Parental Company Guarantees and Division 15 of Part III of the Income Tax Assessment Act 1936

Is a guarantee provided by a non-resident parent company, in its capacity as a parent company, to its resident company subsidiary an 'insurance contract' under section 141 of the Income Tax Assessment Act 1936 (ITAA 1936)?

No. A guarantee provided by a non-resident parent company, in its capacity as a parent company, to its resident company subsidiary is not an 'insurance contract' under section 141 of the ITAA 1936.

ABC is a resident Australian company.

ABC is not an insurance company and does not carry on the business of insurance.

ABC's parent company is DEF, a non-resident of Australia.

ABC raised finance from unrelated finance providers in order to fund its operations in Australia.

DEF provided a guarantee to the finance providers. Under the guarantee, DEF agreed that it would meet the obligations of ABC to the finance providers in the event that ABC defaulted on its obligations. ABC paid a fee to DEF in return for DEF providing this guarantee.

The guarantee was provided because DEF is the parent company of ABC. The guarantee allowed ABC to obtain finance at a lower interest rate than would be the case without the provision of the guarantee.

DEF is not an insurance company and does not carry on a business of insurance. DEF is not in the business of providing guarantees to other companies.

The DEF group also comprises other subsidiary companies that operate a number of businesses involving commercial, finance and insurance activities.

Division 15 of Part III of the ITAA 1936 includes sections 141 to 143 of the ITAA 1936 which set out certain taxation consequences for insurance with non-residents.

Section 141 of the ITAA 1936 defines an 'insurance contract' for the purposes of Division 15 of Part III of the ITAA 1936 as meaning: ... a contract or guarantee whereby liability is undertaken, contingent upon the happening of any specified event, to pay any money or make good any loss or damage, but does not include a contract of life assurance.

Section 142 of the ITAA 1936 operates to include an insurance premium under an insurance contract in the assessable income of a non-resident insurer. Section 143 of the ITAA 1936 then deems the non-resident insurer to have derived a taxable income equal to 10% of premiums paid or payable under insurance contracts during the year.

In determining whether the guarantee provided by DEF is an insurance contract within the meaning of section 141 of the ITAA 1936, it is necessary to consider the intent of the provision as ascertained from an examination of its history and the accompanying Explanatory Memorandum.

Prior to the introduction of the ITAA 1936 the income tax provisions relating to insurance with non-residents were contained in section 28B of the Income Tax Assessment Act 1922 (ITAA 1922).

The Explanatory Memorandum to the Income Tax Assessment Bill 1930 makes it clear that the intention of section 28B of the ITAA 1922 was to tax all forms of insurance business (other than life insurance) provided by non-resident insurers. This is confirmed by Clause 14 of the Explanatory Memorandum which stated that section 28B was being inserted to: ...cause income tax to be payable by or on behalf of ex-Australian underwriters such as Lloyd's Insurance Association of London upon an assumed profit of 10 per cent. of all premiums on insurances effected in Australia by or on behalf of that underwriter.

As part of the re-write of the taxation law in the 1930s, the principles contained in section 28B of the ITAA 1922 were incorporated into Division 15 of Part III of the ITAA 1936.

The Explanatory Memorandum to the Income Tax Assessment Bill 1935 (the Bill for the ITAA 1936) states that section 28B of the ITAA 1922: ... was originally introduced to tax ex-Australian underwriters in respect of Australian business undertaken by them in competition with companies established in Australia.

The Explanatory Memorandum to the Income Tax Assessment Bill 1935 also discusses a change in the law that was made to overcome a 'weakness' in section 28B of the ITAA 1922 and then concludes by stating that the 'remaining clauses restate the existing law'.

Accordingly, an examination of the Explanatory Memorandums to both Acts confirms that the purpose of Division 15 of Part III of the ITAA 1936 is the same as section 28B of the ITAA 1922.

Division 15 of Part III of the ITAA 1936 was amended in 1975 and the Explanatory Memorandum to the Income Tax Assessment Bill 1975 included the following statement about Division 15: The objective of the Division is to secure the imposition of tax on foreign insurance underwriters in respect of business (other than life assurance) undertaken by them in Australia in competition with companies established in Australia.

The Explanatory Memorandums therefore confirm that Division 15 of Part III of the ITAA 1936 is intended to apply only to those entities that carry on the business of insurance, other than the business of life insurance.

DEF is the corporate head of a group of companies that includes entities that carry on the business of insurance. However, DEF does not carry on the business of insurance.

The providing of parental guarantees by DEF to its subsidiaries is not the carrying on of a business of insurance. The courts have confirmed that the provision of a parental guarantee can be for the purpose of enhancing or protecting the parent company's profit yielding structure, rather than being an incident of any business being carried on between the parent and its subsidiaries or associated companies: Bell and Moir Corporation Pty Ltd v. Federal Commissioner of Taxation [1999] FCA 1009; 99 ATC 4738; (1999) 42 ATR 421; Commissioner of Taxation v. Email Ltd [1999] FCA 1177; 99 ATC 4868; (1999) 42 ATR 698.

The courts have looked to the relationship between insurance companies and their subsidiaries to determine whether the activities of the subsidiaries were integral to the business of the parent company: GRE Insurance Limited v. Commissioner of Taxation (1992) 34 FCR 160; 92 ATC 4089; (1992) 23 ATR 88 ( GRE Unitraders ); AGC (Investments) Limited v. F C of T 91 ATC 4180; (1991) 21 ATR 1379; CMI Services Pty Limited v. FC of T 89 ATC 4847; (1989) 20 ATR 1152.

The relationship between these entities was confined to determining whether the profits on realisation of investments were of a revenue nature. Notwithstanding the relationship between the two entities, the courts made it clear that the two entities were distinct from one another.

In GRE Unitraders the Full Court of the Federal Court in finding that the activities of the subsidiary company were integral to the activities of the parent insurance company stated at FCR 166; ATC 4094; ATR 94: [t]hat is not to say that Unitraders should not be considered as a taxpayer in its own right. It was such a taxpayer and its activities should be so considered.

This principle applies to DEF and to any subsidiary of it that carried on the business of insurance. DEF does not take on the attributes of the business activities of its subsidiaries for the purposes of Division 15 of Part III of the ITAA 1936. Therefore, the fact that DEF has a subsidiary that is an insurance company does not mean that it is an insurance company for these purposes.

Accordingly, the guarantee provided by DEF is not an insurance contract as defined in section 141 of the ITAA 1936 because DEF is not an insurance company and the guarantee was provided by DEF in its capacity as a parent company.