Taxpayer Alert TA 2003/2: Investment into Foreign Life Insurance Policies
Date of issue: 25 March 2003
Status: Current


Description: This Taxpayer Alert describes an arrangement which has as one of its features the purchase of a life insurance policy from a tax haven based life insurance company. An investor borrows money to indirectly invest in the life insurance policy, via a trust and a company. The investor seeks to earn tax-free income outside Australia on the investment and income tax deductions for interest payments on the borrowings. It would seem that the only economic benefit achievable by an investor entering into this arrangement is through the claimed tax savings. | The alert applies to arrangements having the following features: 1. A investor obtains for a small premium, for example $1,000, a life insurance policy from a tax haven based life insurance company. The policy can be surrendered at any time. 2. At the same time, the investor subscribes for units in an Australian resident unit trust to the value of, for example, $100,000. Payment for the units may be funded by a loan from a tax haven based bank related to the life insurance company at an interest rate of, for example, 10%. 3. The unit trust invests the funds from the unit subscription into an Australian resident company. 4. That company enters into an Investment Agreement with the life insurance company to invest the $100,000 into the same life insurance policy purchased by the investor for a guaranteed return which approximates the interest rate on the investor's loan, 10%. Under the terms of the Investment Agreement the company will receive a return of, for example, 3%. The balance of the income, being 7%, will accrue on the life insurance policy for the benefit of the investor. 5. The company pays this return of 3% as franked dividends to the unit trust. In turn any profit the trust makes after deducting various fees and expenses will be distributed to the investor. 6. The investor receiving a distribution of income claims a rebate for the franking credits and deductions for the interest payments made on the borrowing. 7. After 10 years the company surrenders its interest in the life insurance policy and receives its invested amount of $100,000. The company is liquidated with a capital return to the unit trust of $100,000 whose units in turn will be redeemed allowing the investor to use these funds to pay out the borrowing. 8. At the time of this surrender by the company, the amounts that have accrued on the life insurance policy will be paid to the investor. | 1. A investor obtains for a small premium, for example $1,000, a life insurance policy from a tax haven based life insurance company. The policy can be surrendered at any time. 2. At the same time, the investor subscribes for units in an Australian resident unit trust to the value of, for example, $100,000. Payment for the units may be funded by a loan from a tax haven based bank related to the life insurance company at an interest rate of, for example, 10%. 3. The unit trust invests the funds from the unit subscription into an Australian resident company. 4. That company enters into an Investment Agreement with the life insurance company to invest the $100,000 into the same life insurance policy purchased by the investor for a guaranteed return which approximates the interest rate on the investor's loan, 10%. Under the terms of the Investment Agreement the company will receive a return of, for example, 3%. The balance of the income, being 7%, will accrue on the life insurance policy for the benefit of the investor. 5. The company pays this return of 3% as franked dividends to the unit trust. In turn any profit the trust makes after deducting various fees and expenses will be distributed to the investor. 6. The investor receiving a distribution of income claims a rebate for the franking credits and deductions for the interest payments made on the borrowing. 7. After 10 years the company surrenders its interest in the life insurance policy and receives its invested amount of $100,000. The company is liquidated with a capital return to the unit trust of $100,000 whose units in turn will be redeemed allowing the investor to use these funds to pay out the borrowing. 8. At the time of this surrender by the company, the amounts that have accrued on the life insurance policy will be paid to the investor. | The ATO considers that the arrangement outlined above gives rise to taxation issues which include: (a) The application of the Foreign Investment Fund ('FIF') measures contained in Part XI of the Income Tax Assessment Act 1936 (the ITAA 1936). An Australian resident who has invested in a offshore life insurance policy with an investment component will be subject to the FIF measures (section 482 of the ITAA 1936). These provisions are an accruals system of taxing foreign source income such that an amount of income will be attributed each year to the investor. (b) The application of section 26AH of the ITAA 1936 and the availability of the rebate in section 160AAB of the ITAA 1936. (c) Whether the interest expenses on funds borrowed to acquire units in the trust are deductible. (d) Whether the general anti-avoidance provisions of Part IVA of the ITAA 1936 apply having regard to the appearance of round robin funding or a circular movement of funds and guaranteed returns. | (a) The application of the Foreign Investment Fund ('FIF') measures contained in Part XI of the Income Tax Assessment Act 1936 (the ITAA 1936). An Australian resident who has invested in a offshore life insurance policy with an investment component will be subject to the FIF measures (section 482 of the ITAA 1936). These provisions are an accruals system of taxing foreign source income such that an amount of income will be attributed each year to the investor. (b) The application of section 26AH of the ITAA 1936 and the availability of the rebate in section 160AAB of the ITAA 1936. (c) Whether the interest expenses on funds borrowed to acquire units in the trust are deductible. (d) Whether the general anti-avoidance provisions of Part IVA of the ITAA 1936 apply having regard to the appearance of round robin funding or a circular movement of funds and guaranteed returns. | The Australian Taxation Office is examining these and similar arrangements.





Related documents: TR 2004/3 | PS 2001/15 - Taxpayer Alerts | ITAA 1936 section 26AH | ITAA 1936 section 160AAB | ITAA 1936 section 482 | ITAA 1936 Part IVA

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