Background
On 10 July 2023, Treasury issued Exposure Draft Treasury Laws Amendment (Measures for Future Bills) Bill 2023: Income Tax Amendments for Updates to Accounting Standards for General Insurance Contracts (ED) for public consultation.
The ED is a result of the 2023-24 Federal Budget announcement to introduce a measure to reduce compliance costs for general insurers. Broadly, the ED amends Division 321 of the Income Tax Assessment Act 1997 (Cth) (ITAA 1997) to align the tax income recognition methodology of general insurance contracts with the Australian Accounting Standard Board (AASB 17), subject to certain legislated accounting to tax adjustments. The new law is intended to reduce the regulatory burden for general insurers from maintaining substantially different sets of records for tax and accounting purposes. The amendments apply to income years starting on or after 1 January 2023 and transitional arrangements provide for a smooth transition that avoids permanent tax differences upon the adoption of AASB 17.
Context of amendments
Division 321 of the ITAA 1997 sets out the requirements for calculating tax liabilities that arise from general insurance contracts. Division 321 currently refers to the accounting outcomes that arrive from applying AASB 1023. However, from 1 January 2023 AASB 17 replaced AASB 1023 as the mandatory accounting standard for insurance contracts for financial reporting purpose. The proposed amendments in the ED seek to minimise regulatory burdens facing general insurers by allowing them to continue to use audited financial reporting information as a basis for their tax returns.
Key features of the proposed new law
The ED proposes to amend Subdivision 321-A and Subdivision 321-B of the ITAA 1997 such that the income tax treatment for general insurance companies is determined by reference to audited financial statements prepared in accordance with AASB 17.
The key features of the proposed new law include:
Subdivision 321-A - liability for incurred claims
Under AASB 17, the concept of ‘liability for incurred claims’ comprises the fulfilment cash flows related to past services allocated to the relevant group of contracts at that date.
This concept is to be included in Subdivision 321-A and replaces the current tax law concept of ‘outstanding claims liability’. Specifically, the adjusted liability for incurred claims is compared at the end of an income year with the value of those adjusted liabilities at the end of the previous income year to determine if the change in the adjusted liability for incurred claims should be treated as assessable income or as a tax deduction. The tax method of valuation aligns with AASB 17 but there are tax adjustments for certain accounting values (such as excluding indirect claims handling costs) and the estimated recoveries from certain reinsurance premiums.
Subdivision 321-B: liability for remaining coverage
Under AASB 17, the concept of ‘liability for remaining coverage’ comprises the fulfillment cash flows related to future services allocated to the relevant group of contracts at that date.
The concept of ‘liability for remaining coverage’ is to be included in Subdivision 321-B and replaces the current tax law concept of ‘unearned premium reserve’. Specifically, the adjusted liability for remaining coverage is compared at the end of an income year with the value of the liability at the end of the previous income year to determine if the change in the adjusted liability for remaining coverage should be treated as assessable income or as a tax deduction. The tax method of valuation aligns with AASB 17 but there are adjustments for certain accounting values, for certain reinsurance premiums paid or payable, commissions, and onerous contracts.
AASB 17
The ED introduces several definitions, including the reference to AASB 17 being the version that existed on 1 January 2023, and relevant terms used in AASB 17 (AASB 17 (2023). The relevant version can be accessed here.
Amending Division 321 so that it applies to AASB 17 (2023) as in force on 1 January 2023 ensures any future changes to the standard will not change the tax outcomes as considered by Government at the time the tax law amendments to Division 321 are made.
No changes to payment of claims
The ED does not alter the taxation treatment of claim payments, allowing for a deduction of amounts paid during an income year. In this regard, broadly, a claim is taken to be paid for the purposes of the provisions if the claim is settled within the income year, the relevant liability is no longer reflected in the company’s liability for incurred claims at the end of the income year, and the claim is payable by the insurer at the end of that income year.
Income Tax consolidation consequential amendments
The ED proposes consequential amendments to the income tax consolidation rules as a result of differences that are reflected in AASB 17 which are not aligned with the current income tax treatment of general insurance companies. Specifically, the tax cost setting rules are modified to reflect these differences where a general insurance company joins or leaves a tax consolidated group.
Commencement and transitional arrangements
The amendments are to apply to income years starting on or after 1 January 2023 which is consistent with the general application of AASB 17.
The transitional arrangements provide for a smooth transition to the new rules for general insurance companies and these rules should avoid permanent tax differences arising from the adoption of AASB 17. Specifically, this has been dealt with under the transitional rules by for the first income year to which the amendments apply (starting on or after 1 January 2023) requiring for the purposes of applying Subdivisions 321-A and 321-B, that the opening position will be determined by applying the old tax law’s method statements and treatments for ‘liability for outstanding claims’ and ‘unearned premium reserve’.
What is missing from the ED?
The ED amendments are directed at general insurance companies and general insurance contracts. It is still not clear how life insurance companies applying Division 320 of the ITAA 1997 will be catered for. Some health insurance companies apply Division 321 in calculating their tax position and more health insurers may seek to do this for certainty.
The transitional arrangements that have been included in the ED capture all differences arising between the old tax law method statements and new tax law method statements in the first income year to ensure alignment with the operation of AASB 17. To ease the burden of a one-year transition, the government should consider giving taxpayers a choice to spread the tax impact over a longer period of time (so effectively any assessable or deductible amounts are spread) consistent with previous transition measures (for example, TOFA and Division 320 rules allowed for a spreading of the tax impact over four and five years respectively).
What should taxpayers do?
The proposed changes provide a degree of consistency between accounting and taxation recognition of income and thereby should provide some reduced compliance burden for the general insurance industry going forward. It is essential for general insurance companies to assess the impact of these amendments and ensure compliance with the updated requirements.
Treasury is seeking views from interested parties on the ED and explanatory materials by 21 July 2023. This is a tight turnaround, given that the material was released on 10 July. However, we will be aiming to consult with relevant industry participants and assist with submissions to Treasury.
Should you have any queries or interested in raising concerns as part of a submission to Treasury please contact your local Insurance Services adviser.