Issue
Can a general insurance company claim a deduction under section 321-25 of Schedule 2J to the Income Tax Assessment Act 1936 (ITAA 1936) for the consideration given to cede its outstanding claims liability under a portfolio transfer?
Decision
Yes. A general insurance company can claim a deduction under section 321-25 of the ITAA 1936 for the consideration given to cede its outstanding claims liability under a portfolio transfer.
Facts
The taxpayer is a general insurance company for the purposes of section 995-1 of the Income Tax Assessment Act 1997 (ITAA 1997) and the Insurance Act 1973.
The taxpayer entered into a portfolio transfer arrangement whereby the whole of its insurance liabilities are to be transferred to another insurance company (the transferee). The taxpayer intends to cease its insurance operation after the portfolio transfer.
The portfolio transfer is done in accordance with the provisions of the Insurance Act. The transferee is also an authorised general insurer under the Insurance Act.
Under the portfolio transfer the taxpayer is required to give consideration to the transferee for assuming the outstanding claims liability under its general insurance policies. The outstanding claims liability is the accounting value, being a proper and reasonable estimate of the present value of the sum of the taxpayer's liability for claims under its general insurance policies and direct settlement costs associated with those claims, increased by a margin for prudence.
Reasons for Decision
Under section 321-25 of the ITAA 1936, 'a general insurance company can deduct amounts paid during the year of income in respect of claims under general insurance policies.'
The word 'claim', when used in an insurance policy has different meanings depending on the context ( Drayton and Ors v. Martin and Ors (1996) 9 ANZ Insurance Cases 61,322 at 76,590). Generally, the word is defined, amongst other things, as, 'submit a request for payment under an insurance policy' ( The Australian Oxford Dictionary , 1999, Oxford University Press, Melbourne).
Therefore, a 'claim' entails a policyholder's legal right to be indemnified or compensated by the general insurance company in accordance with the terms of the insurance policy. The cost of meeting the claims is reported by the general insurance company as outstanding claims liability and is measured as the present value of the expected future payments.
When the claims are paid or settled a general insurance company is entitled to a deduction under section 321-25 of the ITAA 1936. Under a portfolio transfer the claims cannot be said to be paid or settled as the policyholder is neither indemnified nor compensated. Instead, the consideration is paid to another insurance company to take on the obligation to eventually pay or settle the claims.
However, the condition for deductibility under section 321-25 of the ITAA 1936 is not whether the claims have been paid or settled, but rather whether the amount paid is 'in respect of claims under general insurance policies'.
The words 'in respect of' which precede 'claims under general insurance policies' were interpreted by the High Court in Technical Products Pty Ltd v. State Government Insurance (Qld) (1989) 167 CLR 45 in the following passage: 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...
Therefore, 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 sufficient nexus or material connection, and a discernible and rational link, between the amount and claims under general insurance policies.
Consideration given to cede the outstanding claims liability is an amount paid 'in respect of' claims under general insurance policies for the reason that it discharges the general insurance company's obligations that arose under the policies of insurance. The fact that the payment is not made directly to, or on behalf of, the policyholders does not mean that the payment assumes a different character (per Gibbs CJ in Federal Commissioner of Taxation v. Foxwood (Tolga) Pty Ltd (1981) 147 CLR 278; 81 ATC 4261; (1981) 11 ATR 859). The amount paid therefore maintains the same character as if it were paid directly to, or on behalf of, the policyholders.
Accordingly, the taxpayer is entitled to a deduction under section 321-25 of the ITAA 1936 for the amount paid to the transferee under the portfolio transfer in respect of the outstanding claims liability.
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 was slightly altered to adhere to the drafting approach taken in the ITAA 1997, but as outlined in the explanatory memorandum, there has been no change in meaning of the rewritten provisions.
Therefore, from 1 July 2010, all references to Section 321-25 of the ITAA 1936 should be read as referring to section 321-25 of the ITAA 1997.