TT1996/27 and Commissioner of Taxation

[2000] AATA 466

Administrative

Appeals

Tribunal

 

DECISION AND REASONS FOR DECISION [2000] AATA 466

ADMINISTRATIVE APPEALS TRIBUNAL      )

)          No TT1996/27

TAXATION APPEALS  DIVISION		)
Re		TAXPAYER TT96/27

Applicant

And COMMISSIONER OF TAXATION

Respondent

DECISION

Tribunal Deputy President A M Blow OAM QC.,
Ms A F Cunningham (Part-time Member)

Date9 June 2000

PlaceHobart

Decision The decision under review is affirmed. 

..............................................

Deputy President

CATCHWORDS

Income Tax – ascertainment of assessable income – what is income derived by taxpayer – insurance moneys – life insurance policy – surrendering.

Income Tax Assessment Act 1936 – ss.26(i),26AH

Commissioner of Taxation v Haass (1999) 42 ATR 529; 99 ATC 4814; [1999] FCA 1088  Federal Commissioner of Taxation v The Myer Emporium Limited (1987) 163 CLR 199  Westfield Limited v Federal Commissioner of Taxation (1991) 28 FCR 333

REASONS FOR DECISION

9 June 2000	Deputy President A M Blow OAM, QC.,
Ms A F Cunningham (Part-time Member)

1.      The applicant is appealing against a decision of the respondent to disallow an objection against a notice of amended assessment dated 24 March 1994 which included an amount of $20,025 in the applicant’s assessable income for the tax year ended 30 June 1991.   The facts are almost identical to this in Application TT1996/41.   The applicant asked us to take into account all submissions made on behalf of the taxpayer in that case.

2.      The dispute between the parties concerns a policy of life insurance of an unusual type.   The relevant insurance company issued a number of such policies over a short period during the tax year ended 30 June 1990.  The type of policy in question was a modification of an existing investment policy which included debt cover, modified so that the debt cover was reduced to zero.   The reduction in debt cover to zero resulted in a reduced premium.   The maximum term of the policy was 35 years.   The insurer did not require a policy holder to have an insurable interest in the life assured.   After the payment of the second annual premium,  a policy holder was able to borrow up to 92.5% of the cash value of the policy from the insurer.   The policy could not be surrendered with any return to the policy holder until it had been in force for two years.    If the debts by way of loans taken out by a policy holder, plus accrued interest thereon, accumulated to an amount which exceeded the cash value of the policy, the policy would lapse.   Such lapsing was referred to as “journal surrender”.

3.      As originally marketed, the policy had an “accelerated surrender value”.   This meant that on the day after each anniversary of the issue of the policy, the cash value attributed to the policy was increased to a value which it would not normally have had until the end of that new policy year.

4.      When an agent sold such a 35 year policy on behalf of the insurer, and the premium was to be paid yearly, the insurer paid the agent commissions comprising 60% of the annual premium in respect of the first year, 20% of the annual premium in respect of the second year, and 12% of the annual premium in respect of each of the third, fourth and fifth years.    However both the first and second years’ commissions (totalling 80% of the amount of an annual premium) were paid by the insurer to the agent upon the issue of the policy.   Subject to certain eligibility criteria, the insurer also paid bonuses to the agent.    Such bonuses totalled 52% of the amount otherwise payable by way of commission.

5.      The applicant purchased such a 35 year policy with a premium of $100,000 per annum.  Provided the premium was payable annually, the agent who sold the policy was thus entitled upon the issue of the policy to 52% of $80,000 (i.e. $41,600) by way of bonuses in respect of the sale of the policy, making a total entitlement of $121,600.

6.      It was arranged between the applicant and the insurer’s agent that the agent would fund the payment of the first year’s premium by rebating its commission, and that thereafter the annual premium payments of $100,000 would be paid by the applicant borrowing the required amount from the insurer against the security of the cash value of the policy.   The result was that the policy became self-funding.   The applicant entered into an agreement with the agent by which he promised to keep the policy in force for five years.

7.      During the second year when such policies were in force, the insurer became concerned as to their potential cost to it.   At some time in early March 1991 the applicant received a phone call from the insurer’s agent, who said that the insurer wanted to  terminate the policies, and that he would receive over $20,000 if he agreed to sign some documents.   As a result, on or about 9 March 1991 the applicant signed two agreements and a letter to the insurer.   In return he was given a cheque for $20,025.   The respondent contends that that amount constitutes assessable income, and the applicant contends that it does not.   It appears that the amount paid represented a loan to the applicant.   Shortly thereafter the debts by way of loans and interest came to exceed the cash value of the policy, and the policy lapsed.   The net result of all the transactions relating to the policy was that the applicant had received a gain of $20,025.  

8.      This Tribunal has already heard and determined an application involving a similar policy and similar transactions that was the subject of an appeal to the Federal Court of Australia: Commissioner of Taxation v Haass (1999) 42 ATR 529; 99 ATC 4814; [1999] FCA 1088. In that case it was argued on the basis of Federal Commissioner of Taxation v The Myer Emporium Limited (1987) 163 CLR 199 and Westfield Limited v Federal Commissioner of Taxation (1991) 28 FCR 333 that the gain to the taxpayer did not constitute assessable income because the transaction was outside the ordinary scope of his business and the profit-making purpose which led him to enter into the transaction was distinct from the means by which his profit or gain was made. But Heerey J rejected that submission and held that the gain received by the taxpayer constituted assessable income. Although the Tribunal had found that the taxpayer, when he took out the policy had not contemplated making a gain by borrowing against the policy and then letting it lapse, he had contemplated receiving cash in return for the surrender of the policy, and His Honour apparently saw no material distinction between the two means of obtaining a cash gain before the expiry of the term of the policy.

9.      We are bound by that decision.   We must therefore treat the payment received by the applicant as assessable income unless there is either some basis for distinguishing that decision or some argument that was not raised before Heerey J that entitles the applicant to succeed.

10.     As was the case in Haass, the applicant was a business proprietor at all material times.

11.     I n this case the applicant had entered into an agreement to keep the policy in force for at least five years, but allowed the policy to lapse sooner than he had ever intended to surrender it.   We do not think that makes any difference.   It is clear from Myer Emporium and from Westfield that only the means by which a taxpayer makes a gain, as distinct from the timing of that gain, can result in a gain not constituting assessable income.    It was submitted on behalf of the applicant in Application TT1996/41 that Myer Emporium was irrelevant since it did not relate to insurance policies.  We regard it as being of general application, but as inapplicable to the facts of this case.

12. The applicant contends that, because the policy was terminated within ten years of its commencement, the only appropriate basis for assessment involves applying s.26(i) and/or s.26AH of the Income Tax Assessment Act 1936 (“the Act”). No such argument was advanced in Haass.   If this argument is correct, the effect would apparently be to that any profit or gain under the policy would have to be taxed at the applicant’s marginal tax rate less a rebate of 39%.   The result would apparently be a zero tax liability.

13. Section 26(i) of the Act provides that the assessable income of a taxpayer shall include “any amount received as or by way of bonus other than a reversionary  bonus on a policy of life assurance”.   None of the money received by the applicant constituted a bonus.  He received the proceeds of a loan that he was never required to repay.   In the context of life insurance, a bonus is an addition to the sum insured which is payable when that sum is payable.   It represents a form of participation by the policyholder in the insurer’s profits, or a share in the surpluses derived by that company while the policy is in force.

14. So far as s.26AH is concerned, the central provision in that section is subsection (6), which provides as follows:

“Where, during the eligible period in relation to an eligible policy, a taxpayer receives an amount (in this sub-section referred to as the “relevant amount”) under the policy as or by way of a bonus, being an amount that, but for this section, would not be included in the assessable income of the taxpayer of any year of income, the assessable income of the taxpayer of the year of income in which the relevant amount is received shall include –

(a)if the relevant amount is received during the first 8 years of the eligible period – an amount equal to the relevant amount;

(b)if the relevant amount is received during the ninth year of the eligible period – an amount equal to two-thirds of the relevant amount; or

(c)if the relevant amount is received during the tenth year of the eligible period – an amount equal to one-third of the relevant amount.”

15. As the moneys the applicant received were the proceeds of a loan, rather than a bonus added to the sum insured, s.26AH has no application in this case. The Commissioner has a discretion under s.26AH(9) to treat an amount other than a bonus as if it were a bonus, but only where he is of the opinion that that amount or part of it represents the whole or part of a bonus that has accrued or has been declared in respect of the policy, or of a bonus that can reasonably be expected to accrue in respect of the policy. It seems clear that in this case no bonus accrued, no bonus was declared, and the moneys paid to the applicant had nothing to do with any bonus that could reasonably be expected to accrue in the future. We therefore reject the submission based on s.26AH.

16.     The applicant contends that many thousands of policies issued by insurance companies are terminated early, and that such policies are often charged to secure loans made by the insurers to the policyholders, but that there has apparently never been any attempt by the Commissioner to treat the proceeds of such policies in the same way as the proceeds of policies like his.   He further contends that the gains made by taxpayers in Tasmania as a result of transactions concerning these policies are being treated as assessable income, but that a different view is being taken in relation to over 2,000 such policies issued in other States.   Whether or not the applicant is correct about these matters, we consider it our duty to apply the law as we understand it to the facts of this case.   We see no basis for distinguishing Haass. The result must be that the moneys received by the applicant constituted “income” within the meaning of s.25(1)(a) of the Act, and thus assessable income. We therefore have no option but to affirm the decision under review.

I certify that the 16 preceding paragraphs are a true copy of the reasons for the decision herein of Deputy President A M Blow OAM, QC.,

Signed:         .....................................................................................
  Personal Assistant

Date/s of Hearing  17 March 2000
Date of Decision  9 June 2000
Representative for the Applicant               The applicant appeared in person.

Representative for the Respondent          Mr S Loader (Australian Taxation Office)