Income tax amendments for updates to the Accounting Standard for general insurance contracts - legislative certainty finally achieved

General insurers will be able to continue to use audited financial reporting information as a basis for their tax returns following the amendments to Division 321 of the Income Tax Assessment Act 1997 (‘ITAA 1997') in Treasury Laws Amendment Support for Small Business and Charities and Other Measures 2023 (The Bill) passing through Parliament this week.

Division 321 deals with the income tax treatment of premium income of general insurance companies, which is broadly aligned with the accounting standards in AASB 1023 and allowed general insurance companies to use audited financial reporting information as a basis for their tax returns. However, on 1 January 2023, AASB17 replaced AASB 1023. The introduction of AASB17 as the mandatory accounting standard for insurance contracts meant that the tax treatment in Division 321 no longer aligned with the accounting treatment of premium income of general insurers. This meant calculating tax liabilities arising from general insurance contracts became uncertain.

The new law makes amendments to Division 321 ITAA 1997, aligning the tax income recognition methodology for general insurance contracts with the Australian Accounting Standard Board (AASB 17), subject to certain legislated accounting-to-tax adjustments. The amendments apply to income years starting on or after 1 January 2023, with transitional arrangements (including extended transitional arrangement) to ensure a smooth transition without permanent tax differences upon adopting AASB 17.

On 10 July 2023, Treasury issued the Exposure Draft Treasury Laws Amendment (Measures for Future Bills) Bill 2023: Income Tax Amendments for Updates to Accounting Standards for General Insurance Contracts (The ED) for public consultation. This initiative stemmed from the 2023-24 Federal Budget announcement aimed at reducing compliance costs for general insurers.

Legislative certainty achieved

There will now be certainty around the income tax amendments for updates to the accounting standard for general insurance contracts with the passing of the Treasury Laws Amendment (Support for Small Business and Charities and Other Measures) 2023 (The Bill). The Bill, which includes measures aimed at reducing compliance costs for general insurers, had been stuck in Parliament and now has retrospective effect to align with the accounting standard start date, applying to income years starting on or after 1 January 2023.

The Bill had been held up in the Senate following debate over the instant asset write-off threshold, which created uncertainty for general insurers in preparing their financial accounts and filing their income tax returns. The Bill will become law when it receives Royal Assent.

Context of amendments

Division 321 of the ITAA 1997 outlines the requirements for calculating tax liabilities arising from general insurance contracts, previously referencing accounting outcomes from applying AASB 1023. From 1 January 2023, AASB 17 replaced AASB 1023 as the mandatory accounting standard for insurance contracts for financial reporting purposes. The amendments in the Bill seek to minimise regulatory burdens for 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

Subdivision 321-A: Liability for Incurred Claims

Under AASB 17, the ‘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 replaces the current tax law concept of ‘outstanding claims liability.’ The adjusted liability for incurred claims is compared at the end of an income year with the value at the end of the previous income year to determine if the change should be treated as assessable income or a tax deduction. The tax valuation method aligns with AASB 17 but includes tax adjustments for certain accounting values, such as excluding indirect claims handling costs and estimated recoveries from certain reinsurance premiums.

Subdivision 321-B: liability for remaining coverage

Under AASB 17, the ‘liability for remaining coverage’ comprises the fulfilment cash flows related to future services allocated to the relevant group of contracts at that date. This replaces the current tax law concept of ‘unearned premium reserve.’ The adjusted liability for remaining coverage is compared at the end of an income year with the value at the end of the previous income year to determine if the change should be treated as assessable income or a tax deduction. The tax valuation method aligns with AASB 17 but includes adjustments for certain accounting values, reinsurance premiums, commissions, and onerous contracts.

AASB 17 definition

The amendments introduce definitions referencing AASB 17 as it existed on 1 January 2023. This ensures that any future changes to the standard will not alter the tax outcomes considered by the government when amending Division 321.

No changes to payment of claims

The amendment does not change the taxation treatment of claim payments, allowing for a deduction of amounts paid during an income year. A claim is considered paid if settled within the income year, the relevant liability is no longer reflected in the insurer’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 year.

Income tax consolidation consequential amendments

The Bill makes consequential amendments to the income tax consolidation rules, reflecting differences in AASB 17 not aligned with the current income tax treatment of general insurance companies. The tax cost setting rules are modified to reflect these differences when a general insurance company joins or leaves a tax-consolidated group.

Commencement and transitional arrangements (including extended transitional arrangements)

The amendments apply to income years starting on or after 1 January 2023, consistent with the general application of AASB 17. Transitional arrangements ensure a smooth transition, avoiding permanent tax differences from adopting AASB 17. The first income year applying the amendments will use the old tax law’s method statements and treatments for ‘liability for outstanding claims’ and ‘unearned premium reserve’ to determine the opening position.

Taxpayers have the option to apply extended transitional arrangements to isolate changes due to AASB 17 and reallocate them over five income years. This choice is irrevocable and must be communicated to the Commissioner via an approved form, submitted by the due date of the taxpayer’s income tax return for the applicable income year or the actual lodgement date, whichever is earlier. The reallocation of assessable income or deductions will apply to the start year and the four following income years.

Feedback from Public Consultation taken onboard

During the public consultation period ended on 21 July 2023, industry participants provided valuable feedback, leading to further clarifications and refinements in the final amendments. Treasury considered the feedback, emphasising the importance of transitional relief and flexibility for insurers during the initial implementation phase. Industry stakeholders expressed concerns about the tight timeline, suggesting a phased approach to allow for better preparedness.

What Should Insurers Do?

The law changes aim to provide consistency between accounting and taxation recognition of income, reducing compliance burdens for the general insurance industry. General insurance companies must assess the impact of these amendments and ensure compliance with the updated requirements.

Next Steps

General insurers should engage with their Insurance Services advisers to navigate these changes. For further queries, please contact your local Insurance Services adviser.