement, the maximum benefit permitted will be the benefit calculated as above but reduced by the ratio that the service which will be completed at retirement bears to twenty years.

21.44. If a superannuation fund fails to qualify for exemption from tax under any of the foregoing provisions, it may nonetheless qualify for approval under section 79 which was inserted in the Act in 1965. Funds to which section 79 applies do not receive exemption from tax but instead are granted a deduction from assessable income of an amount equal to 5 per cent of the cost price of the assets of the fund. The balance of the income of the fund is liable to tax at a rate currently fixed at 50 per cent. However, by investing in assets such as shares that have a dividend yield of 5 per cent or less but high capital growth prospects, it is possible to avoid tax altogether and indeed this is the policy followed by most funds approved under this section. The main tests a fund must satisfy for approval under section 79 are:

• (a) its membership must be restricted to persons following a gainful occupation either as employees or self-employed persons;
• (b) it must impose restrictions on benefits and contributions which are broadly similar to those applicable to a fund approved under section 23 (ja); and
• (c) no benefits may be paid out of the fund prior to a member's sixtieth birthday or his prior death or disablement.

It is to be noted that funds of this type do not have to comply with the 30/20 ratio nor must they have a minimum number of members, as is the case with a fund approved under section 23 (ja). Several large funds approved under section 79 have been set up by banks and similar institutions to cater for self-employed people or employees whose employers may not have a staff superannuation fund of their own.

21.45. A superannuation fund that fails to qualify for concessional treatment under any of the foregoing provisions will be taxed on its income under section 121DA. The rate of tax currently applicable in such cases is a flat 50 per cent.

21.46. Many superannuation funds are managed by life insurance companies and the assets of the funds comprise life policies of one type or another. Changes to the Act made in 1961 have the effect of exempting life insurance companies from tax on that part of their investment income attributable to policies issued for the purposes of tax-exempt superannuation funds. This exemption is subject to certain conditions, including compliance by the life insurance company with the 30/20 ratio in respect of all its assets. The exemption from tax on superannuation policies results in the life insurance company being able to issue these policies on more favourable terms than non-superannuation policies. One minor anomaly of these provisions is that where a policy is issued in respect of a fund approved under section 79 of the Act, the whole of the investment income attributable to that policy is exempt rather than simply the first 5 per cent of the cost price of the assets concerned. On the other hand, as the life insurance company has to comply with the 30/20 ratio in respect of such a policy, the two aspects probably balance out fairly evenly.

Taxation of Benefits Received from Superannuation Funds

21.47. A benefit received from a superannuation fund in a lump sum on the occasion of the taxpayer's termination of office or employment is assessable as to 5 per cent under section 26 (d). In the absence of this provision such a receipt would be


  ― 359 ―
regarded as a capital amount and would not be subject to tax at all. Benefits paid from a fund upon the death of a member do not come within the scope of section 26 (d) and are regarded as receipts of capital. The question of whether or not the fund is an approved one for the purpose of total or partial exemption from tax of the fund's income is not relevant in determining whether or not section 26 (d) applies to the benefit received by the member.

21.48. Pension benefits received from a superannuation fund are wholly assessable in the hands of the recipient, either on general law principles or under the specific provisions of section 26AA. This latter section includes in assessable income of a taxpayer:

‘the amount of any annuity, excluding, in the case of an annuity which has been purchased, that part of the amount of the annuity which represents the undeducted purchase price.’

The exclusion does not operate in the case of a pension or annuity provided by a superannuation fund, since either the annuity is not a purchased annuity or, if it is, there is no ‘undeducted purchase price’, unless, and to the extent that, the member had made personal contributions to the fund in excess of the limits allowed as a deduction under section 82H.

21.49. Use can however be made of section 26AA to give a substantial relief from tax on a superannuation pension. If the retiring employee receives a lump-sum benefit and then elects to use this lump sum (after meeting his tax liability on 5 per cent of the amount under section 26 (d)) to purchase an annuity from a life insurance company, section 26AA will operate to exempt from tax that part of the annuity payments representing the undeducted purchase price of the annuity. The amount to be exempted in each year is found by dividing the purchase price of the annuity by the life expectancy of the employee at the time of purchase according to the prescribed tables of expectation of life. In spite of the theoretical tax-saving advantages of such a transaction, it is seldom encountered in practice.

21.50. Where a retiring employee wishes to receive a lump-sum superannuation benefit it is possible, subject to the rules of the fund concerned, for him to avoid even the minor imposition of tax on 5 per cent of the benefit. If he elects to receive a pension and then, after one or two pension payments have been made, exercises a right to exchange the pension for a lump sum, the latter amount is not received ‘in consequence of retirement’ but in consequence of giving up a right to future income and, according to long-standing legal authorities, is a receipt of capital. This technique is now not uncommon, retiring employees from some funds that pay pensions being advised to make use of it.

21.51. Where a lump-sum benefit is received from a superannuation fund other than in consequence of termination of an office or employment, it will normally be a capital receipt and, being outside the scope of section 26 (d), will escape tax altogether. This will usually be the case with benefits received from funds approved under section 23 (ja) or section 79, since the time of receipt of the benefit will be different to the time at which the office or employment terminated and since many members of such funds are self-employed people to whom section 26 (d) will not be applicable. However, it has been held that this exemption from tax will extend to cases where lump-sum benefits are paid to persons whose employment has not been terminated. It has come to the Committee's attention that this position is being increasingly abused by people who set up funds that comply with section 23F and


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then amend the deed governing the fund to permit benefits to be paid out of the fund while members of the fund are still employed. The benefits so received are exempt from tax; and while the fund can be taxed at the rate of 50 per cent on income derived in that year, the amount involved is usually quite small and there is no power to reopen the assessments of previous years.

International Comparisons: A Brief Summary

21.52. All industrialised countries with which Australia can be compared have special tax regimes governing provision for retirement. In general and subject to a multitude of conditions, contributions to superannuation funds by employers, selfemployed persons, and, in most countries, employees are allowed as a deduction in computing assessable income. The income of superannuation funds is, again subject to a variety of conditions, exempt from tax. Thus far the present Australian position is comparable with that obtaining in other countries. However, in the treatment of benefits other than in the form of pensions flowing from superannuation funds or paid directly by an employer on retirement, the Australian tax treatment is markedly more favourable. Australia virtually stands alone in the generosity of its treatment of lump-sum retiring allowances paid to employees.

21.53. Information currently available to the Committee shows that legislation and practice in New Zealand, Canada, the United Kingdom and the United States are as follows.

21.54. The New Zealand Government, though still regarding lump-sum benefits received from superannuation funds as wholly exempt, has been forced to legislate to limit the excessive lump-sum retiring allowances paid directly to employees by their employers. Broadly speaking, the effect of section 88B of the New Zealand Land and Income Tax Act is that an employee with ten years or more service is taxable on a lump sum received in consequence of retirement as to 5 per cent to the extent it does not exceed one-third of his total remuneration for the last three years of service and in full to the extent it exceeds that amount.

21.55. In Canada there is no escape from tax on retiring allowance or superannuation benefit paid in a lump sum. However, the effect of the tax is alleviated by general income-averaging provisions and further relief can be obtained by the taxpayer, if he so desires, purchasing an income-averaging annuity contract.

21.56. In the United Kingdom, as in New Zealand, the Government was forced to act to tax large amounts paid on retirement or removal from office, especially on the occasion of take-over bids. Very broadly the provisions of the United Kingdom legislation tax the excess of the retiring allowance over £5,000 and relief is allowed for the long-service or superannuation component included in the payment. In respect of any amount chargeable to tax, relief is allowed by way of a reduction of tax which is based on the additional tax payable being spread over a period of six years. Further constraints are imposed in the United Kingdom by virtue of provisions governing the contributions to and income of superannuation funds which require that benefits must be paid predominantly in pension form if concessional treatment is to be obtained.

21.57. In the United States lump-sum payments from exempt superannuation funds are taxed as income but subject to generous forward-spreading provisions. These provisions have been significantly changed by the Pension Reform Act 1974 and form the basis for the proposals contained in paragraph 21.77 below. Other amounts received on retirement are taxable in full, subject however to the application of the


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general income-averaging provisions which are briefly described in Chapter 14 (paragraph 14.74).

Proposals

21.58. The number and variety of superannuation schemes in existence make it difficult to effect any fundamental change in the tax treatment of superannuation funds, particularly if such change is directed to a restructuring of the benefits provided by the schemes and the contributions that may be made to them. The long-term nature of these funds and the expectations arising from membership of them have been referred to at the beginning of the chapter. Proper transitional arrangements are necessary to reduce the aspect of retrospectivity to which amendments to the law may give rise.

21.59. The findings of the Committee are set out in the form of two views. The first view proceeds on the basis that, while the obvious anomalies and shortcomings of the existing tax regime ought to be corrected, the basic structure of superannuation and other retirement provisions should be left untouched. The second view recommends some fundamental changes which for their implementation would have to be confined to new schemes following amendment to the law. The proposals in the second view take full account of the proposals in the first view and are expressed partly as differences from the latter.

21.60. After the paragraphs setting out the second view some observations on the advantages and disadvantages of the two views are made. It should not be thought that the use of the terms ‘the first view’ and ‘the second view’ indicates a preference: the approach in the form of two views has been adopted for ease of exposition.

The First View

21.61. This view proceeds to comment on section 26 (d), referring to the ultimate position and the transitional arrangements by which it is reached. The discussion then moves to the income of approved superannuation funds and the conditions to be observed if the income is not to be subject to tax. Contributions to such funds, provisions for self-employed persons and the ‘30/20 requirements’ are referred to before the proposals in the second view are set out.

21.62. Section 26 (d) is a section of the Act by which practically every taxpayer who has been or is in employment is likely to benefit at least once in the course of his working life. In many cases, both the benefit and the corresponding loss in potential revenue are substantial. The weaknesses of the section, the inequities which flow from it and some of the methods adopted to abuse its provisions have already been outlined.

21.63. The problems inherent in making any change in this area are not to be underestimated. The present tax treatment of lump-sum retiring allowances has been with us since 1915, making it one of the oldest, best-known and most entrenched aspects of our income tax structure. Many people, particularly those nearing retirement, have made their plans for the future on the assumption that the amounts they receive on retirement would continue to be taxed on the present basis. The legitimate expectations of such people deserve the utmost consideration. To change suddenly to a harsher basis of taxing such receipts would generate justifiable complaints that the legislation was retrospective in nature, since the amounts concerned would normally have accrued over a considerable period—possibly over the entire working life of the person concerned.

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21.64. There is nonetheless a limit to the extent to which concern over such retrospectivity can be allowed to influence recommendations for a fundamental change in the tax structure. Pushed to its extreme such an argument leads to a legislative straitjacket where it is impossible to make changes to any revenue law for fear of disadvantaging those who have made their plans on the basis of the existing legislation. It would, for instance, prevent any change to estate duty legislation, since the change might conceivably disadvantage the estate of somebody who had accumulated his wealth and done his estate planning on the basis of the present legislation.

21.65. The Committee is acutely aware of the difficulties in reconciling the considerations advanced in the above two paragraphs but believes that some attempt must be made to do so. The inequities inherent in section 26 (d) are likely to become greater rather than less in the future and, if the problems involved in making a change now are formidable, they are unlikely to diminish as the years go by.

21.66. There is a very strong tradition in Australia of lump-sum rather than pension benefits upon retirement. The reasons for this, and in particular the relevance of the existing tax structure, can be debated endlessly and the Committee sees no merit in expressing an opinion on this point. It recognises that there are valid reasons for many people wishing to receive a lump sum at retirement; and indeed some payments received on termination of employment, such as accrued holiday and long-service leave pay, can in practice only be received in lump-sum form. The Committee does not think that the tax system should be used to discourage people from choosing a lump sum rather than a pension at retirement. If a person is entitled to a lump sum he should be quite free to receive it, but he should not gain an unwarranted tax advantage by so doing. The Committee notes the view of the National Superannuation Committee of Inquiry, in its Interim Report (1974), that steps be taken to achieve parity of treatment for benefits received as pensions and those received as lump sums.

21.67. What follows in relation to section 26 (d) is in two parts. The first deals with the ultimate situation to which the tax system should move in lieu of the present section 26 (d), and the second deals with the type of transitional arrangements that might be appropriate in order to avoid too sudden a change for those nearing retirement.

21.68. The ultimate position. It is proposed that section 26 (d) be repealed and replaced by provisions to the following effect.

21.69. With the exception of payments that can validly be regarded as received upon age retirement or earlier retirement because of ill health, all amounts received by a taxpayer upon or in consequence of the termination of an office or employment should be included in full in taxable income and taxed in the ordinary way. This inclusion should extend to amounts received from a superannuation fund prior to the termination of employment. However, where a taxpayer receives a lump-sum retiring allowance or lump-sum benefit from a superannuation scheme, he should be exempted from tax if, within three months of the receipt of the amount, he applies it as a contribution to another approved superannuation fund.

21.70. Where retirement occurs on account of age or ill health the taxing of the lump-sum retirement benefit is also proposed. However, the additional tax that would be incurred under the progressive personal income tax scale were the total amount received to be included in taxable income in the year of receipt could be onerous. Accordingly, it is proposed that the spreading provisions outlined later in paragraph


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21.77 should be available in respect of lump-sum retiring allowances, superannuation benefits, payments under service contracts and accrued long-service leave payments received upon the retirement of a taxpayer at the age of fifty-five or over, or upon his earlier cessation of work through ill health. To cater for certain employees such as members of the armed forces who retire before fifty-five, this concessional treatment could be extended down to the age of forty-five if the Commissioner is satisfied that it is reasonable for a taxpayer in that employment to retire before fifty-five. There seems to be no reason, however, for extending any concessional treatment to lump-sum receipts representing accrued holiday pay.

21.71. Lump-sum amounts received by self-employed persons after the age of fifty-five (or upon earlier cessation of work through ill health) should be accorded similar treatment to amounts received by employees. These amounts would include lump sums received for loss of office, amounts received from a superannuation fund and amounts received upon the termination of employment of a person who is both an employee and a self-employed person.

21.72. Any part of a lump-sum superannuation benefit received by an employee or self-employed person representing contributions made by that person which have not been an allowable deduction under section 82H should be exempt from tax.

21.73. It is to be noted that the ‘bunching’ effect of a large taxable lump sum can be mitigated by the taxpayer, if he so desires, making use of the income equalisation scheme recommended by the Committee in Chapter 14. It would however be necessary to restrict the availability of the income equalisation scheme for these amounts to circumstances where ‘forward spreading’ of the amount has not been availed of.

21.74. Payments received as consideration for entering into a restrictive covenant (such as a covenant not to join a competitor of the employer) present considerable difficulties. On the one hand, where the transaction is at arm's length and bona fide it could be argued that it is an affair of capital, with the employee agreeing in return for a lump-sum payment to give up a substantial future area of activity. On the other hand, there is the possibility of such restrictive covenants being used merely to cloak what is in substance a retiring allowance. On the whole it is thought best simply to give the Commissioner power to examine payments made under such agreements and include them in assessable income if he is not satisfied that the amount received by the employee corresponds to the area of future activity forgone.

21.75. The acceptance of the views above would mean that all lump-sum retiring allowances would be taxable in full, subject to whatever ‘spreading’ arrangements are thought appropriate. If the person receiving the amount wishes to use it to provide a pension for himself at retirement, then as long as the pension is going to be assessable there should be no liability for tax on the lump sum. Where a person receives such a sum, he should be permitted to exclude it from his assessable income provided that he applies it immediately to the purchase of an annuity to commence not earlier than his sixtieth birthday (or earlier cessation of work owing to ill health). The subsequent commutation to a lump sum of any such annuity would be taxed as if it were the receipt of a lump-sum retiring allowance.

21.76. In paragraph 21.70 it was emphasised that it would be inequitable to tax as income in the year of receipt the whole of any lump-sum retirement benefit. Various methods are available to ‘spread’ the amount received over a number of years. Two methods in particular are worth close attention:

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• (a) The amount received is divided by 10 and the result added to the taxable income of the taxpayer in each of the ten succeeding years. This is an attempt to approximate the tax treatment of a pension, the ten-year period being close to the average life expectancy of a person at retirement. Since it is undesirable to defer the tax until up to ten years after the amount has been received, it would be necessary to levy provisional tax at the time of receipt and then give progressive credits for this provisional tax against the tax liability of the taxpayer over the next ten years. Because the final tax liability attributable to the lump sum is not known until more than ten years after its receipt, difficulties will arise in the event of the death or emigration of the taxpayer before the expiration of that period.
• (b) Alternatively, there is the method now adopted in the United States under the Pension Reform Act 1974. This involves looking only at the lump-sum receipt and ignoring all other income of the taxpayer. After an initial exemption of $US10,000, the lump sum is divided by 10 and the tax on an income of this amount is calculated and the result is multiplied by 10 to give the total tax payable. Since the calculation pays no regard to the other income of the taxpayer, it is necessary to have provisions for aggregating lump sums received from different sources and at different times. Under the United States legislation there is a six-year ‘look-back’ period whereby the tax on a lump sum is calculated having regard to all such lump sums received in the preceding six years. This method has the considerable merit of simplicity in that the tax liability attributable to the lump sum is determined once and for all at the time of its receipt. However, since it ignores the other income of the taxpayer it might be thought to offend notions of equity and progressivity in the income tax system.

21.77. On balance the Committee favours the new United States treatment and proposes that it be adopted with certain modifications. There would seem to be no justification for any initial exemption and the look-back period should be extended to ten years. In view of the differences between personal income tax scales in the United States and Australia (see Table 14.A in Chapter 14), the forward-spreading period should be fifteen rather than ten years. However, the Committee has proposed changes in the rate scale, and if these are adopted the forward-spreading period will need to be reconsidered.

21.78. Reference has already been made to the need to enable a person who receives a lump-sum retiring allowance to defer the tax on the amount received by purchasing a deferred or immediate annuity. It is also anticipated that the proposals made earlier in paragraphs 21.68–21.77 will lead to a reduction in the present bias in favour of lump-sum superannuation benefits. Many superannuation funds however are geared only to providing lump-sum benefits, and in particular those that operate on the money accumulation principle would find it almost impossible to underwrite pensions themselves. Thus many employees who might prefer to receive a pension could be forced into accepting a lump sum on which they would be taxed. This problem could largely be solved by permitting life insurance companies to sell annuities to the trustees of approved superannuation funds at the time of the employee's retirement, the investment supporting the annuity to be subject to the same tax treatment as the investment supporting a pension paid directly from the fund itself. At the moment, apart from the inbuilt bias towards lump sums, there are two factors militating against a life insurance company offering annuities on realistic terms under these circumstances.

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• (a) There is considerable uncertainty as to whether such contracts are ‘superannuation policies’ for the purpose of the exemption from tax of that part of the life insurance company's investment income derived from assets held in respect of those contracts. This uncertainty should be removed by making it quite clear that annuity contracts of this type are ‘superannuation policies’ for the purposes of the Act.
• (b) More importantly, the Life Insurance Act 1945–1973 specifies that the reserves held by a company in respect of annuity business must be calculated on a certain minimum basis. Under present conditions, this basis is unnecessarily conservative. This leaves a life insurance company with two choices as far as the underwriting of annuity business is concerned. It can write the business on a realistic basis, in which event the rest of the policy-owners have to provide a large initial subsidy to the business, thus putting a brake on the volume of annuity business the company can undertake without severely disadvantaging the other policy-owners; or it can write the business on the basis used in the Life Insurance Act for calculating the reserves, thus disadvantaging the annuitant. It is essential that the relevant provisions in the Life Insurance Act be amended to enable annuity business to be freely undertaken on a realistic basis. The National Superannuation Committee of Inquiry has made a similar recommendation.

Consistent with the tax treatment of lump-sum benefits, it appears advisable to provide that if an annuity acquired by the trustees of a superannuation fund, or an ordinary superannuation pension, is commuted into a capital sum, that capital sum will be taxed as if it were the receipt of a lump-sum benefit from a superannuation fund.

21.79. If the foregoing proposals for replacing section 26 (d) are adopted, most of the avenues for avoidance and inherent weaknesses of the present tax system in the area of superannuation and retiring allowances will be removed. Nonetheless, in order to ensure parity of treatment between unfunded retiring allowances and benefits paid from superannuation funds, it is proposed that section 78 (1) (c) be amended and strengthened to make it clear that retiring allowances paid by an employer are deductible only under this section and only up to the amount that would be allowed as a reasonable benefit from an approved superannuation fund. For this purpose, amounts receivable in consequence of retirement or cessation of employment from a superannuation fund should be taken into account in determining whether the amount paid was in fact reasonable.

21.80. Transitional provisions: lump-sum retirement benefits. The opinion has been expressed that the main difficulty in making changes to the present basis of taxing lump-sum retirement benefits derives from the fact that the taxpayers have built up expectations and often made plans on the basis of the existing provision. The problem of dealing with such legitimate expectations was the reason why the recommendations of the Spooner Committee on this matter in 1951 were ultimately not followed. This difficulty, while not to be underrated, is nonetheless not insuperable and to this end transitional provisions should be adopted which ease, as far as possible, the change from the old basis of taxation to the one recommended above. These transitional provisions should be such as to err, if at all, on the side of generosity and ease of understanding. The Committee has given a great deal of attention to the practical effects of the various possible types of transitional provisions.

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21.81. Nonetheless it is necessary to distinguish legitimate expectations from mere hopes. A person who is one day from retirement obviously has a legitimate expectation that his retiring allowance or superannuation benefit which may have accrued over forty years or more will be accorded the present treatment. On the other hand, it is unrealistic and unnecessary to give much weight to the expectations of the twenty-year-old as to the tax treatment of his ultimate retirement benefits.

21.82. In theory the approach might be that only amounts which can be regarded as accruing after the date of the legislation should be subject to the new treatment. This would prevent radically different treatment of the man who retires one day after that date and the man who retires one day before. It would also largely remove any complaints about retroactivity in the new legislation. There are certain types of payment, however, which are currently subject to tax only as to 5 per cent under section 26 (d) for which transitional provisions of this type are either undesirable or unworkable. Accrued holiday pay, for instance, would present administrative difficulties on apportionment and in any case should not be regarded as a retiring allowance.

21.83. The method by which such payments should be apportioned into pre and post legislation amounts is open to some debate. With superannuation entitlements, for instance, it might be argued that the amounts accrued in respect of each member of a superannuation fund at the crucial date should be calculated at that date and those amounts should be the amounts subject to exemption. Similarly with longservice leave entitlements, the entitlement of each person could be calculated at that date having regard to his current salary and the amounts so calculated would eventually be exempt. On balance this approach is not favoured, largely because of the administrative complexity involved and the extremely high compliance costs for employers, employees and superannuation funds.

21.84. If an apportionment method is to be used, then the benefit should be regarded as accruing uniformly over the period of employment (or self-employment in the case of a self-employed person) and should be apportioned accordingly into the amount accrued before the commencement of the legislation and the amount accrued after such date. It is to be noted that this assumption of uniform accrual will usually be generous to the taxpayer, since in practice most such amounts accrue at an increasing rate. The apportionment should only apply to amounts attributable to the employment (or self-employment) of the taxpayer current at the date of the legislation and, for administrative reasons, it may be necessary to regard the employment (or self-employment) as having commenced no earlier than the age of twenty.

21.85. The apportionment method of the latter type would be difficult to administer and give rise to disputes. The greatest difficulties would be in the need to establish the date of commencement of employment (or self-employment), particularly where there has been a break in employment.

21.86. If the apportionment method is adopted so as to tax only a portion of a lump-sum receipt, there is no reason for retaining the present inclusion in taxable income of 5 per cent of the balance. The 5 per cent is a derisory figure and serves only to confuse and complicate the picture. Accordingly, it is proposed that any amount to be given concessional treatment under these provisions should be totally exempt.

21.87. An alternative approach, and one that is considerably simpler than the apportionment method, would be to phase out section 26 (d) by providing that the figure of 5 per cent be progressively increased to 100 per cent over a lengthy period. This method has the advantage of certainty in that the percentage inclusion at any


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time would be the same for all taxpayers and would apply regardless of whether the payment involved arose from an employment (or self-employment) entered into before or after the date of the legislation. It would, of course, be necessary to provide that certain superannuation payments received by self-employed persons (and some employees) which are currently wholly exempt should be brought within the escalating inclusion provisions.

21.88. The choice of the period over which section 26 (d) should be phased out involves conflicting considerations. On the one hand, if the period is too short then those employees who are now middle-aged would have just cause for complaint; moreover, there may be a tendency for employees to change jobs immediately so as to receive an almost totally exempt lump sum instead of waiting until the normal retiring age and receiving an admittedly larger benefit which will be subject to a higher rate of tax. On the other hand, it is undesirable that the transitional period should be excessively lengthy. A long transition with its slowly escalating rate of inclusion is very generous to those persons, often relatively young, who change jobs and receive superannuation benefits and lump sums in lieu of accrued long-service leave.

21.89. On balance the second approach is favoured largely because of its certainty and simplicity. The period during which section 26 (d) is phased out should not be less than twenty-five years or more than forty. Furthermore, to avoid sudden jumps in the rate of inclusion, the adjustments should be made at quarterly rather than annual intervals.

21.90. The transitional provisions (of whatever type) should be available in respect of lump-sum retiring allowances, benefits from superannuation funds, amounts paid under service contracts or accrued long-service leave payments. They should not however be available in respect of amounts representing accrued holiday pay. These latter amounts should be regarded as income and taxed accordingly.

21.91. The amount that is not exempted under the transitional provisions would be eligible for forward spreading as outlined in paragraph 21.77 if received after the age of fifty-five or upon earlier retirement because of ill health.

21.92. There is some difficulty in devising an equitable method of taxing benefits paid upon the death of an employee, and amounts received from a superannuation fund upon the death of a self-employed member of that fund. At present such amounts, if paid as a lump sum, are totally exempt from tax. Strict logic would seem to suggest that if such lump sums received during life are to be taxable they should also be taxable if received at death. To exempt them at death is to give markedly different treatment to the man who dies one day after receiving his retirement benefit (and paying tax thereon) as compared to the man who dies one day before retirement and whose retirement benefit is thus received, tax-free, by his widow or estate.

21.93. The Committee will be recommending in Chapter 24 that such amounts be included in the deceased person's dutiable estate, though it would not be possible to include in the dutiable estates pure ex gratia payments made by the employer to the widow or dependants of a deceased employee. The Committee believes that to subject such benefits to income tax as well as to estate duty would be undesirable and unwarranted. Accordingly, no change in the present system is recommended.

21.94. The income of superannuation funds. As stated in Section I of this chapter, the Committee believes that the present exemption from tax enjoyed by most superannuation funds can be justified. It encourages the provision of the future needs of employees both by themselves and by employers recognising a moral obligation. It


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also serves to correct the bias against saving inherent in a system of tax on income and helps promote capital formation.

21.95. Furthermore, if the benefits that eventually emerge from a superannuation fund are to be taxed, the contributions to the fund, whether made by employer, employee or self-employed person, should be an allowable deduction at the time they are made.

21.96. The general propositions advanced in the two preceding paragraphs must, however, be qualified in the following manner:

• (a) The amount of fund income exempt from tax must be subject to some limitation, preferably by the imposition of limits on the benefits that can be provided by such funds and thus, indirectly, on the assets and income of the funds.
• (b) Exemption of the income of, or deductibility of the contributions to, such funds is not justified unless there is some assurance that the funds will only provide benefits in the event of age retirement or earlier death or ill health. In other words, there must be some assurance that the savings undertaken through such media are indeed long-term savings.

21.97. Ignoring foreign superannuation funds, there are at present four different provisions of the Act under which a superannuation fund may gain total or partial exemption from tax on its income. These four different types of fund should be replaced by an omnibus category of ‘approved superannuation fund’. The fact that government superannuation funds are subject to no controls and do not have to satisfy the same criteria for exemption as do private sector funds is open to question. Similarly, if some funds have to comply with the 30/20 requirements there seems no good reason why others should not be under a similar obligation.

21.98. To gain approval, such a fund should satisfy the criteria set out in the following paragraphs, in addition to those outlined earlier in paragraphs 21.37–21.42.

21.99. The benefits to be provided by the fund must not be excessive and the amount of the fund should not be excessive having regard to the benefits to be provided. The existing ‘reasonable benefits’ limits have been outlined at paragraph 21.43 and these are regarded as satisfactory in principle since they take into account the earnings of the person concerned (except in the case of funds for self-employed persons) and impose overall limitations on the dollar amount of the benefits. However, a stricter approach should be taken to the period of service necessary to qualify for maximum benefits: in this respect it is noteworthy that the new superannuation scheme for Australian Government employees proceeds on the basis of a thirty-year period. It is proposed that the scale of reasonable benefits which may be provided by an approved fund should only apply in the case of an employee with at least thirty years service at retirement and should be reduced for those with lesser service. Furthermore, greater attention should be paid to the current value of assets of superannuation funds, since the benefits actually paid will in many cases be based on current values at that time.

21.100. There should be power to reopen past assessments of a fund if, at any time, its rules are changed to permit the payment of benefits before the death or retirement of its members.

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21.101. The fund should be debarred from investing (except to a minor extent) in shares of or loans to an employer of the members of the fund. Such ‘investment’ is undesirable from the standpoint of the security of the members’ benefits, since if the employer's business fails they lose not only their jobs but also such part of their superannuation entitlement as is represented by the investment. If this proposal were to be adopted, a transitional period would clearly be necessary.

21.102. Contributions to approved superannuation funds. The present tax treatment of contributions to superannuation funds is illogical and defective. Personal contributions are aggregated with life insurance premiums and are subject to a maximum deduction of $1,200 under section 82H, whereas contributions by an employer are, broadly speaking, deductible up to whatever amount will, when aggregated with the employee's contributions, produce a ‘reasonable’ benefit. This often results in different tax treatment of members of contributory superannuation funds vis-a-vis members of non-contributory funds. For instance, if the maximum overall contribution in respect of a certain employee that will not produce an excessive benefit is $3,000 per annum, then the tax consequences will be different if the contribution is divided equally between employer and employee than if the contributions are paid wholly by the employer. The differences will be accentuated where the employee is already using part of his $1,200 deduction under section 82H to pay life insurance premiums. It is hard to see the justification for this.

21.103. Subject to the conditions set out in the next paragraph, contributions to an approved superannuation fund should be an allowable deduction for both the member of the fund and his employer without any specific limit. There will of course be an indirect limit imposed by virtue of the fact that approved superannuation funds will be restricted to providing ‘reasonable’ benefits and, if contributions were to be made that would lead to benefits becoming excessive, they would have the effect of terminating the status of the fund and hence of the deductibility of such contributions. In particular, personal contributions by the member of the fund should be taken outside the ambit of section 82H, thus divorcing them from life insurance premiums.

21.104. Such contributions, to qualify for a deduction, must have some element of regularity about them, for otherwise employers and employees may tend to make large irregular contributions. This would be alien to the concept of long-term contractual saving which is one of the justifications for giving special treatment to superannuation, and would also lead to superannuation contributions being used as an income-averaging device. This assurance of regularity is best achieved by giving the Commissioner a discretionary power to disallow a deduction for large irregular contributions.

21.105. Provision for self-employed persons. The Committee has considered many submissions relating to the tax treatment of superannuation provisions for the self-employed. In the Committee's view it is necessary to take some steps in order to achieve a greater parity of treatment between employees and self-employed in this area. The proposals made above in regard to the taxation of benefits will apply equally to both categories of taxpayer. However, it is in the area of deductibility of contributions and maximum benefits that some change from the present system is needed. Owing to the fluctuations in the earnings patterns of self-employed persons, it is difficult to lay down the same standards of reasonableness for benefits as would be applicable to employees. Accordingly, it is proposed that the benefits to be provided from a superannuation fund for self-employed persons should, as now, be subject to overall dollar limitation. It is suggested that this amount be in the vicinity of


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$200,000. Moreover, contributions made by a self-employed person should be an allowable deduction up to a limit of 15 per cent of the taxpayer's personal exertion income from self-employment, averaged over the three years preceding the year in which the contribution is made. Provision should also be made for limited carry-forward of unused contributions. The figure of 15 per cent is chosen as representing the total of employer and employee contributions that could be expected in a reasonably generous superannuation fund.

21.106. Transitional provisions for superannuation funds. The proposals made above in relation to superannuation funds represent a significant departure from the present position and, as such, would give rise to a considerable amount of work for both the revenue authorities and the fund administrators before they could be fully implemented. The problems encountered after the 1964 and 1965 legislation indicate the need for a prolonged phasing-in period and for continuous consultation between fund administrators and the revenue authorities before the details of the legislation are settled and before the guidelines for the exercise of the Commissioner's discretion in various areas are determined.

21.107. The 30/20 requirements. The virtual compulsion on superannuation funds (and life insurance companies) to invest 30 per cent of their assets in public sector securities should be reconsidered. Compliance with the 30/20 rule need not be regarded as some sort of quid pro quo for the exemption from tax of the income of a superannuation fund: as already indicated, this exemption can be justified on other grounds. If the 30/20 requirements are to be retained, the Government should give consideration to the issue of special index-linked bonds, bearing a relatively low interest rate, which would provide that both principal and interest would escalate in step with the consumer price index or some other suitable measure of inflation. Furthermore, the Government should ensure that there is a market at all times for any security that a superannuation fund is required to hold.

The Second View

21.108. The second view adopts the proposals advanced in the first view, subject to five main differences. The first difference requires that a reasonable benefit from an approved superannuation fund, as described in the following paragraphs, should be a standard amount for which any employee or self-employed person may qualify. The amount of saving made by a person or in respect of him to be tax-assisted, up to a common stated maximum, will depend on capacity to save.

21.109. The second of the five differences is connected with the first and requires that the maximum amounts of contributions to an approved fund to be allowed as tax deductions should be limited only by a requirement that the standard amount of total benefit should be gradually built up.

21.110. The third difference requires that only benefits flowing from an approved superannuation fund should receive the forward-spreading treatment described in paragraph 21.77. This treatment involves a concession which should apply only to receipts that may fairly be said to be the return to the taxpayer of income invested by him or in respect of him by his employer in long-term saving the consumption of which has thus been deferred. Other receipts should be subject to anti-bunching provisions of the type proposed in Chapter 23 (paragraphs 23.34–23.37) for capital gains, unless applied in the purchase of an annuity in accordance with paragraph 21.73. Alternatively, the taxpayer would be able to make use of the income-equalisation scheme proposed by the Committee in Chapter 14.

  ― 371 ―

21.111. The fourth difference requires that an employee's interest in contributions made in respect of him by his employer, after a qualifying period, should be vested, in the sense that on retirement these contributions and accumulations of income will be available to him, or on ceasing to be a member of the fund other than by retirement they will be retained for him in the fund until he reaches retiring age, or they will be transferred to his account with another approved fund, or they will be paid to him and attract income tax. If the tax law gives its assistance to savings that are subject to forfeiture on the employee leaving his employment, it is assisting the restriction on mobility of labour that the prospect of forfeiture involves.

21.112. The fifth difference requires that there should be a complete assimilation of the tax treatment of a lump sum paid on retirement and a pension paid on retirement from an approved superannuation fund.

21.113. The first, second, fourth and fifth differences, more especially the fourth, would cause difficulties for many existing superannuation schemes and it would be necessary to give effect to them by new law which would apply to a person who is not a member of an existing scheme or who withdraws from an existing scheme.

21.114. This new law would seek to give effect to the following principles:

• (a) The maximum amount of long-term saving for which any tax assistance can be expected should be the same for everyone.
• (b) The maximum amount of the deduction against earned income available to a person for contributions to an approved superannuation fund should be the same for everyone.
• (c) Contributions made by an employer in respect of his employee to an approved fund should be treated as income of the employee, but the total of those contributions and the employee's own contributions would be allowable deductions by the employee within the amount referred to in (b). Equality of treatment of the employed person and the self-employed person would in this way be assured.
• (d) The fund to which contributions would be made must be an ‘approved’ fund—i.e. approved by the Commissioner or some other government authority which may take over his function. A cardinal condition of approval should be that an employee's interest in contributions made in respect of him by his employer is vested, in the sense explained in paragraph 21.111.
• (e) To be approved a fund should give to the taxpayer a right to receive all contributions and accumulations in the form of a lump sum on his retirement. He may elect to take a pension, in which event he will be taxed on a notional receipt of the lump sum and will be taxed on pension receipts as if he had received the lump sum and then applied it in payment for the pension. In the result, the amount of each pension receipt that is a return of the payment for the pension will be free of tax. Equality of treatment of a lump-sum receipt and a pension would in this way be assured.
• (f) A lump-sum receipt from an approved superannuation scheme should receive special income tax treatment, a portion up to a stated amount being exempt from tax and a further portion, where applicable, being subject to forward spreading. In today's circumstances, up to the first $50,000, say,
  
  
    ― 372 ―
  should be exempt from tax and up to a further $100,000 subjected to forward spreading over ten years by the method shown in paragraph 21.76(b).
• (g) When the new law comes into operation, only schemes complying with it should be allowed to admit new members; and a person by or in respect of whom contributions continue to be made to a fund approved under the old law should not be entitled to join a fund complying with the new law.

21.115. The way in which some of these principles would be expressed in the details of the proposed law requires some elaboration.

21.116. The amount of tax-assisted saving. At present prices tax-assisted saving might be set at $150,000. The authority supervising approval of funds would need to be satisfied by the trustees of a fund that any member's estimated entitlement will not exceed the maximum on his retirement. For this purpose the authority need only be concerned with the amounts already standing to the credit of the employee or self-employed person and the estimated earning rate of the fund. If it appears that the maximum will be exceeded, the fund would not be allowed to accept contributions by, or in respect of, the taxpayer.

21.117. Contributions to the fund. The amount of contributions that may be made to a fund and that will be deductible against earned income should be set at a figure which, if made over a period of the full working life, will produce with accumulations an amount not exceeding $150,000, with provision for benefit on early retirement due to ill health and for dependants on the taxpayer's death. There should, however, be some increase in the amount of deductible contributions with the age of the taxpayer to allow for later entry into a scheme and to take account of inflation. The amount of contributions deductible should be reviewed annually. The employer's contributions to an approved fund are treated as employee contributions. The deductibility by the employer of his contributions will follow general principles in regard to the deduction by an employer of salary paid to his employee.

21.118. It is not contemplated that the increase in allowable deductions by reference to the age of the taxpayer should be such as to make any substantial allowance for late entry. Tax assistance should be given only to long-term saving.

21.119. Approved funds. The tests of approval should be applied to all schemes in respect of which tax assistance is claimed. Thus a fund that does not give an employee a vested interest in the employer's contributions would not be approved under the new law. Only an amount received on retirement standing to the credit of the employee's account in an approved fund would receive the treatment proposed in paragraph 21.114 (f). Exemption from tax on its income would be available only to an approved fund. Contributions would be deductible only if made to such a fund.

21.120. The taxing of receipts from an approved fund. Provided the amount received does not exceed the ceiling of $150,000, it will be taxed as proposed in paragraph 21.114 (f) if the taxpayer is over fifty-five or it is paid as a result of the death of the contributor or his early retirement due to ill health. The supervision of approved funds will not always ensure that the taxpayer's entitlement does not exceed this figure. To the extent that it does, the receipt by the taxpayer should be subject to tax in the same fashion as an unfunded retiring allowance.

21.121. If the taxpayer is not yet fifty-five at the time of the receipt and he has not retired due to ill health, the receipt should be treated as an unfunded retiring allowance and taxed as proposed in paragraph 21.110. However, the taxpayer should be


  ― 373 ―
allowed a deduction of a contribution he makes to another fund subject to the new law, and the fund should be allowed to accept his contribution, provided the contribution will not involve the consequence that the taxpayer's entitlement on retirement will exceed the maximum of $150,000. He will thus ‘roll-over’ his entitlement from one new fund into another.

21.122. A taxpayer who, in similar circumstances, receives an amount from a fund approved under the old law should also be allowed a deduction of any part of it contributed to a fund approved under the new law, subject to the same qualification. He will thus ‘roll-over’ his entitlement from an old fund into a new fund.

21.123. The phasing out of funds approved under the old law. The fact that only funds approved under the new law would be allowed to take in new members and the restrictions that would preclude a continuing member of a fund approved under the old law from joining a new fund, must in time ensure that old funds disappear. It might however be anticipated that old funds will tend to be converted to new funds.

21.124. Some employer-employee funds would continue, but the financial advantages of new funds for employees, other than those on high incomes, would generate a significant pressure for conversion. In addition, pressure for conversion would arise from the vesting of an employee's interest under the new law, which may not be available under the old law.

Comparison of the Two Views.

21.125. The two views put forward are alternatives but it is of course possible to construct other alternatives combining aspects of each. The Committee does not express a preference for one view over the other, and some members of the Committee would not wish to commit themselves to certain aspects of each view.

21.126. A comparison of the major aspects of the two views is briefly summarised in the following paragraphs.

21.127. The first view, in its application to employee superannuation, follows closely the present law in giving tax concessions to provisions for retirement benefits, which may not always involve long-term saving, if they are considered reasonable having regard to earnings from employment. The second view believes that tax concessions should be given only to long-term saving and that there should be a maximum standard tax-assisted benefit available to all persons in employment but not directly related to their employment earnings.

21.128. The first view also follows the present law in giving concessional tax treatment to a lump-sum payment on retirement whether or not any provision has been built up to meet the payment. Under the second view a lump-sum benefit paid on retirement other than from funds that have been built up from long-term saving would not receive any tax concession. Thus a non-funded benefit received from a scheme of the type now generally used in the public sector would not qualify for any concessional treatment in the hands of the recipient.

21.129. The basic approaches of the two views to achieve parity in taxing a pension benefit and a lump-sum benefit also differ. Under the first view pensions would continue to be fully taxable as at present and lump-sum benefits would fall to be taxed on the assumption that the total amount was to be paid by equal annual instalments over the fifteen years subsequent to retirement and that this instalment would be the sole annual income of the recipient in that period. Admittedly, true parity would not be


  ― 374 ―
achieved in this way in many instances. Under the second view parity would be sought by requiring that on his retirement an employee should always be entitled to take a lump-sum benefit. The first $50,000 of this lump sum would be exempt from tax and the balance of up to $100,000 would be subject to forward spreading on the basis applying under the first view but over a ten-year period. If the retired person elected to take a pension, he would be taxed at the time of election as if he had received a lump sum, and he would be exempt from tax on so much of the pension receipts as represented the sum he had applied in purchasing the pension. Parity in taxing a lump sum and a pension flowing from an approved fund would thus be substantially achieved.

21.130. Under the first view an employer would be able, subject to the Commissioner's discretion to disallow irregular contributions, to make tax deductible contributions for the later years of an employee's service in an effort to ensure that his total retirement benefit was reasonable in relation to his remuneration close to retirement and these contributions would not be income of the employee. Under the second view, where the approach is that only long-term saving should qualify for tax assistance, the consequence might be different. Although the employer would obtain a deduction for an additional contribution to meet this eventuality, the employee might be taxed on the additional contribution: he could fail to obtain a deduction for the contribution, which would have been treated as his income, because it exceeded the set maximum annual contribution for a person in his circumstances.

21.131. Under the first view it is not proposed that there should be a requirement that the employer's contribution for an employee's benefit be vested. Under the second view it is a basic principle that a contribution by an employer to an approved fund is to be allocated as being for the benefit of identified employees. The approach of the second view will therefore impose vesting on benefits flowing from contributions by both the employer and the employee to an approved fund.

21.132. Expenses in varying trust deeds to fit in with the first view should be minor and thereafter there ought to be no continuing added costs. Under the second view, which requires more substantial changes to the rules of existing funds, and in some cases the institution of new funds and the running down of old ones, the initial administrative costs could tend to be heavy. It also seems that there will be heavier continuing administrative costs under the second view due to the requirement to keep separate accounts for the contributions and share of earnings of all members of the fund, including some members who have left the employer's service but have not yet reached retiring age. In addition each employee would need to be advised annually of the employer's contribution to the approved fund for his benefit.

21.133. In the first view the present flexibility in the adoption of a type of fund—for example, an accumulating fund or an actuarial-type deferred benefit fund—would continue. Under the second view an accumulation-type fund only would in practice be permitted. An actuarial-type fund, which is now used by many business organisations, would be incompatible with the requirements of the second view: these funds by their very nature do not identify a specific contribution for each member or the annual division of the total fund in proportion to the actuarial liability of the benefit planned for each member on retirement.

  ― 375 ―

III. Life Insurance

Background and Present Legislation

Deductibility of Premiums

21.134. The granting of some form of tax concession in respect of premiums paid on life insurance policies is of long standing, both in Australia and overseas, going back in the case of the United Kingdom to 1799.

21.135. In Australia the position is now governed by section 82H of the Act the predecessors of which date back to the first levying of income tax by the Australian Government in 1915. The concession granted in respect of life insurance premiums has at various times taken the form of a deduction from income or a rebate of tax and, since 1936, amounts paid as premiums have been aggregated with superannuation contributions for the purpose of determining the maximum amount in respect of which the concession is granted. Since 1951 the concession has been by way of a deduction the maximum amount of which has, since 1968, been $1,200 per annum.

21.136. Section 82H as it now stands provides in subsection (1) (a) that:

‘(1) Amounts paid by the taxpayer in the year of income…as—

(a) premiums or sums—

(i) for insurance on the life of, or against sickness of, or against personal injury or accident to, the taxpayer or his spouse or child; or

(ii) for a deferred annuity or other like provision for his spouse or child …

shall be allowable deductions.’

Subsection (1) (b) allows as a deduction payments to superannuation funds and friendly societies, while subsection (2) provides that the total deduction allowable under this section is not to exceed $1,200.

21.137. Section 82H was amended in 1973 by the insertion of new subsections (1A)-(1H). These were directed to curtailing abuses that had developed in relation to policies of a very short term or policies surrendered shortly after being effected. The amendments result in the deduction of premium payments being disallowed if the policy is for a term of less than ten years and in the retrospective disallowance (by the reopening of past assessments) of all or a part of the deduction of premiums paid on a policy taken out for a term greater than ten years if discontinued within ten years of its commencement for any reason other than serious financial difficulty. These provisions apply only to policies the first premium on which was paid on or after 1 January 1973.

21.138. Deductions for premium payments may also be available under section 51 (1) in certain circumstances where an employer effects a policy on the life of an employee. Such cases are relatively few in number and will not be further considered.

21.139. The total amount of deductions claimed under section 82H for life insurance premiums is extremely large, as is the number of taxpayers claiming a deduction. Statistics published by the Life Insurance Commissioner indicate that as at 31 December 1973 approximately $696 million per annum was being paid in premiums on life insurance policies (excluding superannuation policies) and most of this amount would have qualified for deduction under section 82H. No estimate is available of the precise number of taxpayers claiming a deduction for life insurance

  ― 376 ―

premiums, but at 31 December 1973 there were nearly 8 million individual life insurance policies in force in Australia.

Taxation of Life Insurance Companies

21.140. Life insurance companies are the subject of a special tax regime under Division 8 of Part III of the Act. The underlying approach is that the company is taxed on its investment income; but the fact that this is not the only possible approach to taxing life insurance companies is illustrated by the diversity of practice in other countries and, indeed, the diversity that existed in Australia before the introduction of the principle of uniform taxation legislation in 1936.

21.141. Prior to 1936 life insurance companies were taxed on the basis of their investment income under Commonwealth, New South Wales and Western Australian legislation. In Victoria, Queensland and Tasmania they were taxed on a percentage of premium income, while in South Australia the taxable income was based on the amount of the company's actuarial surplus. All these methods, and others, are in use overseas and a brief summary of some of them is contained in paragraphs 21.150–21.157 below.

21.142. Since 1936 all life insurance companies have been taxed on a basis that owes its origin to the pre-1936 Commonwealth legislation. This followed the recommendation of the Ferguson Commission (1932–34).

21.143. The assessable income of a life insurance company, in respect of its life insurance business, comprises its investment income. Dividends are included in assessable income, though resident life insurance companies are entitled to the rebate of tax thereon provided by section 46. Premiums received in respect of policies and considerations received in respect of annuities are excluded from assessable income under section 111 but form part of the total income of the company for the purpose of determining certain deductions. Furthermore, subject to compliance with the 30/20 requirements, that portion of investment income referrable to superannuation policies is exempted by virtue of section 112A.

21.144. The main deductions allowed in computing the taxable income of a life insurance company are as follows:

• (a) A deduction under section 51 (1) for expenses directly incurred in earning the assessable (investment) income. These are usually a small part of the total expenses of a life insurance company.
• (b) A proportion of the ‘expenses of general management’ of the company. The practical effect of section 113 is to allow a deduction of the proportion of those expenses which is equal to the proportion that the assessable income of the company bears to the total income of the company. Expenses incurred wholly in gaining or producing non-assessable income (primarily salary and commission to salesmen) are specifically excluded from the definition of ‘expenses of general management’, as are expenditure of a capital nature and expenditure incurred in producing assessable income.
• (c) A deduction is allowed in full under section 82AAC of contributions to superannuation and pension funds.
• (d) A deduction is allowed under section 115 of a percentage of the ‘calculated liabilities’ of the company. This is a controversial deduction and is further considered in the next paragraph.
• 
  
  
    ― 377 ―
  (e) Rebates of tax are granted to resident life insurance companies on dividends (under section 46) and a rebate of 10 per cent is granted under section 160AB on interest received on certain Australian and State Government securities issued before 1 November 1968.

21.145. The Ferguson Commission stated in paragraph 858 of its Report:

‘In our opinion a life assurance company should be taxed on the basis of its investment income, which cannot be correctly determined without providing for the interest assumed to be earned on the investments set aside to provide for the payment of the liabilities of the company to its policy holders.’

The Report noted that this principle had already been conceded under Commonwealth legislation, by an amendment made in 1933. The recommendations of the Ferguson Commission were subsequently adopted and a deduction of 4 per cent of the calculated liabilities of a life insurance company was allowed. This figure was reduced to 3 per cent in 1942 when the income tax field was taken over wholly by the Commonwealth. The figure remained at 3 per cent until the 1973–74 Budget which reduced it to 2 per cent and made certain other changes that had the effect of greatly increasing the amount of tax paid by life insurance companies. The figure was further reduced to 1 per cent in the 1974–75 Budget, with the inference that the deduction would be removed completely in the near future.

21.146. Finally, section 116 of the Act provides that a life insurance company shall not be liable to pay income tax in respect of the income derived by it from business of life insurance if its calculated liabilities exceed the value of all its assets.

The 30/20 Requirements

21.147. Under provisions introduced in 1961 a life insurance company is virtually obliged to maintain 30 per cent of its assets in public sector securities, and at least 20 per cent of its assets in Australian Government securities. Failure so to do results in:

• (a) the loss of exemption on the income derived from assets referable to superannuation business; and
• (b) a reduction in the section 46 dividend rebate available.

Over-compliance with the 30/20 requirements generates ‘bonus points’ for a life insurance company in that the section 115 deduction is slightly increased. This has had the effect of making investment in public sector securities relatively more attractive, other things being equal, than investment in the private sector and has led to a greater margin between public and private sector interest rates than would be accounted for by market factors alone. However, the reduction in the section 115 deduction has led to a lessening of the value of such bonus points and the abolition of the deduction would mean that no tax advantage could be gained by exceeding the minimum requirements.

Taxation of Policy Proceeds

21.148. Policy proceeds are in general regarded as a non-income receipt and are accordingly exempt from tax. Exceptions to this arise in the case of certain policies effected by employers on the lives of employees but these are relatively few in number and do not have a significant impact on the overall picture.

  ― 378 ―

21.149. The actuarial surplus of Australian life insurance companies is distributed in the form of reversionary bonuses—i.e. additions to the sum insured. By virtue of section 26 (i) such reversionary bonuses are exempt from tax in the hands of the policy-owner.

International Comparisons: A Brief Summary

21.150. The manner of taxing life insurance in countries with which Australia is broadly comparable presents a pattern of considerable diversity, perhaps indicative of the fact that the taxation of life insurance does not fit easily into any of the accepted categories of taxing income moving through intermediaries.

21.151. The United States and Canada give no tax concessions for premium payments as section 82H does in Australia. New Zealand broadly follows the Australian pattern of giving a concessional deduction (called there a ‘special exemption’) with an overall dollar limitation which applies to the aggregate of life insurance premiums and superannuation contributions. In the United Kingdom relief is allowed in the form of a rebate calculated at the basic rate of tax (currently 33 per cent), subject to a restriction on the amount of premiums qualifying for relief to one-sixth of the taxpayer's total income. Both New Zealand and the United Kingdom have found it necessary to legislate to restrict the availability of the concessions to long-term policies, as was done in Australia in 1973.

21.152. It is in the area of the definition of the taxable income of a life insurance company that the greatest differences emerge.

21.153. The basis used in the United Kingdom is the closest to that employed in Australia. The company is in practice taxed on its investment income but is allowed a deduction for all expenses, including those incurred solely in gaining non-taxable income, such as expenses of selling new policies. Furthermore, the rate of tax is limited to 37½ per cent.

21.154. In New Zealand a life insurance company is taxed on its annual actuarial surplus calculated on a specified basis. The rate of tax is limited to 40 per cent of the general rate of company tax.

21.155. Life insurance companies in the United States are taxed in a complex series of operations which, in substance, include in the tax base both investment income and underwriting profit or loss.

21.156. A life insurance company in Canada is taxed in a manner analogous to the taxation of a general insurance company in Australia. All receipts, whether by way of premiums or investment income, are included in its assessable income; a deduction is allowed of all expenses, claims and increases in policy reserves. In addition, a separate tax is levied on investment income subject to certain deductions.

21.157. The proceeds of life insurance policies are wholly exempt from tax in normal circumstances in New Zealand and the United Kingdom. In Canada policy proceeds received otherwise than on death or permanent disability are taxable to the extent that the amount received exceeds the adjusted cost base of the policy, which is the premiums paid less any dividends paid during the currency of the policy. The United States treatment is similar to the Canadian. Unlike life insurance companies in Australia, New Zealand and United Kingdom, which distribute their surplus in the form of reversionary bonuses, United States and Canadian companies traditionally distribute their surplus in the form of cash dividends.

  ― 379 ―

Conclusion

21.158. Having regard to the fact that two of its members are directors of Australian life insurance companies, the Committee feels that it is unable to make detailed recommendations on tax changes in this area. In addition, the subject is one of considerable complexity, particularly when it comes to determining the correct basis of taxing life insurance companies themselves. Life insurance is distinctive in combining elements of investment, protection and mutuality. The very diversity of overseas practice is an indication that no single method of taxing a life insurance company is accepted as correct. It often tends to be arbitrary.

21.159. Accordingly the Committee, while acknowledging assistance received from several submissions, recommends that a review of the taxation aspects of life insurance be undertaken by a separately constituted committee which can consider the particular problems in this area in greater depth than the present Committee has been able to do. Though minor anomalies such as the denial of the section 46 dividend rebate to non-resident life insurance companies and the treatment of foreign-source income may be noted, the Committee wishes to confine itself to some observations of a general nature.

21.160. Firstly, as with superannuation, the taxation of life insurance must be considered as a whole. There must be harmony between the treatment of premium payments, the income of the life insurance fund and payments of policy proceeds. No one element can be looked at in isolation from the other two.

21.161. Secondly, unlike the situation with superannuation benefits, it is neither feasible nor desirable to tax the proceeds of a life insurance policy; nor is it possible to impute to a policy-owner for tax purposes his share of the company's income during the term of the policy. Because of the insurance, as distinct from investment, aspects of life insurance, there is no reasonable way of taxing the excess of the policy proceeds over the amount of premiums paid. This being so it is necessary to exact some tax from the company itself, particularly since there is no way of imposing a limit on the extent to which high-income taxpayers may use life insurance as a saving and investment medium. Maximum benefit limitations can be imposed on tax-exempt superannuation funds to prevent the tax-free accumulation of excessive amounts, but this approach cannot be adopted with life insurance.

21.162. Thirdly, if it is desired that life insurance be encouraged there is justification for giving some form of concession related to the payment of premiums. The Committee has already recommended in paragraph 21.103 that superannuation contributions be taken outside the ambit of the present section 82H and divorced from the treatment of life insurance premiums. While a deduction system should be retained for superannuation contributions, largely because the benefit will emerge in taxable form, it is felt that a rebate, which is an equal per-dollar subsidy, is more appropriate in the case of premiums for life insurance the benefits from which are non-taxable.

21.163. Fourthly, and most significantly, the Committee wishes to stress that the tax treatment of life insurance should not be subject to abrupt changes. Life insurance is a long-term undertaking for both the policy-owner and the company. The long-term financial plans of individuals should not be lightly interfered with and it should be borne in mind that a life insurance company must be able to build up assets to meet liabilities due many years in the future. Because of the long-term nature of the contract entered into between the policy-owner and the company, it is necessary that there be some stability of the tax structure within which this contract will function.

  ― 380 ―

21.164. Finally, regard must be paid to the eroding effect of inflation on the protection and savings provided under life insurance policies. No less than in the case of business and professional income, the tax system should have regard to the impact of inflation on the income of life insurance funds, which are particularly vulnerable because of their required holdings of fixed-interest securities.