Personal Portfolio Bond

Overview

A Personal Portfolio Bond (PPB) is a type of financial product that is designed with reference to the UK tax rules and which is sold in many overseas jurisdictions around the world.An offshore PPB is a single or regular premium investment vehicle which provides expatriate investors with the flexibility of creating and managing a portfolio of assets in a single tax efficient and flexible structure.

Section 516 of the UK tax act defines a PPB as ‘a policy of life insurance, contract for a life annuity or capital redemption policy that meets conditions A and B’.Condition A defines the types of investments that can be held within a PPB and Condition B relates to the ability of the investor or a person acting on the investor’s behalf to select the investments held within the PPB.If the investor or their agent cannot select the investment, the policy is not a PPB.

It is outside the scope of this eBook to go into the detail of why this type of product was created and how it can be used to minimise UK tax.The focus in this eBook is simply how a PPB is taxed in Australia after an expat returns to Australia or an immigrant moves to Australia.

Current Australian tax treatment

When the FIF rules were repealed in 2009, the old draconian approach PPBs was not replaced with a new tax regime.In the absence of special rules applying to foreign life policies, section 26AH applied by default.

Section 26AH provides for the taxation of bonuses when received by a policyholder.The meaning of ‘bonus’ is not actually defined in the Tax Act, but in IT 2346, the Tax Office 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 the term ‘received’ means the policy holder has actually been paid and has received as a cash payment the policy proceeds including the profit element.The policy holder 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 policy holder 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.

10 year rule

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 not tax resident of Australia.

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.

Why would the Australian Government allow investments held for 10 years or more to go untaxed in Australia?The answer to that question is that Section 26 AH is targeted at Australian insurance bonds where the product provider has paid tax at the company tax rate (currently 30%) on the earnings derived on the investments held within the insurance bond.The products are therefore considered a ‘tax paid’ investment to the policy owner when the bond runs for 10 years or more.

Given that the operators of foreign life policies are not paying Australian tax on earnings within PPBs – because they do not operate in Australia – it seems illogical that the ‘tax paid’ status should be allowed in respect of foreign life policies in the same way as the concession is allowed for domestic insurance bonds.Therein lies the tax loophole.

Australian tax law is not always logical and is not always fair, and in this case there is a benefit which is available to those who have purchased a PPB and who choose to hold the PPB for 10 years or more.These types of policies are not available to investors who are based in Australia.

Will this tax loophole be closed?History shows that wherever there is a perceived ‘threat to the revenue’, governments can move swiftly to close the loophole through new legislation.In the case of foreign life policies, it appears that the Australian government is not yet sufficiently concerned to make changes to the tax rules regarding this type of financial product.However, investors should be wary of the potential for change in this area and the time to consider whether you retain or redeem this type of product is prior to repatriation.

Private Binding Ruling (PBR)

If you want to be sure of the tax treatment of a foreign life policy you own, you can seek a Private Binding Ruling from the Australian Taxation Office.A ruling can be obtained in respect of future tax years – for example if you have a PPB that will reach its 10th anniversary in the 2020 tax year, you could ask the Tax Office for a ruling in respect of the tax treatment that will apply in that year – i.e. to ensure that the investment will indeed be tax free if held for the full ten years.

However, if you go down the path of engaging with the Tax Office you need to be prepared for the possibility – for whatever reason – that the ruling you receive is not the ruling you want.If the ruling is not favourable and you wanted to pursue the matter, in most cases you could object and if necessary take the matter to the Administrative Appeals Tribunal and even the Supreme Court.

This is a complex area of the tax law and I would suggest that if you want to obtain a Private Binding Ruling that you engage a suitably qualified professional to prepare the ruling request on your behalf and to manage the process through to its logical conclusion, including lodging an objection or appeal if necessary.