Colonial Mutual Life Assurance Society Limited v Commissioner of Inland Revenue Ca202/99

IN THE COURT OF APPEAL OF NEW ZEALAND

CA 202/99

BETWEEN	COLONIAL MUTUAL LIFE ASSURANCE SOCIETY LIMITED
Appellant

AND	THE COMMISSIONER OF INLAND REVENUE
First Respondent

Hearing:	7 February 2000
Coram:	Richardson P Gault J Henry J Thomas J Blanchard J
Appearances:	L McKay and A M Grace for Appellant
P J H Jenkin QC and R Wallace for Respondent
Judgment:	18 May 2000

JUDGMENTS OF THE COURT

Judgments
Paras No
Richardson P  [1] -   [37]
Gault J  [38] -   [69]
Henry J  [70] -   [89]
Thomas J  [90] - [176]
Blanchard J  [177] - [194]

RICHARDSON P

The question for decision in this appeal from a judgment of Hammond J reported at (1999) 19 NZTC 15,375 is whether interest charged by Colonial Mutual Life Assurance Society Limited (“CML”) on outstanding premiums on its whole of life insurance policies in the 1987‑1990 income years was taxable income of CML for those years.

Background

The taxation of life insurance companies does not fit readily into any of the accepted categories of taxing income moving through intermediaries. Historically, life insurance has focused on long‑term contracts involving a form of co‑operative risk sharing, but also including a saving and investment element. The insurer receives a premium which is calculated actuarially to be a sufficient payment with the income from the investment of the premiums to meet expenses and provide the amount to discharge the contractual liability to the policy holder when the time arrives.
It is not feasible for tax purposes to impute to and collect from a policy holder his or her share of the company’s income year by year during the term of the policy. Also, because of the insurance, as distinct from investment, aspects of life insurance there has been no reasonable way of taxing the excess of policy proceeds over the amount of premiums payable. And, because of the contractual liability of the insurer and the continuing influence of the historical mutual basis for life insurance, it has traditionally been considered inappropriate to treat premiums received as income of the company. Nevertheless, governments have considered it important for fiscal and wider policy reasons to exact some tax from the company itself in respect of its annual income earning activity.
In New Zealand as in other countries different approaches have been adopted at different times. The original Land and Income Assessment Act 1891 Schedule C, Rule 4 provided for tax to be assessed on “the income derived by [any company carrying on the business of life insurance in New Zealand] from investments of any kind other than investments in land or upon mortgages of land”. That pattern continued until 1930. By then the subject of the tax in the case of foreign insurance companies was income from investments out of New Zealand held on behalf of the New Zealand branch and from investments of any kind in New Zealand less 2% of its New Zealand investments which were not exempt from taxation (Land and Income Tax Act 1923 s95); and s96 went on to provide a further reduction to effectively one‑half the income tax that would otherwise be payable (excluding from that reduction income derived from debentures).
In 1930, and in response to a concern that overseas insurance companies were not investing in New Zealand and were not contributing a fair share compared with the Government Life Insurance Department (see 225 NZPD 460 and 496), the basis for taxing life offices changed to taxing the amount of the surplus funds allotted to policy holders by way of reversionary bonuses (Land and Income Tax Amendment Act 1930 s9) and with the s96 reduction being reduced to ⁹/₂₀.
With some adjustments that remained the basis for taxing life insurance offices until 1982. The Report of the Taxation Review Committee (Taxation in New Zealand), known as the Ross Report (1967 A to J, H of R B18) para 1021 noted that the basis of assessment and the rates of tax were “the subject of direct negotiation between the life insurance companies and the Government, and the Committee has been requested to exclude the position of life insurance companies from its considerations”.
Reporting in 1982, the Task Force on Tax Reform (the McCaw Report) concluded at para 12.11 that there was a strong prima facie case for treating the life office/superannuation fund as an agent of the policy‑holders and liable for income tax on investment income at the average marginal income tax rate that would be payable by the policy‑holders if they derived the investment income in their own right; discussed the options for treatment of premium payments and receipts on retirement/maturity; and recommended at para 12.24 that the whole treatment of life offices and superannuation funds for taxation purposes should be the subject of separate and urgent review by the Government. However, and giving effect to the Budget announcement a few weeks after that report was delivered, a new tax regime for life insurance companies was enacted by the Income Tax Amendment Act (No 2) 1982 s34. Applying for the income year commencing 1 April 1983 it provided, as the Minister stated in moving the second reading, that “the assessable income of a life insurance company will be the income derived from investments” taxed at 31 cents in the dollar (449 NZPD 5218; and to similar effect the Explanatory Note to the Bill). Section 34 substituted a new s204 in place of the existing ss204, 205 and 206 of the Income Tax Act 1976. The new section applies to the tax years in this case.
Following further reviews a new comprehensive tax regime replaced the 1982 regime in 1990 (Income Tax Amendment Act (No 2) 1990 s13). The new regime established a two tier tax base, taxing a life insurer first on all its income in accordance with a given formula, and second on the income of the policy holders, again in accordance with a formula, to identify gains derived as a result of the increase in the value of their policies, thus taxing the fund as proxy for the member but with a credit for tax paid at the first (the life office base) level. Since then there have been further reviews and reports on the tax treatment of life insurance and related areas.
Given the divergent approaches over the years to taxing life insurance companies, there is all the more reason for determining the issue in the present case as a question of construction of the material provision, s204 of the 1976 Act as it read during the income years in question.

Section 204

The section read:
(1)For the purposes of this section,--
‘Direct investment revenue costs’, in relation to revenue from investments, fees, and commissions (excluding commissions in respect of contracts for reinsurance) derived in any income year by a company to which this section applies, means costs incurred in carrying on its business of life insurance in that income year by that company exclusively in deriving that revenue, not being costs which are recoverable, directly or indirectly, from any person:
‘Direct premium revenue costs’, in relation to revenue derived in any income year by a company to which this section applies in respect of premiums on policies of life insurance and contracts for reinsurance and annuities granted, means costs incurred in that income year by that company exclusively in deriving such revenue, and without in any way limiting the meaning of the expression, includes the costs of developing, marketing, promoting, advertising, servicing, and selling such policies, contracts, and annuities (including salaries, wages, commissions, fees, allowances, or other remuneration paid or payable to employees and agents):
‘Gross revenue’, in relation to any company to which this section applies and to any income year, means the gross revenue derived by that company in carrying on its business of life insurance and reinsurance and granting of annuities; and includes--
(a)   Premiums on policies of life insurance issued by that company, reduced by the amount of any premiums or other considerations paid or payable in respect of contracts of reinsurance made in respect of those policies:
(b)   Premiums or other considerations received or receivable by that company in respect of contracts of reinsurance made in respect of policies of life insurance issued by any other person:
(c)   Considerations received or receivable by that company in respect of the granting of annuities:
(d) Total revenue received or receivable by that company from its investments otherwise than by way of sale or other disposal of any investment:
(e)   The aggregate amount of all profits derived from the sale or other disposal of any investment of that company:
(f)   All commissions and fees received or receivable by that company, reduced by--
(i)    Commissions in respect of contracts for reinsurance; and
(ii)   Fees in respect of policies of life insurance, contracts of reinsurance, and annuities granted,--
reduced by the aggregate amount of all losses incurred in carrying on its business of life insurance on the sale or other disposal of any investments of that company:
‘Indirect general revenue costs’, in relation to a company to which this section applies and to any income year, means costs of a revenue nature incurred in that income year by that company in carrying on its business of life insurance, not being direct investment revenue costs or direct premium revenue costs:
‘Indirect investment revenue costs’, in relation to any company to which this section applies and to any income year, means the indirect general revenue costs incurred by that company in carrying on its business of life insurance in that income year, reduced by the indirect premium revenue costs incurred by that company in that income year:
‘Indirect premium revenue costs’, in relation to any company to which this section applies and to any income year, means costs incurred by that company indirectly in respect of or in relation to policies of life insurance, contracts of reinsurance, and the granting of annuities, being that proportion of the indirect general revenue costs of that company in that income year ascertained in accordance with subsection (6) of this section:
‘Life Insurance Fund’, in relation to a company to which this section applies, means the Life Insurance Fund (within the meaning of section 15 of the Life Insurance Act 1908) of that company:
‘Policy’ includes a contract for a policy:
...
(2)This section applies to every company, whether established or incorporated in New Zealand or elsewhere, engaged in the business of life insurance or reinsurance in New Zealand where the Commissioner is satisfied that the business in New Zealand consists of--
(a)   The issue by that company of policies of life insurance upon human life in New Zealand or the entering into contracts of reinsurance in relation to policies of life insurance upon human life in New Zealand or the granting of annuities upon human life in New Zealand; and
(b)   The investment and management of money received by way of premiums in respect of those policies and consideration for those contracts and annuities.
(3)For the purposes of subsection (2) of this section, where a company has, in respect of the whole or, as the case may be, part of any policy of life insurance upon human life in New Zealand issued by it, entered into a contract of reinsurance with any other person as reinsurer, the expression “the issue by that company of policies of life insurance upon human life in New Zealand” shall, in determining whether the requirements of that subsection have been satisfied, be construed without regard to the fact that the company has entered into that contract of reinsurance.
(4)For the purposes of this section, the Government Insurance Commissioner shall be deemed to be a company to which this section applies.
(5)Subject to this section and clause 2A of the First Schedule to this Act, every company to which this section applies shall be assessable and liable for income tax as if it were not a company to which this section applied.
(6)For the purposes of this section, the amount of the indirect premium revenue costs incurred in any income year by any company to which this section applies in carrying on its business of life insurance, shall be an amount calculated in accordance with the following formula:
x
^__ X z
y
Where--
x is an amount equal to the aggregate of all the premiums and other considerations referred to in paragraphs (a), (b), and (c) of the definition of the expression “gross revenue” in subsection (1) of this section received or receivable by that company in that income year; and
y is the gross revenue of that company for that income year; and
z is the indirect general revenue costs incurred by that company in that income year.
...
(8)Every company to which this section applies shall for the purposes of assessing income tax be deemed to have derived and to derive profits from its business of life insurance in any income year of an amount equal to the amount of the gross revenue of that company for that income year reduced by an amount equal to the sum of--
(a)   An amount equal to the aggregate of all the premiums and other considerations referred to in paragraphs (a), (b), and (c) of the definition of the expression “gross revenue” in subsection (1) of this section, received or receivable by that company in that income year; and
(b)   The amount of the direct investment revenue costs incurred by that company in that income year; and
(c)   The amount of the indirect investment revenue costs incurred by that company in that income year.
...
(9)For the purposes of assessing income tax, every company to which this section applies shall be deemed to have derived and to derive assessable income from its business of life insurance in any income year of an amount equal to the profits ascertained in accordance with subsection (8) of this section, reduced by an amount equal to an amount calculated in accordance with the following formula:
a
^__ X c
b
Where--
a is the amount of so much of the liabilities of the company in respect of policies of life insurance, contracts of reinsurance, and annuities granted (being the liabilities at the end of that income year) as, in the opinion of the Commissioner, relates to--
(i)Specified mortgage repayment insurance policies included in the Life Insurance Fund of that company; and
(ii)Superannuation policies included in that Fund; and
(iii)Annuities granted included in that Fund; and
b is the amount of so much of the liabilities of the company as, in the opinion of the Commissioner, relates to all policies of life insurance, contracts of reinsurance, and annuities granted (being the liabilities at the end of that income year) included in that Fund; and
c is the amount of the profits of the company for that income year, ascertained in accordance with subsection (8) of this section,--
and the company shall be assessable and liable for income tax accordingly.
...
(10)For the purposes of subsection (9) of this section, a policy shall be taken to be included in the Life Insurance Fund if, in the opinion of the Commissioner, liabilities under that policy would be payable from that Fund.
...

The relevant policy and factual background

The relevant policy provision, cl 2, reads:
2.PAYMENT OF PREMIUMS
(i)    Premiums must be paid within one calendar month of the due date.
(a)     If default be made in the payment of any premium before this policy shall have been in force for two years and two years’ premiums shall have been paid, this policy shall be forfeited and become void as from the date the unpaid premium fell due and the Society shall not be required to give notice to this effect to the Insured.   Provided always that if the Life Insured shall die within one calendar month after the date of any unpaid premium, the amount hereby insured shall be payable subject to the deduction of the unpaid premium.
(b)     If default be made in the payment of any premium after this policy shall have been in force for two years and two years’ premiums shall have been paid, this policy shall not become void until its surrender value after deduction of any debt shall become insufficient to pay one quarterly premium computed according to the mode adopted by the Society or if the premium be payable more frequently than quarterly, shall become insufficient to pay one premium.   If a claim arise during the continuance of such default and before forfeiture through the exhaustion of the surrender value, the amount hereby insured will be payable subject to the deduction of any debt.   The debt on any policy is defined as arrears of premium plus compound interest and any policy loan plus compound interest.
...

That provision is consistent with the statutory protection provided for policy holders under ss63 and 64 of the Life Insurance Act 1908. They read:

63.A company may, subject to any bylaws or regulations made by it or affecting it, and subject also to the terms and conditions of the policy, apply the surrender value of any policy, or any part of such surrender value, in payment of overdue premiums and interest thereon; and any money so applied, with accrued interest thereon, shall be a first charge on the money payable under such policy and on the surrender value thereof, and may be deducted therefrom as against any mortgagee or assignee whomsoever
64.No policy shall become void by non-payment of premiums so long as the premiums and interest in arrear are not in excess of the surrender value as declared by the company issuing the same in the answer of such company given to the tenth question of the Seventh Schedule hereto.

Clause 2(i)(b) covers cases where premiums are overdue under a policy which has been in force with premiums paid for at least two years. In those circumstances the policy does not become void until, in broad terms, the surrender value - a contingent asset of the insured and contingent liability of the insurer - is insufficient to cover the premium. Once that situation is reached, the policy terminates. If a claim arises before forfeiture through the exhaustion of the surrender value, the amount payable is subject to the deduction of the arrears of premium plus compound interest. There is neither an actual nor a notional advance to the insured of the sums involved.
There was considerable evidence before the High Court, including expert actuary evidence on both sides, as to the accounting treatment and industry practice relating to outstanding premiums. That is discussed at some length in the judgment of Hammond J. At para [33] the Judge records that in the four income years in question CML treated as premium for income tax purposes what it described as notional interest on the late payment of premiums. However, like Hammond J, I do not find material of that kind of particular assistance in determining the legal issue in the present case, which is essentially a matter of construction of the policy provision and s204.
What is relevant as part of the factual matrix is that CML, like other life offices, developed premium rates for particular categories of policies based on actuarial assumptions of demographic risks and financial returns on sums invested.   Assumptions as to the rate of earnings it will derive from the investment of premiums include assumptions as to the time of payment, and so as to the period for which it will be able to invest each premium.   Thus, rate books assumed payment of premiums on a variety of bases, e.g., fortnightly, monthly, six-monthly or yearly in advance; and obviously enough the longer the payment is made in advance the lower the rate.   Adjustments are made to reflect the period chosen because of the potential loss of earnings for later paid premiums, the additional administrative costs where more frequent payments are to be made, and the mortality loss component reflecting a possibility that the insured will die before the year end without having paid the same number of full year’s premiums that a yearly in advance policy holder would have paid.   The typical breakdown of the components of CML’s additional premium was:
hAllowance for additional administrative costs  30%
hAllowance for additional mortality risk  10%
hAdditional premium required to take account of the
lower investment earning potential  60%

The Judge accepted that the principal reason for the need to charge an additional sum if a premium is not paid on the agreed date is the reduction in investment income earned by CML as a consequence of the late payment of the premium (para [39]).

However, for pragmatic reasons CML charged compound interest on outstanding premiums rather than attempting to make a separate additional calculation for each outstanding premium for the period of non‑payment and, unlike the situation that has developed in Australia, a margin has not been applied in New Zealand between interest on policy loans by insurers to policy holders and interest for late payment of premiums.

The High Court judgment

The question for the High Court as posed in the case stated was:
Whether the Commissioner acted correctly by treating the additional sum charged for late paid premiums as interest from investments and therefore assessable income for the tax years 1987 to 1990 inclusive.

However, without demur, in argument in the High Court the Commissioner also contended that the interest amounts, if not receivable from investments, came within “gross revenue” under s204.

Hammond J concluded that he was bound by the decision of this court in Commissioner of Taxes v Australian Mutual Provident Society (1902) 22 NZLR 445 to hold that interest on outstanding premiums was income from investments. But for his obligation to follow that decision he would have found for CML that there was no debt, no loan, and no investment.
In the AMP case, the by‑law of the insurance company provided:
The failure or omission to pay the premium shall not render a policy void so long as the surrender value of such policy, as fixed by the board, is in excess of any loan thereon (if any), and is sufficient for the payment of the premium then due. Any sum so appropriated shall carry interest at such rate as the board shall determine, and shall be a charge on the policy.
Section 55 of the Land and Income Assessment Act 1900 simply deemed the income of the life insurance company to be “a sum equal to its total income from investments of any kind other than investments in or on land”.   The court by a majority (Williams J, Edwards J and Conolly J, Stout CJ dissenting) concluded that interest on sums applied in payment of overdue premiums came within the term “income from investments of any kind”.   Williams J reasoned (at 453‑454):
If interest is payable, it is payable either in respect of a premium which is in arrear or in respect of money advanced or found by the society to pay the premium.   I think that one thing is practically the same as the other.   ...   So, if A says to B, “I want you to place the sum to the credit of a particular account, and in consideration of your doing so I will give you a charge over property of mine for that sum and interest, but I will not become personally liable for it,” and B agrees, B, though he may not have advanced the money to A in the sense that he could recover it back from A, has none the less found the money for A and has invested it in the purchase of the charge from A.
The effect of sections 31 and 32 of the Act of 1884, and of By-law VIII, is to constitute as part of the terms of the assurance an agreement between the policyholder and the society that in consideration of the society keeping the policy on foot and treating the premiums as paid so long as the premiums and interest do not exceed the surrender value, the policyholder agrees that the amount of such premiums, with interest, shall be a charge on the money payable under the policy and on the surrender value of the policy.   ...
It seems to me that such sum of money is “invested,” and that the charge is an “investment” within the ordinary meaning of the word, and that it is immaterial how the society acquired the charge - whether by making an advance or for some other consideration, or even by gift.
Edwards J considered that in the absence of a statutory definition of “investment” the word must be read in its popular meaning, embracing every mode of application of money which is intended to return interest, income, or profit.   He concluded that money advanced by the AMP on the security of its own policies was clearly an investment and continued (at 457 and 458):
Now, what are sums, part of the surrender value of a policy, applied by the defendant society, under its By‑law VIII, in payment of overdue premiums, but sums advanced upon the security of the policy, and bearing interest, and therefore an investment?   ...
It is quite immaterial that no money actually passes: the premium, if paid, would be available for investment.   The contract requires the defendant society for all purposes to treat the premium as paid, and also to treat the moneys so paid as an interest‑bearing advance upon the security, created by the contract, of a charge upon the policy and the moneys payable thereunder.

Conolly J concurred with Williams J and Edwards J.

The Chief Justice rejected the argument that AMP derived income from “an investment”.   The root idea of an investment is the putting out of money.   In that transaction no money was put out.   The cash account was not depleted by the entry of the premium paid.   No money passed.   The surrender value was only a contingent liability of the AMP.   The unpaid premium was a charge on that surrender value (at 451):
That is, the premium is credited on the one hand, and debited on the other against possible liability.   This sum credited is not a loan, for no cash transaction takes place.   The sum credited is not a debt, for it cannot be sued for.   No money is advanced or laid out.   As I have said, the cash account is not lessened.   At most the transaction seems to be in the nature of a set‑off.   ...
It is said interest is charged on this credit payment.   But the charging of interest on a debt - and this is something less than a debt - does not make a debt an investment.   Interest is payable on many mercantile accounts.   Many merchants who deal with each other debit and credit interest.   Can it be contended that such current accounts between merchants are “investments”?   ...
Another test may be applied.   After the “payment” of premiums has been credited for some years the “surrender value” will become not equal to the amount of the payments credited, and then what becomes of the “investment”?   It vanishes with the policy.   When the “investment”, so called, attains its maximum value it ceases.   How?   By payment?   No.   But by the society getting rid of a contingent liability.   The one debit is set against the other possible debit, and the transaction ends.
After discussing the AMP case Hammond J concluded that there was no distinction between the statutory language under the 1900 Act, “total income from investments of any kind”, and the expression in s204(d) of the 1976 Act, “total revenue received or receivable ... from investments” and that he was bound by the decision in the AMP case. However, he went on to say that, on an unencumbered view, he preferred Stout CJ’s reasoning. That, too, was the view taken in the Full Court of South Australia in Australian Mutual Provident Society v Commissioner of Taxes [1907] SALR 88 and by the Full Court of the Supreme Court of Western Australia in The Crown v National Mutual Life Association (1922) 25 WALR 1.
Hammond J considered that a debt was something owed by one person to another. The insured could not be sued during the “life” of that asset; and, on exhaustion of the asset the policy terminated. It was not a “loan”. A business loan transfers a sum of money on condition of payment on a date certain. Here, the “asset” does not change hands. The surrender value remains with the life office. That office is enabled - by statute - to diminish that asset, if necessary to the point of extinction, by charging interest against it. To conclude from that statutory solution that there is a loan (and hence an investment, by some sort of notional advance) seems, he said, quite inappropriate.

The rival arguments

Mr McKay’s primary submission was that as a matter of the proper construction of s204 the amount of interest on overdue premiums in respect of the life insurance policies did not constitute income from an investment within s204(1), but was in the nature of a premium and therefore excluded from calculation of CML’s assessable profits under s204(8). He submitted that an unpaid premium is not an investment within the ordinary usage of that term and that in any event in terms of the scheme and purpose of s204, including the proxy basis on which the insurer is taxed on behalf of those insured, the unpaid premium is not an investment of the life office and interest on it is itself premium. The calculation of the premium always depends on the period of time CML will hold the premium and thus be able to earn income on the premium. The interest charge arising if the premium is not paid by the agreed date is set because of the same considerations and has the character of premium.
Mr Jenkin for the Commissioner submitted that the “interest” applied to overdue premium payments was properly so described. The key element of risk assessment was absent in the calculation of interest both on loans to policy holders and on overdue payments and the compound interest charged, which was at the same rate in both cases, was more than a catch‑up and necessarily included a profit element. In his submission, “interest” was properly so defined in the policy; it was within the definition of “interest” and “money lent” under the general provisions of the Income Tax Act and was part of CML’s “gross revenue”; and that interest was derived by CML in terms of s75 in the year in which it was compounded and capitalised.

Discussion and conclusions

“Gross revenue” is widely defined in s204(1) as meaning the gross revenue derived by the company in carrying on its business of life insurance and as including specific categories, of which (a), (b) and (c) are directed particularly to premium receipts and receivables, (d) and (e) to investment revenues, and (f), it seems, to commissions and fees such as procuration fees, fees for underwriting security issues and the like which are not referable to the premium side of business but might not be considered as coming squarely within the expression “investment”, although incidental to the carrying on of investment or financing activities. But in determining whether interest on overdue premiums is taxable income of the company it is necessary to look at the scheme and purpose of s204 and where outstanding premiums and interest thereon fit in the statutory scheme.
The starting point is s204(2). It provides for s204 to apply where the life insurance (or re‑insurance) business consists of the two specified activities: (a) the issue of policies of life insurance or the entering into contracts of re‑insurance or granting annuities, in both cases life related; and (b) the investment and management of money received by way of premiums in respect of those policies and consideration for those contracts and annuities. It is providing for a code governing the taxation of companies carrying on in New Zealand the business of life insurance or re‑insurance defined as consisting of those two activities. Each of those two sides of the business produces a revenue stream. Each has associated direct and indirect expenses which are recognised and allocated under the statutory scheme. That is the function of subs (8). In terms of that subsection, the company is deemed to derive profits from its business of life insurance - that is its business consisting of the two activities identified in subs (2), namely, its policies and its investments. The profits from those two sides of the business are measured by the gross revenues of the company for the year but reduced in terms of paras (a), (b) and (c).
At the first step, para (a), premiums and the related considerations received and receivable are deducted. They are excluded because they are inputs by the holders of those policies and contracts which are required under their policies or other contracts with the company. The object is to tax income generated from those contractually required contributions. In terms of para (a) premiums and other considerations, “receivable by that company in that income year” are deductible, whatever accounting or other steps are subsequently taken by the insurance company in relation to overdue premiums. And because premiums are excluded in ascertaining the profits of the business under subs (8) and thus from the assessable income under subs (9), there is no provision for deduction of revenue costs directly or indirectly relating to premiums.
Paragraphs (b) and (c) of subs (8) go on to provide for the deduction of direct investment revenue costs and indirect investment revenue costs respectively. The definition of direct investment revenue costs in subs (1) confines the deduction to costs incurred in deriving “revenue from investments, fees, and commissions (excluding commissions in respect of contracts for re‑insurance)” paralleling (d), (e) and (f) of the definition of “gross revenue” and so excluding deduction of costs on the premium receivables side of the business. Similarly, the definition of indirect investment revenue costs (which are deductible under subs (8)(c)) in subs (2), when read together with the definition of indirect general revenue costs and indirect premium revenue costs and the apportionment provisions of subs (6), excludes both direct and indirect premium revenue costs. And so, to take a theoretical possibility unlikely to occur in practice, if a company borrows to make up the outstanding premiums so as to ensure its premium flow, it seems that the interest “costs incurred” would come within the expression “indirect premium revenue cost”.
Given that clear demarcation under the statutory scheme, I consider that overdue premiums are premiums receivable and that interest charged on such premiums has that character and is deductible for the purposes of s204(8). The interest is an adjustment in relation to the premium payable contractually charged because of the delay in payment and made on a daily basis.
Interest is not a technical word. It is not confined to payment for the use of money lent. The word is commonly used to describe compensation for delay in payment of amounts due in respect of late payment, for example, of trade debts. Where it relates to delay in making a payment of a particular character, it may readily be ascribed that same character. The calculation of premium reflects the time value of money. That is reflected in the different premium rates depending on frequency of payment. Interest payable in respect of the delay in payment can readily be viewed in the same way as the agreed adjustment to a premium to reflect the change in the time of payment.
There is a clear distinction applied under the Australian legislation (6 Australian Tax Practice, para 110/05) between a charge for the outstanding premium and interest thereon under a policy condition and a loan by the insurance company or a third party on the security of the policy, the proceeds of which are then applied in payment of outstanding premiums and interest. And it is now well established that, except where sham considerations or anti‑avoidance provisions are applicable, the income tax consequences of a contractual arrangement are determined by reference to the legal arrangements actually entered into, not by the overall economic consequences to the parties and not on the basis of a different arrangement that they might have, but did not, enter into (Re Securitibank Ltd (No 2) [1978] 2 NZLR 136; Buckley & Young Ltd v Commissioner of Inland Revenue [1978] 2 NZLR 485). In that regard I respectfully disagree with the reasoning of Williams J and Edwards J in the AMP case.
Again, I do not see the 1902 decision as inhibiting the approach we should take to the construction and application of s204. There is a limited superficial similarity between the two statutory provisions of s55 of the 1900 Act and s204 of the 1976 Act as enacted in 1982. Both use the language of taxing income from the investments of the insurance company. But investment of premiums is a necessary feature of life insurance and such expressions as profits from investments and income from investments have conventionally been used in the discussion of life insurance business outside the tax field. And the balance sheet of life insurance companies prepared in the form required in the Third Schedule as provided by s16 of the Life Insurance Act 1908 specifies “outstanding premiums on policies in force” separately from mortgages, loans on the company’s policies, and “investments” as listed ending with “other investments”.
As a matter of statutory interpretation the meaning of a word or a phrase often inevitably depends on the context in which it is employed. The scheme of s204 dealing with what is regarded as a complex subject and in doing so seeking to provide a clear demarcation between the two sides of the business of life insurance, is a far cry from the understandably rudimentary approach under the five line s55.
Further, it seems highly improbable that the framers of s204 would have had the AMP decision in mind. It had been decided 80 years previously under a provision which in its subsequently developed form had been repealed over 50 years previously and replaced by an entirely different approach which had been followed for tax purposes up to 1982. And so far as my researches go the decision was not even mentioned in the tax texts current in 1982.
Finally, I cannot see any justification for concluding that interest charged on overdue premiums which would otherwise have the character of premium for the purposes of s204 loses that character because there is an absence of explicit calculation in respect of the mortality risk (the 10% component of the premium referred to in para [14] above) and because there is arguably an element of profit to CML above the catch‑up for the delay in payment.

Result

In accordance with the views of the majority the appeal is allowed and the question arising on the case stated (para [1]) above is answered in the negative. CML is entitled to costs on the appeal which are fixed at $5,000 together with reasonable disbursements as fixed, if necessary, by the Registrar. Costs in the High Court are to be fixed in that court, if the parties are unable to agree.

GAULT J

In the appellant insurer’s standard form of the relevant life insurance policy, in the section headed “Conditions Applicable to All Benefits” clause 2(b) reads:
(b)If default be made in the payment of any premium after this policy shall have been in force for two years and two years’ premiums shall have been paid, this policy shall not become void until its surrender value after deduction of any debt shall become insufficient to pay one quarterly premium computed according to the mode adopted by the Society or if the premium be payable more frequently than quarterly, shall become insufficient to pay one premium. If a claim arises during the continuance of such default and before forfeiture through the exhaustion of the surrender value, the amount hereby insured will be payable subject to the deduction of any debt. The debt on any policy is defined as arrears of premium plus compound interest and any policy loan plus compound interest.
This clause reflects the requirements of s64 of the Life Insurance Act 1908 which reads:
Policies to be kept in force by surrender value - No policy shall become void by non-payment of premiums so long as the premiums and interest in arrear are not in excess of the surrender value as declared by the company issuing the same in the answer of such company given to the tenth question of the Seventh Schedule hereto.

Section 63 also is relevant. It provides:

Applying surrender value to keep policy in force – A company may, subject to any bylaws or regulations made by it or affecting it, and subject also to the terms and conditions of the policy, apply the surrender value of any policy, or any part of such surrender value, in payment of overdue premiums and interest thereon; and any money so applied, with accrued interest thereon, shall be a first charge on the money payable under such policy and on the surrender value thereof, and may be deducted therefrom as against any mortgagee or assignee whomsoever.

The issue for determination in this appeal is whether compound interest on arrears of premium received either by payment from the policyholder or by deduction from the surrender value of the amount insured was assessable income of the appellant in the tax years in question.
The matter is governed by s204 Income Tax Act 1976 which is set out in full in the judgment of the President which I have read in draft That provides for the taxation of companies insofar as they are engaged in the business of life insurance or re-insurance as defined in subs (2). It seems that if the company should conduct other business that would be assessed under the general provisions of the Act.
By subs (8) assessable income is identified as the profits from the business of an amount equal to the gross revenue as defined in sub (1) reduced by premium receipts and direct and indirect investment revenue costs (both as defined).
The company is not taxed on premium receipts nor can it deduct costs in deriving those receipts. The company is, however, taxed on revenue from investments and so is entitled to deduct investment revenue costs.
The Commissioner contends that the interest on arrears of premiums in the relevant years was revenue from investments or is in any event part of the “gross revenue”. The company on the other hand contends that the interest constitutes premiums and so is not taxable.
In Commissioner of Taxes v The Australian Mutual Provident Society (1902) 22 NZLR 445 this Court, by majority, held that interest on arrears of premiums charged against the surrender value of policies fell within “income from investments of any kind” in s55 of The Land and Income Assessment Act 1900. In the present case Hammond J in the High Court determined he was bound by that decision which he considered indistinguishable and held in favour of the Commissioner.
In the AMP case it seems to have been material that the insurer’s By-law VIII which was incorporated into the policy provided:
The failure or omission to pay the premium shall not render a policy void so long as the surrender value of such policy, as fixed by the board, is in excess of any loan thereon (if any), and is sufficient for payment of the premium then due. Any sum so appropriated shall carry interest at such rate as the board shall determine, and shall be a charge on the policy.
That was read together with ss31 and 32 of the Life Assurance Policies Act 1884 which were in the same terms as ss63 and 64 of the 1908 Act now applicable. The reasoning of the majority is captured in the passage from the judgment of Edwards J (p 457):
The policyholder has a vested valued interest in his policy, for which he can call upon the defendant society to pay, at the valuation provided by the contract. Apart from By-law VIII, he would forfeit that interest upon non-payment of any premium. To prevent this result the defendant society and the policyholder agree together by their contract, embodied in the policyholder’s proposal and the policy, and the various by-laws, regulations, and tables incorporated therewith, that, without any application by the policyholder, the surrender value of the policy shall be treated as a fund immediately available for payment of the premiums, that so much of it as is necessary for that purpose shall be so applied accordingly, and that the moneys so advanced shall be a charge upon the policy and the moneys payable thereunder, and shall bear interest. The premiums are for all purposes treated as paid. The policyholder may, if he pleases, at any time pay up the moneys applied in payment of the premiums, with interest, and relieve his policy from the charge. What is this but an advance of money, bearing interest, upon the security of the policy?
The By-law in the AMP case, when read against the statutory entitlement to do so, was interpreted as providing for appropriation of the surrender value in payment of overdue premiums. I am unable to see any basis for distinguishing the wording used in cl 2(b) of CML’s policy with which we are concerned. It is similarly directed to the sufficiency of the surrender value “to pay” the premium and, although it does not use the term “appropriated”, it assumes appropriation in the reference to “exhaustion of the surrender value”. Accordingly, I think the Judge was correct to follow the earlier decision.
We have been invited to prefer the dissenting view of Stout CJ and, in effect, to overrule the 1902 decision. Two principal reasons were advanced. The first was that the law has moved on in the field since 1902 and the majority adopted an equivalence test since rejected for determining tax liability in cases such as Buckley & YoungLtd v Commissioner of Inland Revenue (1978) 3 NZTC 61,271, 61,275. This argument was directed to a comment in the judgment of Williams J in which he was said to have treated the interest on the arrears of premium as the equivalent of interest on money advanced or found by the Society to pay the premium and so could be regarded as interest on an investment by the Society. However, when read in context this is not the process of reasoning adopted by Williams J. In the passage in question he was simply pointing out that if the surrender value was treated as a sum applied to pay the premium it would not be in arrears and so no interest would be payable. He, therefore, sought to rationalise just what the interest was payable for. He then said (p453):
If interest is payable, it is payable either in respect of a premium which is in arrear or in respect of money advanced or found by the society to pay the premium. I think that one thing is practically the same as the other.
He went on to find, however, that what actually occurred was that where a premium is not paid the policy was treated in the books of the Society as if it was paid – the payment was credited to the policy account in the same way as if it had been paid in cash with a corresponding debit somewhere in the Society’s books. That he found met the requirement for investment. I do not find in the judgment reasoning that the interest is taxable because what actually occurred was equivalent to what would have been the position if the Society had made a loan to the policyholder and received interest on that.
Interestingly, it is the very reasoning challenged as invoking equivalence that CML relies on in support of the assertion that the interest is in the nature of premium.
The evidence of what actually occurred in CML’s books was given before Hammond J by Mr Pfeifer, General Manger – Corporate Development for CML. He confirmed that policies in respect of which premiums are not paid continue in force as required by statute and the policy conditions. The timing of payment does not affect the benefits payable under the polices. Bonuses are calculated as if the premiums had been paid on the due date. He said “the effect of the non-forfeiture provisions is that on the non-payment of premium by the policyholder, the premium is treated as having been notionally advanced to the policyholder”. As Williams J pointed out in the AMP case the interest would seem to be earned on the notional advance, rather than on the late premium which is treated as paid. He described the accounting treatments which included:
In CML’s accounting records the notional interest arising from premiums that have remained unpaid for greater than one calendar month is recorded under the heading “Outstanding Premiums including Advances of Premiums” rather than the heading “Outstanding Interest Dividends and Rents”.
The term “Outstanding Premiums” under the heading “Outstanding Premiums including Advances of Premiums” refers to premiums which are due but where the one calendar month period for payment has not yet expired.
The term “Advances of Premiums” in that heading relates to premiums outstanding longer than the one calendar month grace period and where the amount of the outstanding premium has been notionally advanced against the surrender value of the policy. It includes the notional interest accumulated in respect of the advance.

This seems to reflect the process authorised by s63 and is not distinguishable from the position considered in the AMP case.

The second reason advanced for departing from the earlier decision was that the reasoning of the minority judgment of Stout CJ was preferred in two Australian cases: AMP Society v Commissioner of Taxes [1907] SALR 88 and Crown v National Mutual Life Association (1922) 25 WALR 1. In neither of those cases was there reference to any statutory provision corresponding with s31 of the New Zealand Act of 1873 (now s63). The reasoning in each case is brief and does not provide a sufficient basis to persuade me to depart from the previous decision of this Court.
This is not a situation in which any presumption should be made of legislative adoption of the 1902 judicial interpretation because of the legislative history reviewed by the President. Nevertheless, this Court does not depart from earlier decisions on points that are indistinguishable unless good reason is shown. In the present case the issue is purely historical because the legislation has been changed again since the tax years in issue. CML appears to have acted consistently with the earlier decision and I am not persuaded that we should now take a different view.
I have considered the reasoning of Stout CJ. I am not convinced that should be adopted. I am unable to agree that the arrears of premium and interest do not constitute a debt merely because they cannot be sued for. In any event, I am not entirely convinced that there might not be circumstances in which they could be sued for; e.g. if the policy were paid in the mistaken belief there were no arrears to be deducted. Further, I do not accept that in all circumstances there must be money laid out before there can be interest on an investment. A notional advance effected by book entry by which overdraft accommodation is converted to term loan would not prevent interest on the loan being revenue from investment for a bank.
Setting aside the issue of precedent I am unpersuaded that the interest revenue is to be categorised as premium within s204. As I have already mentioned, it is not sufficient that it is in the nature of premium income or can be rationalised as necessary to offset the time value of the unpaid premiums. That would be to accept that because it could have been imposed and collected as premium it is to be regarded as premium. Such equivalence arguments are impermissible. Nor am I convinced that because it may be said that the payment of the interest is a consideration necessary to keep the policy alive, it is to be regarded as premium. A contractually imposed penalty could be necessary to keep a policy alive yet that would not make it a premium. I am reinforced in this view by the wording of s204 where there appears to be a careful distinction drawn between “premiums” and “other considerations”. The latter are included as receivables only in respect of contracts of re-insurance. There is no reference to premiums or other considerations received on policies of life insurance issued by the company. That leads away from a wide interpretation of “premiums”.
In reality it is not the payment of the interest that keeps the policy alive, it is the statute. Further, it is not received in the case of forfeiture or maturity until after the policy has ceased.
Although not determinative, the terms in which the parties contracted are relevant. They identified the obligation as for compound interest not further premium. The quantum, although a percentage of the premium originally struck, was not related to the risk element affected by late payment. Because the rate was fixed as the same as on loans to policyholders it plainly incorporated a portion in excess of that necessary to offset the unavailability to the company of the premium for investment.
In most commercial contexts a requirement for the payment of interest on unpaid debts is motivated by the need to compensate for the “time value” of money. It does not follow that the interest bears the same character as the debt.
Tax consequences of a contractual arrangement are to be determined on the legal arrangement entered into unless it is to be bypassed as sham. Investigation of the intentions of the parties underlying the contract or their perceptions of it would lead to departure from the true nature of the transaction. In this case the policy makes no reference to the underlying rationalisation advanced by CML for treating the interest as of the character of premium. It is no more and no less than what the policy says it is, an obligation to pay compound interest on arrears of premium. When recovered by the company by payment or by set-off against surrender values or policy benefits it is not premium.
It follows from the views I have expressed that if it were necessary to choose between income from investment or premium in categorising the receipt of income on arrears of premiums, I would be inclined to favour the former. But I do not accept there are only the two categories. As I read s204 they are not exhaustive of the revenue streams of a life insurance company.
In s204 “gross revenue” which (subject to specified reductions) is to be taken as profit from the business of life insurance under subs (8), is defined as “the gross revenue derived by that company in carrying on its business of life insurance and re-insurance and granting of annuities; …”. That is broad and plainly encompasses interest received in the course of the business. I do not accept the argument that in its context of the section as a whole it is to be confined to the particular items of revenue the definition “includes”.
The argument is that the definition is to be read narrowly in light of subs (2) which confines the application of the section to companies whose business consists of issuing policies of life insurance, contracting for re-insurance and issuing annuities, and investing and managing moneys received as premiums. Therefore, it is said, because the specified components included in the definition of gross revenue represent revenue items corresponding to the components of which the business of life insurance is said to consist, they are to be regarded as exhaustive. But there is not a true match between subs (2) and (8). For example, the business is limited as regards investment to the investment and management of moneys received as premiums whereas the component of gross revenue is “total revenue received or receivable from its investments …”. That in its terms is wider than investment of premium moneys and plainly that must have been intended. Under s3 Life Insurance Act, before a company can carry on the business of life insurance, substantial securities must be deposited with the Public Trustee and the income from those belongs to the company (s5). That income would seem to be “derived in carrying on the business of life insurance” but is outside income from investments if that is limited by subs (2) to income from the investment of premiums.
If the definition of “gross revenue” in subs (1) is not read down by reference to subs (2), it is wide enough to encompass revenue derived in the course of the business of life insurance other than premiums and income from investments. I can see no policy reason why that should not be the case.
There was a suggestion in the course of argument that if the section is to be construed as leaving room for a third stream of revenue one would expect to find a provision authorising deduction of expenses incurred in generating that revenue. I accept Mr Jenkin’s argument that it is there. The item “ indirect investment revenue costs” for which deduction is provided in subs (8)(c) is defined as indirect general revenue costs after deduction of indirect premium revenue costs. “Indirect general revenue costs” are all residual costs of a revenue nature and would encompass costs of the kind referred to.
Mr McKay argued that the scheme of the legislative provisions reflects a “proxy” or “conduit” approach to taxing life insurance companies. Premium revenue is not taxed against the insurer and the benefits on maturity are not taxed on the policy owner. The company is taxed on income from investment of premiums in effect as the proxy of the insured who is not taxed on a proportionate share of that income. He submitted that it would be inconsistent with this scheme if the company were taxed on interest on arrears of premium. This seems to be a somewhat question-begging argument. If the interest is premium then the argument has force. If it is not, the argument does not show that it should be.
Mr McKay submitted also that there would be an over-taxing effect if the interest were taxed in the hands of the company. That was a complex argument resting on assumption of what the policyholder might otherwise do with the money and was too theoretical to convince me that it would raise a presumption of legislative intent.
For the reasons I have endeavoured to give I would not depart from the earlier decision of this Court which I regard as determining a question no different in principle. But in any event, I would hold that the assessment should be upheld as the interest on premium arrears is part of gross revenue within s204.
I would dismiss the appeal.

HENRY J

This appeal raises a question of statutory interpretation concerning the taxation regime imposed by the Income Tax Act 1976 in relation to a life insurance company. The relevant background, which is set out in the judgment of Richardson P which I have had the benefit of reading in draft, need not be repeated. The short issue is whether the word premium in the context of s204 of the Act includes compound interest accruing under a contract of insurance in respect of unpaid premiums. The issue is relevant to a determination of the taxable income of the appellant (CML) for the income years 1987-1990. The section is no longer in force.
Section 204 applied to companies engaged in the business of life insurance (including the granting of annuities) or reinsurance, and investing monies received by way of premium.   It contained a comprehensive regime governing the tax liability of such companies.   Calculation of profits, which for present purposes forms the basis of assessable income is determined by subs (8) which provided:
(8)Every company to which this section applies shall for the purposes of assessing income tax be deemed to have derived and to derive profits from its business of life insurance in any income year of an amount equal to the amount of the gross revenue of that company for that income year reduced by an amount equal to the sum of--
(a)   An amount equal to the aggregate of all the premiums and other considerations referred to in paragraphs (a), (b) and (c) of the definition of the expression “gross revenue” in subsection (1) of this section, received or receivable by that company in that income year; and
(b)   The amount of the direct investment revenue costs incurred by that company in that income year; and
(c)   The amount of the indirect investment revenue costs incurred by that company in that income year.
The argument for CML is that the compounded interest charged against overdue premium is deductible as being premium referred to in subs (1), which included the following definition for s204 purposes:
‘Gross Revenue’, in relation to any company to which this section applies and to any income year, means the gross revenue derived by that company in carrying on its business of life insurance and reinsurance and granting of annuities; and includes--
(a)Premiums on policies of life insurance issued by that company, reduced by the amount of any premiums or other considerations paid or payable in respect of contracts of reinsurance made in respect of these policies:
(b)Premiums or other considerations received or receivable by that company in respect of contracts of reinsurance made in respect of policies of life insurance issued by any other person:
(c)Considerations received or receivable by that company in respect of the granting of annuities:
(d)Total revenue received or receivable by that company from its investments otherwise than by way of sale or other disposal of any investment:
(e)The aggregate amount of all profits derived from the sale or other disposal of any investment of that company:
(f)All commissions and fees received or receivable by that company, reduced by--
(i)Commissions in respect of contracts for reinsurance; and
(ii) Fees in respect of policies of life insurance, contracts of
insurance, and annuities granted,--
reduced by the aggregate amount of all losses incurred in carrying on its business of life insurance on the sale or other disposal of any investments of that company:

I turn first to the ordinary meaning of the term “premium” as it relates to an insurance policy. The Oxford English Dictionary (second edition, 1989) describes it as “the amount agreed on, in an insurance policy, to be paid at one time or from time to time in consideration of a contract of insurance”. Halsbury’s Laws of England 4th ed Vol 25 para 25 states:
440. Nature and assessment of premium. The consideration required of an assured for any form of insurance is a money payment universally referred to as a premium. There may be a single lump sum premium, but more usually the premium is payable either at specified intervals, as in the case of life assurance, or as consideration for successive renewals of the policy.
To like effect is the statement in Ivamy, General Principles of Insurance Law (6th edition, 1993) at p201:
The premium is the consideration which the insurers receive from the assured in exchange for their undertaking to pay the sum insured in the event insured against.
Any consideration sufficient to support a simple contract may constitute the premium in a contract of insurance.
The author goes on to note that the amount is purely a matter of contract, and will depend on the insurer’s estimate of the risk.
And Lord Diplock in Swain v Law Society [1982] 2 All ER 827 said at p832:
‘Premium’ in the context of insurance law is a term of art. It means a sum of money paid by an assured to an insurer in consideration of his indemnifying the assured for loss sustained in consequence of the risk insured against.
The contract of insurance contained the following provisions:
PAYMENT OF PREMIUMS
(i)Premiums must be paid within one calendar month of the due date.
(a)If default be made in the payment of any premium before this policy shall have been in force for two years and two years’ premiums shall have been paid, this policy shall be forfeited and become void as from the date the unpaid premium fell due and the Society shall not be required to give notice to this effect to the insured. Provided always that if the Life Insured shall die within one calendar month after the due date of any unpaid premium, the amount hereby insured shall be payable subject to the deduction of the unpaid premium.
(b)If default be made in the payment of any premium after this policy shall have been in force for two years and two years’ premiums shall have been paid, this policy shall not become void until its surrender value after deduction of any debt shall become insufficient to pay one quarterly premium computed according to the mode adopted by the Society or if the premium be payable more frequently than quarterly, shall become insufficient to pay one premium. If a claim arise during the continuance of such default and before forfeiture through the exhaustion of the surrender value, the amount hereby insured will be payable subject to the deduction of any debt. The debt on any policy is defined as arrears of premium plus compound interest and any policy loan plus compound interest.
The effect of the contract between the parties, which does not infringe ss63 and 64 of the Life Insurance Act 1908, is that for entitlement to the sum assured on maturity, the insured has to have paid the periodic premiums, and in the case of overdue premiums, compounding interest. Although separated out from the periodic premium which is due on a specified date, the interest payable on overdue premiums still forms part of the consideration moving from the insured which gives entitlement to the cover. The forfeiture provision, which operates when the surrender value of a policy is offset by the amount of overdue premiums and unpaid interest, is not really in point and has no significance to the present issue. What is important is that the insured is not entitled to the sum assured unless what has been contracted to pay, namely premiums and interest on overdue premiums, has been paid. What is envisaged by subsections (1)(a) and (8), is the inclusion of all contracted payments (consideration) receivable by the insurer from the insured in providing life cover, as premiums.
To take an example. An insured fails to pay two periodic annual premiums, due on 1 July 1998 and 1 July 1999. Payment of those, plus accrued interest, is made on 1 December 1999. A claim is later made under the policy and settled on 1 April 2000. It would seem logical, and in accordance with the terms of contract, to treat the entire December payment as payment of premium, being part of the consideration for the claim against the policy which was settled in April. Treatment of the payment as premium would also seem to fit squarely within the general scheme and intent of s204. On the other hand, it would seem artificial to regard the interest component as investment revenue, an aspect I will return to briefly later.
I do not find the analogy with payment of interest in trade or commercial debts helpful. Generally that will arise where the goods or services have been provided to the purchaser. Here it is a necessary pre-requisite to the company fulfilling its part of the bargain, namely payment of the sum assured on maturity.
I do not think the fact that the periodic premium is fixed by reference to risk assessment, whereas the interest factor happens in this case to be an arbitrary figure equating interest charged on a loan investment, assists the argument for the Commissioner. The assessment of the periodic premium necessarily assumes payment on due date. Late payment, or non-payment, has an adverse effect on the insurer’s ability to meet its overall risk obligations, including those undertaken to the defaulting policy holder, and a compensatory additional payment is required to adjust the position. The fact that the additional payment is not itself based on some further risk assessment exercise seem to me to be irrelevant, and does not detract from its status as being consideration payable by the insured for the contracted cover. In substance it is part of the premium, as that word is used in the legislation. Its separate designation in the contract as interest, probably inevitable for drafting purposes where the need to analyse what did or did not form the consideration moving from the insured did not arise, does not affect its true nature or character. Neither do questions of its adequacy - quantum of consideration is a matter of contract.
Support for this conclusion comes from two sources. First, the examination undertaken by Richardson P is indicative of a general legislative approach in dividing the revenue of a life insurance company into two basic, even if they be not exclusive, streams - one emanating from the issue of policies and the other from investment. For reasons which will be briefly traversed later, I do not see the interest receivables in question as constituting investment revenue. Secondly, if they do not have the character of premium revenue, but still come within the definition of gross revenue, then it would seem there is no available mechanism for deducting the cost of obtaining that revenue. The only deductions available could be indirect investment revenue costs under subs (8)(c). Those are defined as being indirect general revenue costs, but reduced by indirect premium revenue costs. It seems clear that costs relating to recovery of interest on unpaid premiums must come within the latter description as being “incurred indirectly in respect of or in relation to policies of life insurance,” and therefore excluded from the deduction process. Apart from the administration costs which may be incurred in the ordinary accounting process, extraordinary costs may be incurred. For example, litigation costs where there is a dispute as to payment of a premium, or as to the right of the company to the amount of interest claimed. If those costs are not deductible, that is a strong indicator that the interest does not form part of the assessable income.
The fact that calculation of the figure is governed by the subs (6) formula as being a specified proportion of all indirect general revenue costs does not affect the substance of the matter. Subsection (6) is simply a statutory method of assessing the indirect premium revenue costs. The scheme of the section remains clear - to take the premium related content of revenue out of the tax net.
I see no indicators to the contrary. There is nothing in the contract itself. Section 204 does not envisage different kinds of revenue being received from policyholders other than investments (loans) made by the insurer. Mr Jenkin QC placed some reliance on a decision of the Supreme Court of California in Summer v New York Life (1921) 200 P 621, where a distinction was drawn between the words “premium” and “interest”. But that concerned the interpretation of a particular contract of insurance in circumstances where the insurer was endeavouring to avoid a policy for late payment of interest on the overdue premium. I do not regard it as of any assistance to the construction of this legislation as it applies to the contracts in question.
It was submitted for the Commissioner that the interest was revenue from investments, and within the meaning of subs(1)(d). Inferentially therefore it was different from and not included as premium identified in subs (1)(a). Reliance for this submission was placed on the early judgment of this Court in Commissioner of Taxes v Australian Mutual Provident Society (1902) 22 NZLR 445. The issue there was whether interest on outstanding premiums came within s55 of the 1900 Land and Income Assessment Act. A majority of the Court, with Stout CJ dissenting, held that it did. I do not find it necessary to embark on a detailed analysis of the judgments. The 1900 Act is significantly different in form from s204 of the 1976 Act. Section 55 said:
In the case of a company carrying on the business of life insurance (including the department created under “The Government Insurance and Annuities Act, 1874”), such income shall be deemed to be a sum equal to its total income from investments of any kind other than investments in or on land, and income-tax shall be payable accordingly.
It contained no equivalent to the detailed and comprehensive provisions of s204, and in particular did not address expressly either the position of premiums, or the question of deductibility. The context of the 1900 Act in which the questions of “investment” arose was therefore quite distinct from that of the 1976 Act. Further, in the AMP case, the by-law provided for appropriation from time to time of the surrender value to payment of the premium, and that was seen as being money advanced by the company and therefore an investment. Whether or not that conclusion is correct, the present contract does not in its terms result in the surrender value, or in fact any money from the company, being applied in payment in that way. Apart from avoiding the policy when the surrender value was less than any “debt”, clause 2(b) of the policy simply permitted the company to deduct arrears of premium plus compound interest from the sum assured when the policy matured.
How the company treats non-payment of premium in its own books is beside the point. Application of the surrender value to payment of overdue premiums and interest is permitted by s63 of the Life Insurance Act 1908, “subject to the terms and conditions of the policy”. But unless forfeited, the terms of this policy entitled the insured to payment of the sum assured on maturity less any debt. Arrears of premium, and interest on those arrears, could be paid at any time during currency of the policy. Application of surrender value and payment of debt thereby during currency of the policy is not envisaged by the contract. In my view there is therefore no justification for contending that under the terms of this contract a debt would be created by the insurer advancing arrears of premium to the policyholder. The debt arises from the failure to pay the contracted periodic sum, and it is that which attracts a further liability interest. There is no further transaction envisaged by the contract, and one cannot arise by virtue of a notional “advance” resulting from the insurer’s unilaterally preferred method of bookkeeping. Accordingly a determination of the primary issue which places reliance on a notional advance is in my respectful view flawed. The issue is governed by the terms of the contract and the relevant legislation.
I cannot see that these contractual arrangements constituted an investment as that word is normally used. Importantly, there is no apparent reason to give the term an extended meaning under para (d) of the definition of gross revenue in the context of s204.
I would allow the appeal.

THOMAS J

Introduction

I have had the marked advantage of reading the draft judgments of Richardson P and Henry and Blanchard JJ, who would allow the appeal, and the draft judgment of Gault J, who would dismiss the appeal. Agree with them or not - and as they differ it is not possible to agree with them all - the judgments are thoroughly reasoned and extremely comprehensive. It is with some diffidence that I venture my own opinion.
I find Gault J’s judgment most convincing and share his view that the appeal should be dismissed.
It seems to me that the issues are two-fold:

Whether “premium” in s 204 of the Income Tax Act 1976 includes compound interest accruing under a contract of insurance in respect of unpaid premiums?
Whether the compound interest is neither premium revenue nor investment revenue but other revenue?

Because the relevant background, the legislative provisions, the terms of the policy and the principal arguments have been canvassed in the previous draft judgments, I propose to direct my attention to particular topics. I will adhere to the following headings:    Paras
1.   The AMP case  [96] - [124]
2.   Economic equivalence?  [125] - [133]
3.   The consideration argument  [134] - [137]
4.   The time-value of money  [138] - [147]
5.   The statutory scheme  [148] - [155]
6.   The question of deductibility  [156] - [159]
7.   Parliament’s intent  [160] - [174]
8.   Tailpiece  [175] - [176]
I apologise in advance for the fact that my judgment will appear somewhat disjointed as a result of adopting this approach. It will, I hope, be drawn together in the final section in which I confront the task of endeavouring to discern Parliament’s intention. For the present, it may be helpful to provide an outline of my analysis of the arrangement or transaction in issue.
In summary, the transaction involves the following elements:

The starting point is the fact that surrender value of the policy, calculated in accordance with the Seventh Schedule to the Life Insurance Act 1908, is an asset belonging to the policyholder.
The policy does not lapse and the surrender value does not fall due on the policyholder defaulting in the payment of premium (ss 63 and 64, and para 2(b) of the policy).
The company advances the amount of the arrears of premium to the policyholder’s account. This advance is effected by credit and debit entries in the company’s books.
In this way, the policyholder’s investment fund in a group of “bundled” policies is sustained, and benefits under the policy and the calculation of bonuses are not affected.
Compound interest is charged on the advances made by the company.
The advances, together with compound interest thereon, are secured against the surrender value of the policy. The policy lapses when the amount of the arrears and the compound interest equates with or exceeds the surrender value.
Because it does not fall due, the surrender value is not to be perceived as a fund or account from which monies are credited direct to the policyholder’s account. It is security for the advances made and it is a matter of calculation as to when the amount of arrears of premium together with compound interest thereon equate with or exceed the surrender value. When that happens, the surrender value has been applied to the arrears of premium and compound interest.
If the policyholder pays the arrears of premium together with compound interest the policy is relieved of the charge and continues as before. If the policy matures, the cover under the policy is paid less the amount of arrears and compound interest due. Otherwise, the security provided by the surrender value is eventually extinguished and the policy lapses.
Eventually, whether the arrears of premium are paid by the policyholder, or the policy matures, or the policy lapses, the company receives compound interest on the advances which it has made. This compound interest is interest on the company’s advance, and therefore properly investment revenue.

1. The AMP case

In recent years, this Court has emphasised its reluctance to review earlier decisions of the Court. (See e.g., dicta in R v Hines [1997] 3 NZLR 529, per Richardson P at 537-538, and in Aoraki Corporation Ltd v McGavin [1998] 3 NZLR 276, per Richardson P at 291-293). Yet, in this case the majority do not propose to follow The Commissioner of Taxes v The Australian Mutual Provident Society (1902) 22 NZLR 445. For my part, I consider that this decision cannot be fairly distinguished from the present case. It has represented the law in New Zealand for 98 years and, in the absence of more persuasive grounds for rejecting it, I consider that it should be applied.
Hammond J at first instance considered that he was bound by the AMP decision and he duly applied it, albeit reluctantly, to the present case. Various reasons are now advanced in this Court for not following that decision -
- the wording of s 55, which was the provision in issue in the AMP case, is different from the wording of s 204;
- in the intervening years there has been no continuity in the relevant legislation;
- there is no current settled practice which would be disrupted;
- in the AMP case the bylaw provided for the appropriation from time to time of the surrender value to payment of the premium, whereas the present contract does not “in its terms” result in the surrender value being applied in that way;
- the AMP decision has been rejected in two Australian cases; and
- it is improbable that the legislature would have had the AMP decision in mind when framing s 204.

Each of these points may be addressed in turn. The argument that the AMP decision was wrongly decided because the majority relied upon the impermissible notion of economic equivalence, and that the decision should not be followed for that reason, is dealt with separately.

Section 55 is certainly worded differently from s 204. But the earlier section gave rise to the question whether interest charged on overdue premiums is income from an “investment”. In holding that the interest charged on outstanding premiums in the present case is premium the majority reject the view that it is interest on an investment. The AMP decision is directly in point on that question.
Next, in my view, the history of the legislation set out in some detail in the President’s judgment does not demonstrate that the Court’s earlier decision that interest on overdue premiums is interest on an investment became irrelevant or redundant. I must confess to being somewhat uncomfortable with this reason for rejecting the AMP decision as the history of the various legislative regimes was not canvassed in any detail at the hearing. Certainly, Mr McKay, who appeared for CML, contended that the statutory scheme in which the “income from investment” issue arose in the AMP case was different in significant respects from the statutory scheme introduced with effect from 1 April 1983. But this contention was not accepted by Mr Jenkins QC for the Commissioner. He submitted, in my view correctly, that while there are structural differences between the two regimes there is no critical difference between the words “income from investments” as used in the 1900 Act and the phrase “revenue received from its investments” adopted in 1983.

I am unable to accept that the scheme of the section supports the view that the outstanding premiums are premiums received or receivable and that interest charged on such premiums has that character because of the clear demarcation between indirect premium revenue costs on the one hand, and indirect investment revenue costs on the other. The demarcation in itself neither impresses the compound interest with the character of premium nor the character of interest on an investment. To reach the conclusion that the compound interest has the character of premium requires an assumption that the compound interest is the equivalent of premium - which is to beg the question.
All that can safely be deduced from the scheme of the section is an intent to isolate premium revenue and identify and allow for the costs of deriving that premium revenue. Compound interest charged on outstanding premiums is neither a direct nor indirect cost of deriving premium revenue. It is either premium deductible under paras (a) to (c) of subs (8) or it is not. In what way, then, does the definition or demarcation of costs suggest that the interest is premium or even that it has the character of premium? All that reference to costs shows is that, if the compound interest is premium, the direct and indirect premium revenue costs in deriving that premium revenue are automatically taken into account in assessing the company’s profit. If, however, the compound interest is interest on an investment, the costs of recovering that investment revenue are deducted under paras (b) and (c) of subs (8). The investment revenue remains part of the profits of the company.

The question of deductibility

It has been suggested that Mr Jenkins’ alternative argument that the compound interest represents revenue other than either premium revenue or investment revenue is unsustainable because there is no provision for deducting costs incurred in respect of any such revenue stream. The focus has been on indirect costs, but the problem, if there is a problem, relates to the deductibility of direct costs in respect of a third revenue stream.
I would be surprised, however, if all costs incurred in respect of other revenue are not deductible. Gross revenue “includes”, and does not therefore exhaust, the revenue or revenue sources which form part of the company’s gross revenue. There is no sound reason to disregard the word “includes” in the definition of gross revenue or to ignore the fact that “commissions and fees”, which are included, are neither premium income nor investment income. Moreover, as can be seen from the above examination of the section, those indirect costs incurred in respect of other revenue are ultimately deducted from the company’s profits under para (c) of subs (8) as “indirect investment revenue costs”. Indirect investment revenue costs are all indirect revenue costs other than indirect premium revenue costs and so, however inappropriate or incomplete that description, indirect revenue costs incurred in respect of other revenue, become deductible under para (c).
The possible problem relating to direct costs which are incurred in respect of other revenue, if it is to be securely asserted that there is a third income stream, stems from the fact that no provision is made for the deduction of such direct costs in subs (8), and direct costs incurred in earning other revenue do not appear to be included in the definition of “indirect investment revenue costs”. Paragraph (b) of subs (8) deals with direct investment revenue costs, and such costs are defined in subs (1) to mean “revenue from investments, fees and commissions (excluding commissions in respect of contracts for reinsurance)”. Not only does this omission raise a difficulty, but it creates an anomaly if indirect investment revenue costs include indirect other revenue costs but no provision is made for the inclusion of direct other revenue costs in subs (8). Direct other revenue costs would need to be encompassed within “indirect investment revenue costs” to be deductible.
Whether this omission is a gap in the legislation or there is another answer I do not know. The inclusion of “fees and commissions”, which are not investments, in the definition of direct investment revenue costs would suggest that the omission may not be a gap. But I remain reluctant to accept that the omission in itself counters the express language and the sense of the section which otherwise emerges. Nevertheless, this one niggle leads me to conclude that I should rest my judgment on the fact that the compound interest in issue is interest on an investment and therefore investment revenue.

Parliament’s intent

As with all questions of interpretation, the primary objective is to determine Parliament’s intention from the wording of the enactment. Framing the question in terms of whether the compound interest on arrears of premium is “premium”, or whether it has the character of premium, cannot be allowed to obscure the fundamental objective of ascertaining the legislature’s intent. Did Parliament contemplate that compound interest charged in respect of the late payment of premiums was to be deducted from gross revenue as premium and thus be non-assessable? The question of Parliament’s intention must predominate.
In accordance with the Privy Council’s bidding, however, what is first required is a rigorous and objective examination of the contractual arrangement. See para [128] above. The nature of the contractual arrangement has been fully examined already in this judgment.
I would not, however, wish to lose sight of the language used by the parties. Unable by virtue of s 64 to declare a policy void, the parties have confirmed that the policy shall not lapse until its surrender value after the deduction of any debt shall become insufficient to pay the arrears of premium plus compound interest thereon. They have termed the payment over and above the outstanding premiums “compound interest”, and not “additional premium” or the like. They have used the same language as is used in respect of a policy loan which is clearly an investment. They have expressly described the arrears and compound interest thereon as a “debt”. A close analysis of the transaction then confirms that the company advances the arrears of premium to the policyholder’s account against the security of the surrender value of the policy. Compound interest is charged on the advances. Reference is made to the outline of the transaction in para [95] above.
I am satisfied that, giving predominance to ascertaining Parliament’s intent, the compound interest charged in this arrangement cannot be construed as premium for the purposes of s 204. Because most of the points I will make here have been touched upon in the course of this judgment, I can be brief in listing my reasons.
Take, first, the language of the section. Compound interest charged on unpaid premiums does not fall comfortably within the meaning of “premiums on policies of insurance”, or “premiums or other considerations … in respect of contracts of reinsurance”, or of “considerations … in respect of the granting of annuities” used in paras (a) (b) and (c) respectively of the definition of gross revenue. If Parliament had intended to equate compound interest charged on advances made by a life insurance company in respect of outstanding premiums with premium income, there would have been a much more direct and felicitous way of saying so.
Nor is there any statutory mandate for expanding the word “premium” to mean “having the character of premium”. Subsection (8)(a) does not say: “An amount equal to the aggregate of all the premiums …referred to in paragraphs (a),(b) or (c) or revenue having that character”. To all intents and purposes, the compound interest in issue must fall within the phrase “premiums on policies of insurance” in subs (1)(a) or be excluded from the scope of subs (8)(a).
Secondly, reference to any number of texts, taxation handbooks, or the like, confirms that interest has traditionally been treated as assessable income. To deem it premium in this case would be to exclude it from that conventional treatment. (See the various editions of the New Zealand Master Tax Guide up until 1994 (when the new legislation made the tax treatment of interest subject to the accrual rules). As examples, see the 1990 edition at para 5.385 and the 1991 edition, at para 5-384. The 2000 edition now provides that interest is to be included within gross income, and see also Staple’s Guide to New Zealand Tax Practice (58 ed, 1998), at para 830.10. Internationally, see the Australian Master Tax Guide 2000, at para 10-470 and the Canadian Master Tax Guide 2000, at para 3018).
Thirdly, there is no reason to adopt a narrow or strained meaning of the word “investment”. The ordinary or popular meaning, I would think, must embrace every mode of application of money which is intended to return interest, income or profit. The advances made by the company fall within this meaning. They are a form of investment. All the hallmarks of an investment are present other than that the advance is not entirely voluntary in the sense that s 64 requires the policy to subsist until the surrender value is exceeded. If, apart altogether from its statutory framework, the present arrangement was an entirely voluntary one entered into by the life insurance company with the defaulting policyholder, would there be any real problem in describing the advance as an investment?
Fourthly, when the basic concern is to ascertain Parliament’s intent it is not irrelevant that compound interest charged on a policy loan is investment revenue. As a matter of Parliament’s intent, why should compound interest on advances by way of a loan from the company to pay unpaid premiums be any different in respect of interest on advances made by the company to pay unpaid premiums in accordance with an internal accounting arrangement?
Fifthly, I have pointed out above ([paras [148] to [155]) that the scheme of the section does not support the view that the compound interest is premium revenue because of the clear demarcation between indirect investment revenue costs and indirect premium revenue costs. Rather, I believe that the structure of the section points, if anything, to the compound interest being investment revenue (or possibly other revenue). The section begins by defining gross revenue to include all revenue derived by the company in carrying on its business of life insurance. Without the need to extract premium revenue from the profits of the company, no question would arise but that the compound interest would remain part of the gross revenue of the company and be duly assessable for tax. Unless, therefore, the interest is to be regarded as the equivalent of premium and not as interest charged on an advance made by the company against the security of the policy, there can be no reason why the interest should be rendered non-assessable. As I have sought to emphasise in this judgment, a close analysis of the arrangement confirms that an advance is undoubtedly involved.
Sixthly, I consider that some regard may be had to the definition of “money lent” in s 2 of the Act. “Interest” in relation to the deriving of income means any payment made in relation to money lent. “Money lent” means, inter alia, any amount of credit given (including the forbearance of any debt) whether on current account or otherwise and extends to amounts for which credit is given pursuant to arrangements similar to the one involved in this case. CML has agreed to forbear recovery of the “debt” other than by deduction from the proceeds of the policy on surrender or maturity. Thus, the company’s advances in this case would fall within the meaning of money lent in the statute.
Mr McKay did not seriously contend otherwise. The argument against the introduction of the definition, as I understand it, is that s 204 is a code and that a definition of money lent has no application to the section. Certainly, the definition is not contained within the confines of s 204 and I am not disposed to contend that the section is not a code. But when the objective is to ascertain Parliament’s intention, I do not see why the legislature’s conception of “money lent” should not be thought to be a guide to its intent when enacting s 204. Shortly put, Parliament does not tend to take a narrow view of investments for tax purposes.
Seventhly, I am not prepared to assume that s 204 was not enacted with the AMP decision in mind. Indeed, I am at a loss to know why the usual principle that Parliament is presumed to legislate in the knowledge of, and having regard to, relevant judicial decisions should not apply. See Bennion, Statutory Interpretation (1997), at 543, although I freely acknowledge that this rule is only useful for lending support to an argument already based on independent grounds. But in this case it is unrealistic not to recognise that the legislation, as with all tax measures, will have been prepared and scrutinised by a number of expert advisers fully familiar with tax law or sufficiently competent to ascertain whether there are any relevant court decisions. Those advisers would surely have been aware, or made themselves aware, of this Court’s decision in the AMP case. That being the case, why should they not have concluded that the issue is settled: interest on unpaid arrears of premium is assessable as investment revenue? As at 1983, when s 204 was enacted, the authority of the AMP decision had not been challenged.
Finally, I am of a mind to accept that in this case Parliament’s intention when enacting s 204 is confirmed by the subsequent legislation expressly excluding interest on unpaid premiums from the meaning of “premium”. See para [101] above. Of course, I am fully alert to the argument that subsequent legislation, even when in pari materia, is generally equivocal in that Parliament may just as well have intended to change the law. But in this case the amendment was enacted in 1990 in response to the life insurance companies challenge to the authority of the AMP decision. In the event that this decision is reversed or distinguished, the future accessibility of compound interest on unpaid premiums is secured by the amendment and the subsequent legislation in 1994. Because of the existence of the AMP decision, however, it cannot be said that Parliament was simply moving to fill a “loophole” which had appeared in the law. On balance it is more plausible to accept that Parliament was reaffirming its intention that interest on unpaid premiums is not premium rather than effecting a change in the law. Why should Parliament’s intent have been any different in 1983 than it manifestly is today (or has been since 1990)?
For these reasons, some of which I acknowledge are to be accorded greater weight than others, I do not consider that the compound interest in issue is premium for the purposes of s 204. It is revenue received or receivable by the company as investment revenue.

Tailpiece

Further reflection since completing the above judgment has led me to conclude that, in addition to all that has been said, there is something almost incongruous about treating the compound interest as premium. Possibly, lawyers do not have an instinctive feel for compound interest and fail to fully appreciate the geometric ratio or exponential rate at which a number is multiplied when compounded. Yet, everyone knows the story of the Dutch who bought Manhattan Island from the Indians for about $24. If the Indians had placed the money in a compound interest account, their successors could afford to buy the Island back today, including the Empire State Building, the World Trade Centre, and all other “improvements” made since the 17th Century. (See Bucwholz, New Ideas from Dead Economists (1989–Penguin) at p 47). Take another example. Let us say that A wants to watch a rugby match on B’s television set. B is reluctant to share his good fortune and exacts a promise from A to pay him one cent on June 1 and to double up each day until the game takes place 20 days later. At kick-off on June 21, A owes B $10,485.75!
Of course, while not 100% as in the previous example, the geometric or exponential progression of compound interest in the present context can be seen by comparing two hypothetical examples where there are arrears of premium. First, take a premium of $100 payable quarterly and compound interest at 10%. Assume the surrender value is $2,000. The debt, made up of unpaid arrears and compound interest, will approximate the surrender value after four years. Of that debt, just on 19% will be compound interest. Then, in order to highlight the geometric progression of the compound interest over a longer period of time assume that the surrender value is $10,000. The surrender value will be effectively exhausted in twelve and-a-half years. At that time the interest component in the debt will be just on 50%.

BLANCHARD J

My reading of s204 of the Income Tax Act 1976 has led me to the conclusion that it was intended to be a self-contained code governing the taxation of companies carrying on in New Zealand the business of life insurance or reinsurance consisting of the activities described in (a) and (b) of subs(2). The first of those activities comprises the issue of life policies, entry into life reinsurance contracts and the granting of life annuities. For this range of activities the legislation contemplates (in the definition of “gross revenues”) that premiums or other considerations will be received or receivable. In accordance with subs(8)(a) they would be deductible from gross revenues for the purpose of assessing the income tax payable by the insurance company. Since, in this way, premiums are excluded from the assessable sum there is no provision for deduction of costs directly or indirectly relating to them.
The second activity is the investment and management of money so received. In calculating gross revenue there is to be included the total revenue received or receivable from investments otherwise than by sale or disposal of any investment, plus profits from any such sale or disposal (paras (d) and (e) of the definition of “gross revenues”).
The legislature recognised that this investment activity involves a cost to the insurance company. One part of this (“direct investment revenue costs”) is exclusively incurred in deriving that revenue and, under subs(8)(b), is deductible. The other part (“indirect investment revenue costs”) is arrived at by apportioning the general indirect costs of running the life insurance business, the apportionment being done by contrasting the earnings from premiums and other items within (a) (b) and (c) with gross revenues. Only the indirect costs not notionally attributed to the writing and administration of life policies, reinsurance contracts and annuities are deductible as indirect investment revenue costs under subs(8)(c).
The argument for CML is that the definition of “gross revenues” and the provision for deductions therefrom in subs(8) contemplates only revenues from and costs incurred in respect of two categories, namely (i) premiums and other considerations in respect of life insurance, reinsurance and annuities, and (ii) investments made by the insurer utilising its receipts from category (i). It is submitted that the section neither contemplates nor permits any third stream of gross revenues and accordingly makes no provision for deduction of costs so incurred.
In the view that I take it is not necessary for me to reach a firm view on this question but I note the proposition by Mr Jenkin QC, for the Commissioner, that all revenues do not have to be fitted into one or other of the two categories. “Gross revenue” is defined as including those things described in (a) – (f). Any other form of revenue not coming in the form of premiums or considerations within (a) – (c) or derived from investments ((d) and (e)) is still within “gross revenue”. A specific example of an apparent third stream is to be found in (f) of the definition which appears unrelated to either of those two categories. It refers to commissions or fees (other than those in respect of policies, reinsurance contracts and annuities). Counsel for the appellant was unable to suggest how these might be produced by an investment. Therefore, it is arguable that if interest for late payment of premium were neither premium nor a return on an investment, nevertheless it could come within the “gross revenue” of the taxpayer.

On this basis, it is also arguable, as Mr Jenkin submitted, that any expenses attributable to the collection of such interest would then have been deductible as an “indirect investment revenue cost”. This term includes all “indirect general revenue costs”, meaning costs of a revenue nature incurred by the insurance company in carrying on its life insurance business (not being direct investment or direct premium revenue costs). Such interest is certainly received as a facet of the insurance business. There would accordingly be no need to look beyond s204 on the question of deductibility. I leave this question open.
I am readily able to conclude that interest charged for late payment of premiums is not income derived from an investment made by the insurance company. I find unconvincing the judgments of the majority of this Court in Commissioner of Taxes v Australian Mutual Provident Society (1902) 22 NZLR 445 and counsel for the Commissioner’s endeavours to support the view taken in that case. Being of the opinion that the AMP case was wrongly decided, I have nevertheless had to consider whether this Court should in the circumstances depart from a decision which might appear to have stood unchallenged in this country for nearly a century. If the statutory framework governing the taxation of life insurers had remained substantially unchanged since 1902 I would have taken the view that the law on the point should be regarded as settled for New Zealand (short of any appeal to the Judicial Committee) and that any reversal must be a matter for Parliament. In the field of taxation it is particularly undesirable to disturb a settled and current practice which has been judicially endorsed at appellate level.
But in this case there is an absence of continuity in the legislation and no settled current practice. For over 50 years before the enactment of s204 the taxation of life offices stood on a basis entirely different from that which existed in 1902 and also from that introduced in 1982, with effect from 1 April 1983. Section 204, operating from that date, bears no resemblance to its immediate predecessor or to s55 of the Land and Income Assessment Act 1900 which was under consideration in AMP. The current legislation, dating from 1990 is different again. Because it is explicit on the issue before us no existing practice will be disturbed. Furthermore, we were not referred to any material suggesting that Parliament had in mind the AMP decision when s204 was enacted. And in two instances Australian Courts, one at appellate level, have preferred the dissenting judgment of Stout CJ (Australian Mutual Provident Society v Commissioner of Taxes [1907] SALR 88, 100 and The Crown v National Mutual Life Association of Australasia Ltd (1922) 25 WAR 1,8).
I accept the Commissioner’s argument that the policy holder’s contractual obligation to receive the imposition of interest on late payment of premium gives rise to a debt in favour of the insurer, notwithstanding the latter’s apparent inability to sue for the interest. It is, I think, implicit in s63 and the terms of the policy, and confirmed by what seems to be an invariable longstanding practice or custom on the part of insurers, that the remedy for a default in punctual payment is, in the case of a policy which has not been in force, with the premiums paid, for two years, the lapsing of the policy after one month of default; and, in the case of a policy of two years standing, when a surrender value will exist, the remedy is, similarly, the debiting of what CML’s policy actually describes as a “debt” (including in that term arrears of premium and compound interest thereon) against the surrender value, with the policy lapsing only once the net balance is reduced to a point where the residual surrender value is insufficient to meet the next premium payment. This is, of course, merely a process of accounting by book entries and, as Way CJ said in the South Australian case (at 99), the entries do not constitute a settlement of account or represent payments. Lest the policy mature by death of the insured or effluxion of time before the accruing debt overtakes the surrender value, the statute and the policy provide for the overdue premiums and the interest to be charged against and deductible from the policy proceeds in priority to the claims of any mortgagee or assignee.
These arrangements, as the insurer has in this case recognised in its policy terms, give rise to a debt for the accruing interest. It is not denied that character because the means of recovery is restricted by statute and, consistently therewith, by contract. It does not follow, however, that upon the insured’s default in payment the insurer is to be taken to have made a loan or some other form of investment. There has been no agreement on the part of the insurer to lend money and no advance, any more than there is when a trader’s terms of sale require payment on a specified day and allow the charging of default interest and a default occurs. The fact that the trader may then choose not to sue and, instead, awaits the late payment from its customer does not mean that in law it is to be taken to have made a loan (Fahey v MSD Spiers Ltd [1975] 1 NZLR 240, 246) or that the debt due to it is to be properly called an “investment”. That word is not defined in s204 or elsewhere in the Income Tax Act and is to be taken to bear its ordinary meaning, which The Oxford English Dictionary gives as the “conversion of money or circulating capital into some species of property from which an income or profit is expected to be derived in the ordinary course of trade or business”. To “invest” involves, at least colloquially, the laying out of money (see also the references given in the judgment of Stout CJ in the New Zealand AMP case at p450). Counsel for the Commissioner sought to invoke the definition of “money lent” but those words do not appear in s204.
The existence of an ability for the insurer to set-off indebtedness against policy proceeds in the event of maturity occurring does not in my view transform the character of the transaction. Even in the absence of such an express provision set-off would surely have been permissible. The only “security” taken is therefore one which would ordinarily be available when there are mutual debts.
Nor does it follow that because a defaulting policy holder might have arranged with CML for a loan with which to remedy the default, and that loan would undoubtedly have been an investment, that the default itself gives rise to an investment. Such an argument is an appeal to economic equivalence as a basis for liability and is unsound in a taxation context. The true nature of the transaction, as has often been said, is to be ascertained by reference to the legal arrangements actually entered into and carried out (e.g Buckley & Young Ltd v Commissioner of Inland Revenue [1978] 2 NZLR 485). The analogy which in the New Zealand AMP case attracted Williams J (“one thing is practically the same as another” (p453)) and Edwards J (p457) (Conolly J concurring) is therefore misleading as a matter of taxation law. In this respect the view of Stout CJ is to be preferred, although he too was in my respectful view guilty of error in rejecting the idea that the outstanding premium was a debt.
If the unpaid premiums and accruing interest thereon are not therefore an investment, is the interest a form of additional premium due from the policyholder? This question must be answered bearing in mind the assumption already made that a finding that the interest is not an “investment” does not mean that it necessarily is “premium”. I think, however, that consistently with the scheme of s204 it must be so regarded. That scheme distinguishes between income of the insurer received from policyholders in that capacity (“premiums”) and other income. Payments to purchase or keep up a life policy are tax exempt payments which are intended to be invested by the insurer. It may be suggested that there is no legally binding obligation on the insurer to utilise the money for investments and no promise of a particular rate of return, but the insurer would surely be in breach of the implied understanding upon which the contract of insurance was formed if it did nothing at all with the money other than meet its expenses.
Interest actually paid to compensate for late payment of a premium is money paid to keep up the policy, for if there is a continuing failure to pay premiums and interest the policy will eventually lapse. In contrast, interest on a policy loan, though it will under the terms of the policy, if not paid, be set-off against the surrender value, is not paid to preserve the policy (and can be sued for even after the policy lapses). The loan proceeds may sometimes be applied to pay arrears of premium and interest for late payment, but even in such a case it is the payment to the insurer, not its advance of the money, which keeps up the policy.
Section 204 must have been drafted in the knowledge that an insurance company does not reduce the level of policy cover because of late payment. Therefore premiums must vary according to when payment is made. This is done by taking account of the time value of money and adding a sum calculated by the application of an interest rate. When the life assured elects not to pay annual premiums in advance and the policy is written accordingly, it is possible expressly to write the consequence of this choice into the premium instalments. But that is not possible where payments are made late because naturally the amount needed to effect the adjustment is not known until actual payment and cannot be stated otherwise than by the use of an interest rate. This inability to state the actual figure of the variation should not however be taken to make the “interest” something different in character from the additional amount payable where, say, premiums are paid fortnightly. Counsel confirmed to us that in Mr Pfeifer’s figures the same interest rate was used for the adjustment from annual to six-monthly, quarterly, monthly or fortnightly payments as was used for the “interest” payable for late payment. There is in my view no significance in the absence of any further adjustment of the risk factor which amounts to only 10%. The stipulated premium and the adjustment are properly viewed as an aggregate sum, which includes the risk factor, if that is required before a payment to an insurer can amount to a premium.
The bargain between the insurer and the party who takes out a policy is that premiums are calculated on the basis of punctual payment. If they are not punctually paid, and there is no compensatory payment recognising the time value of money, there is an unfairness both to the insurer itself which, if it is not a mutual company, eventually profits from actuarial surpluses in the life fund arising from both premium and investment income, and to the other policyholders who did pay on time. A payment of interest intended to adjust the tax exempt payment to compensate for late payment has in this unique context a tax exempt character. It is an adjustment to the stipulated payment to maintain its value in the hands of the recipient. The situation differs from a purchase of goods where the recipient retailer is receiving both cash price and interest as an earning stream, though even there also the interest can be viewed as a compensatory adjustment of the price.
Nor am I impressed by the notion that because the interest rate actually charged equates the rate payable on loans to policyholders, and thus would contain an element of additional profit to the insurer if not taxed in the same way, it ought to be regarded as a revenue item in terms of s204. As I have pointed out, premiums are a contributor to eventual profits. And as to the fixing of the rate, it was not to be expected that until the present question was resolved CML would charge a lower rate, as is the practice in Australia.
I would allow the appeal.

Solicitors
Chapman Tripp Sheffield Young, Wellington, for appellant
Crown Law Office, Wellington, for respondent

[2000] NZCA 417

18 May 2000