Issue
Is a general insurance company entitled to a deduction under section 321-25 of Schedule 2J to the Income Tax Assessment Act 1936 (ITAA 1936) for a reinsurance premium paid during a year of income?
Decision
No. A general insurance company is not entitled to a deduction under section 321-25 of Schedule 2J to the ITAA 1936 for a reinsurance premium paid during a year of income.
Facts
A general insurance company paid a reinsurance premium under a reinsurance policy during the year.
The reinsurance policy provides that the reinsurer will indemnify the general insurance company for claims paid up to an agreed amount.
Reasons for Decision
Section 321-25 of the ITAA 1936 provides that a general insurance company can deduct amounts paid during the year of income in respect of claims under general insurance policies.
The phrase 'in respect of' denotes a relationship or connection between two things or subject matters. In Technical Products Pty. Ltd. v. State Government Insurance (Qld) (1989) 167 CLR 45 at 47, Brennan, Deane and Gaudron JJ stated: The words "in respect of" have a very wide meaning. Indeed, they have a chameleon-like quality in that they commonly reflect the context in which they appear ... That nexus will not, however, exist unless there be some discernible and rational link...
In a separate judgment, Dawson J at CLR 51 stated: The words "in respect of" require some material connection between the two matters referred to ... a merely coincidental or extraneous connection between those two things can hardly be sufficient...
Accordingly, an amount is paid 'in respect of claims' under general insurance policies where, in the context in which section 321-25 of the ITAA 1936 appears, there is a discernible and rational link, or a sufficient nexus or material connection between the expense and claims under general insurance policies.
Interpreting a phrase in the context in which it appears was discussed in Cooper Brookes (Wollongong) Pty. Ltd. v. Federal Commissioner of Taxation (1981) 147 CLR 297; 81 ATC 4292; (1981) 11 ATR 949. Gibbs CJ stated, 'Of course, no part of a statute can be considered in isolation from its context - the whole must be considered.'
Applying this principle, section 321-25 of the ITAA 1936 must be read in the context of Subdivision 321-A of the ITAA 1936. Accordingly, section 321-25 of the ITAA 1936 must be read in conjunction with sections 321-10, 321-15 and 321-20 of the ITAA 1936.
Section 321-15 of the ITAA 1936 allows a deduction to a general insurance company for the value of the excess of the outstanding claims liability for the current income year over the value of the previous year's outstanding claims liability. Where the current year's value of outstanding claims liability is less than the value of the previous year's liability, section 321-10 of the ITAA 1936 includes that difference in the general insurance company's assessable income.
The method for calculating the outstanding claims liability is provided for under section 321-20 of the ITAA 1936. Subparagraphs 321-20(a)(i) and 321-20(a)(ii) of the ITAA 1936 require that the value of outstanding claims liability, at the end of the year of income, is to be based on proper and reasonable estimates of what is appropriate to set aside and invest in order to meet the liabilities for outstanding claims and direct settlement costs associated with those outstanding claims.
When some part of the outstanding claims liability ceases to be outstanding because that part is paid, section 321-25 of the ITAA 1936 operates to allow a general insurance company a deduction for that amount. The overall effect of section 321-25 of the ITAA 1936 is to allow the nominal value of that liability at the time of settlement and discharge.
The interaction of sections 321-10, 321-15 and 321-25 of the ITAA 1936 requires that the same expense items be used in arriving at the outstanding claims liability value and the amount paid in respect of claims under general insurance policies.
Guided by section 321-20 of the ITAA 1936, costs directly associated with the settlement and payment of claims are considered to be amounts paid in respect of claims under general insurance policies for the purpose of section 321-25 of the ITAA 1936. These expense items have a material, discernible and rational connection to claims under general insurance policies.
Although the ultimate benefit to the general insurance company from the reinsurance premium is the receipt of recoveries to be used to meet the payment of claims, it cannot be said that the reinsurance premium was paid in respect of the settlement and discharge of those claims. The link between the reinsurance premium and the claim is too tenuous and distant to be regarded as being a material, discernible and rational connection. Accordingly, the reinsurance premium is not deductible under section 321-25 of the ITAA 1936.
Note: Although the reinsurance premium is not deductible under section 321-25 of the ITAA 1936, it may, subject to satisfying the tests in section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997), be deductible under that provision.
From 1 July 2010, the Tax Laws Amendment (Transfer of Provisions) Act 2010 repealed Schedule 2J of the ITAA 1936 and rewrote those provisions into Division 321 of the ITAA 1997. The wording and format was altered to adhere to the drafting approach taken in the ITAA 1997, but as outlined in Chapter 6 of the Explanatory Memorandum to the Tax Laws Amendment (Transfer of Provisions) Bill 2010, there has been no change in meaning of the rewritten provisions.
Section 321-20 of the ITAA 1997 has, however, been clarified to include reference to section 148(1) of the ITAA 1936, which relates to reinsurance with non-residents. Therefore, from 1 July 2010, all references to sections 321-10 to 321-25 of the ITAA 1936 should be read as referring to Sections 321-10 to 321-25 of the ITAA 1997.