Q: How can returning Australians (and expats moving to Australia) make MASSIVE tax savings by using offshore investment bonds and investment-linked life policy wrappers?
A: Set it up while you’re an expat working abroad, and keep it running at least ten years (even if you go back home) for maximum tax benefits.
Read below to find out more. Click the button on the right to download a PDF.
(Note: this article is relevant to expatriate Australians working in Singapore and other overseas locations, as well as other nationalities who may be moving to Australia in the future.)
Background - Repeal of Foreign Investment Fund legislation
For several years the Australian Tax Office (ATO) had very defined, and perhaps harsh, rules for how foreign insurance bonds were treated in respect of capital gains for tax residents in Australia. In effect, these tax wrappers were treated in a ‘look through’ manner and holders were liable for tax on actual gains made or at a deemed rate set by the authorities. This regime, part of the Foreign Investment Fund (FIF) rules, was repealed by the Australian government with effect from 1st July 2010.
So Why The Change In Foreign Investments Taxation For Australians?
One important reason is this: it wasn’t just Australians returning from abroad that were affected. The rules applied to non-Australians moving to Australia for work, who became tax-resident. For tax-planning reasons, insurance bond investment structures are widely used around the globe, particular by mid- and senior-level professionals with international experience. These expatriates moving to Australia found that their offshore investments and retirement plans were being hit by the FIF rules. For a growing economy in need of specialist and business expertise, this was a human resources disaster. Many professional expats considered Australia as ‘off the list’ of desirable locations.
The New And Favourable Tax Situation For Australians
With the repeal of the FIF legislation, offshore insurance bond and life policies have become immensely valuable tools for long-term tax-planning for Australians and other nationalities moving to or returning to Australia.
Such structures are now treated under the long-established section 26AH of the Income Tax Assessment Act 1936. Section 26AH was inserted in that Act by the Income Tax Assessment Amendment Act 1984 (Act No. 14 of 1984), which received the Royal Assent on 12 April 1984. The section provides for the taxing of amounts paid as or by way of bonuses under life assurance policies taken out after 27 August 1982, and which are not subject to tax under any other provision of the income tax law.
Taxation Of Foreign Life Policy Proceeds (Individual Policyholders)
The legislation is applicable to resident policyholders of foreign life policies and provides for the taxation of bonuses paid on termination or at the time of a partial withdrawal. The relevant taxation ruling is IT.2346 (31st July 1986).
Bonuses Received By The Policyholder
Section 26AH ITAA 1936 provides for the taxation of bonuses when received by the policyholder. The meaning of ‘bonus’ is not actually defined in the legislation but the Australian Tax Office (ATO) in ruling IT2346 explains that for investment unit linked policies, the profit derived on the sale of units is, when paid to the policyholder, to be regarded as a bonus payment. The gain or surrender or partial withdrawal is therefore a ‘bonus’ payment from a foreign unit linked single premium or regular premium policy.
The ATO has ruled that ‘received’ means the policyholder has actually been paid and received as a cash payment the policy proceeds including the profit element. The policyholder will also be deemed to have received a bonus when it is paid to someone on their behalf for the purpose of reinvestment outside the policy.
A bonus is not received if it is reinvested in the same policy and used to purchase further units on behalf of the policyholder which then contribute to the surrender value of the policy. Such a bonus payment would include loyalty bonuses that increase the unit holding on a periodic basis.
Tax On Full Or Partial Surrender (Encashment)
If a policy has made an investment gain and is held for ten years or more (or extended eligible period as per the paragraph below), any gain made on surrender or maturity may be disregarded if the beneficiary (i) is the original beneficial owner of the policy; or (ii) acquired the interest in the policy for no consideration.
The holding period includes when the policyholder was a non-Australian resident.
In accordance with Section 26AH (6) ITAA 1936, the policyholder will be assessed for income tax on chargeable bonuses arising during the eligible period as follows:
- Within 8 years - The full gain is included as assessable income and taxed at the policyholder’s marginal rate
- During the 9th year - Two thirds of the gain is included as assessable income and taxed at the policyholder’s marginal rate
- During the 10th year - One third of the gain is included as assessable income and taxed at the policyholder’s margin rate
- After 10 years - The whole gain does not have to be included as assessable income under Section 26AH
This is explained succinctly on the ATO website in the guidance notes for completing an income tax return.
Note that if you have a qualifying policy, saving tax on withdrawals is easy and involves no extra paperwork - you don’t even need to declare it on your tax return!
Extending The Eligible Period Following A Significant Premium Increase
To guard against a deliberate attempt to gain a tax advantage on certain capital investments by paying only nominal premiums at outset which are then significantly increased later, Section 26AH (13) provides that if the premium is increased by an amount in excess of 25% of the premium paid in the previous policy year, the eligible period shall be extended and will be 10 years from the start date of the policy year in which the premium increase takes place. Until such time as this new revised eligible period is completed, bonuses received will remain assessable to income tax.
Death Benefits Payable Under The Policy
In accordance with Section 26AH(7) the amount paid on the death of the life assured resulting in the policy terminating is not assessable to income tax on receipt by a tax payer.
Also, the estate of the deceased will not be subject to capital gains tax on the proceeds as they will be received with no consideration resulting in any gain or loss being disregarded.
Contact me to find out more about simple, cost effective, qualifying schemes for Australians to save tax and make your money grow.
Important Disclaimer. Neither myself nor IPP Financial Advisers Pte Ltd provide tax advice. This article is sourced from materials provided to me by relevant regulated institutions in Singapore, in addition to the Australian Taxation Office website. This article presents general information only, and you should obtain your own independent tax advice appropriate to your specific circumstances. Whilst I believe this information to be accurate at time of publication (February 2013), neither myself nor IPP Financial Advisers Pte Ltd shall bear any liability whatsoever for any actions reliant upon this information.