Submission No. 152 Back to full list of submissions
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16 April 1999
The Secretary
Review of Business Taxation
Department of the Treasury
Parkes Place

Dear Sir,

Submission on Discussion Paper

Phillips Fox Actuaries and Consultants is impressed with the considerable work and thought which has gone into the Review of Business Taxation. We consider that the Government will be able to use the work of the Review to reform Australia=s corporate taxation structure to the benefit of the whole community.

Our firm works in the financial services industry and the majority of our clients are financial institutions and superannuation funds. Accordingly, we have a particular interest in the Taxation of life insurance, namely chapters 34 to 37 of your Discussion Paper. We have a number of comments on your proposal and options.

Financial Products & Services

Financial institutions are not the same as other companies. They generally deal in intangible products and services. Often the profits are dependent on the duration the product is held as new business acquisition costs tend to be spread over a number of years. Furthermore, in the case of life and general insurance risk business, the profits generated during the term of the policies are akin to unrealised gains as the true financial position is only known when the policy has been completed. Even then, with some types of policies, claims can be notified a considerable time (often many years) after the claim event.

It should be noted that there has been an extensive review of the life insurance industry in recent years, culminating in the 1995 Life Insurance Act. There are now uniform rules for solvency and capital adequacy and financial reporting. We consider that any review of taxation should take into account the special nature of this business and not recommend changes which will impact on the role or structure of the industry itself.

Some types of investment products are particularly complicated. Life companies and friendly societies sell capital guaranteed policies. Although sales of these are less common than in previous years, the assets backing these policies are still significant, being about $69 billion (or 40% of the $173 billion combined life insurance & friendly society industry).

Many clients are attracted to life insurance products as they provide a positive return each year, have a history of delivering a real rate of return and the risks of volatile results are held by the life company. The returns credited to member accounts are different to the actual earnings on the assets since results are smoothed from year to year to avoid volatility (and negative declared rates). Industry superannuation funds use similar techniques.

Reserves are set up and maintained to ensure that the company can meet its future (unknown) obligations. These reserves are not necessarily allocated to a single class of business, but can be used to support the solvency position of a Statutory Fund into which many different types of investment and risk policies are placed. It would be punitive to tax the income on these reserves at the corporate rate in cases where they are held in respect of concessionally taxed superannuation and annuity policies.

Even though some of the reserves are notionally owned by share-holders, they are required for capital adequacy purposes. We consider that they should be taxed only when transferred to share-holder funds as profits. The earnings on those reserves held over and above the required actuarial amounts for capital adequacy purposes could also be taxed at the corporate rate.

Entities & the Flow-through theory

One major impact on financial institutions is the recommendation to tax all classes of business at the corporate rate (currently 36% but possibly reducing to 30% under some Review options). This causes particular problems for life companies and some other institutions.

Given that the majority of taxpayers will have marginal rates at or below the corporate tax rate, the government will effectively over-tax much of the business of the industry. People will then be expected to reclaim this excessive tax in their annual tax returns. This will have several unsatisfactory outcomes:

# it will cause confusion since many people will have to include earnings on their policies within their tax returns (and it will force many people to submit a tax return solely for the purpose of reclaiming these taxes);

# it will force life companies and friendly societies to change their computer systems, write to millions of people to explain the changes (which are complex for the layman) and incur considerable expenditure for no gain in productivity; and

# it will place the life insurance industry at a comparative disadvantage to other industries in areas such as post-retirement products and superannuation.

We believe this approach is wrong. There are two situations where a lower tax rate is valid and the entity concept should not apply. The first is where a product is taxed concessionally. An example is a Retirement Savings Account which is taxed at 15%. The second situation is where all the investors in a product are treated concessionally. One example is that of a Pooled Superannuation Trust. Another is a Statutory Fund (or a friendly society Benefit Fund) investing superannuation money on behalf of members.

National Savings & Tax-paid policies

Over many decades, the life insurance industry has been the prime source of medium and long term savings in Australia. On Ordinary (non-superannuation) business, life companies (and friendly societies) provide a tax-free benefit if the policy has been held for ten or more years. This encourages medium-term savings.

There has been some criticism that life policies do not provide good value as the Ordinary tax rate of 39% is higher than the marginal rate of many policy-holders. However, this is more a reflection of the rate being too high, rather than the concept being wrong. Furthermore, many policy-holders on lower marginal rates still often benefit from real rates of return (after tax and inflation) and they have the added advantage of not needing to complete a tax return to show their life policy returns.

We consider that the Governments will, from time to time, encourage savings over consumption and that tax-paid policies are an appropriate vehicle. In the U.K., concessional savings plans, (PEP=s and TESSA=s) were set up by the Conservative Government with major tax concessions (up to ,9,000 of contributions could be made each year). The Blair Labour Government has replaced these with Individual Savings Accounts (ISA=s) which can be invested in a wide range of short to long-term savings with annual deductible contributions of up to ,5,000 p.a. They operate as tax-paid contracts similar to Australian life policies (but with no minimum term).

Over the last 25 years, tax concessions on superannuation have encouraged this form of saving at the expense of any other. The introduction of compulsory superannuation has exacerbated this trend. The life insurers hold a substantial share of the total superannuation market.

The growth of the unit trust industry over the last ten years has also been spectacular. It is now much larger than the non-superannuation life insurance industry. Public trusts (excluding cash management trusts) held $73 billion at the end of 1998 against some $27 billion for Ordinary life insurance business. Part of the reason for this growth (at the expense of the life companies) has been the emergence of financial advisers. However, the high tax-paid rate of 39% has also disadvantaged the life industry.

The unit trust industry currently does not follow the entity concept. The distribution of income and realised gains is allocated to unit holders on an annual basis and they must show this in their tax returns. The Review requires a "withholding tax" at the corporate rate with a similar treatment for life insurance, despite the major differences in structure of these institutions and their policies.

We are concerned that the Review's recommendation will lead to all investment business gradually being sold in unit trusts (including superannuation). For Ordinary (non-superannuation business), this is a concern. Currently, Ordinary life business has an approximate imputation system for money withdrawn in the first ten years and is treated as tax paid after ten years. This means that investment in Ordinary life policies tends to be longer term than unit trust investments. We consider that long-term investment capital is desirable and that there is a strong case for continuing with the current arrangement but with a lower rate than 39%. This would give an incentive to invest for at least ten years. This incentive is consistent with the concept proposed in the Review's suggested capital gains tax scales which vary with the duration that the investment is held.

Tax-free Investments

We note with some dismay the proposed treatment of annuity and pensions. We consider that the earnings on the assets held in respect of these products should remain tax-free until the Government has reviewed the whole tax structure of post-retirement products and superannuation generally.

There are other products available which are tax-free. For example, financial institutions invest on behalf of charities and religious organisations and friendly societies hold funeral bonds in a tax-free Benefit Fund.

We consider that these arrangements should continue provided that the assets are quarantined and are not co-mingled with assets subject to higher rates of taxation. We believe that all financial institutions should be able to develop products to meet market needs. Therefore, we would recommend that the current advantage offered to friendly societies in holding tax-free investments for funeral bonds be extended to any other form of financial institution, subject to proper prudential regulation of the supplier.


As a result of our comments, we ask the Review to re-consider its treatment of the life industry. The review should recognise that there may continue to be several different tax rates for the businesses of life companies. These can be accommodated by requiring life companies to hold businesses subject to each tax rate within separate Statutory Funds.

Superannuation Review

The current Government has instigated two wide-ranging and practical reviews (namely Wallis and Ralph). However, both committees were expressly forbidden from looking at superannuation. We now need to complete the trilogy with a separate review of superannuation and retirement incomes policy. Such a committee should also look at the role of superannuation within a broader savings regime. Outside superannuation, Australia provides no incentive for medium term savings. In fact, our tax regime encourages high-income earners to borrow (negative gearing).

Phillips Fox Actuaries and Consultants

We thank you for the opportunity to present our opinions. We would be pleased to meet with staff of the Review should you wish us to expand upon any of the matters we have raised. More information about our firm and its capabilities can be found on our web-page (

Yours sincerely,


Michael J. Rice
Fellow of the Institute of Actuaries of Australia