Portfolio transfer of general insurance liabilities: consideration received by a general insurance company in respect of deferred acquisition costs

Is the consideration received by a general insurance company from another general insurance company under a portfolio transfer in respect of deferred acquisition costs assessable under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Yes. The amount of consideration received by a general insurance company from another general insurance company under a portfolio transfer in respect of deferred acquisition costs is assessable under section 6-5 of the ITAA 1997.

The taxpayer is a general insurance company for the purposes of section 995-1 of the 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.

The taxpayer, in the course of issuing insurance policies to its policyholders, incurred costs commonly referred to in the industry as acquisition costs. These costs were wholly deductible for taxation purposes in the year they were incurred. However, for accounting purposes, these costs were not wholly expensed but were deferred and recognised as they gave rise to premium revenue. The deferred costs are recorded as an asset by the taxpayer. Under the portfolio transfer, the transferee reimburses the taxpayer for these costs.

Section 6-5 of the ITAA 1997 states that 'your income includes income according to ordinary concepts, which is called ordinary income.' The characterisation of the consideration received by the taxpayer will determine whether the amount is assessable under section 6-5 of the ITAA 1997.

It is established law that a reimbursement or recoupment of a previously allowed deduction does not necessarily give rise to assessable income ( Federal Commissioner of Taxation v. Rowe (1997) 187 CLR 266; 97 ATC 4317; (1997) 35 ATR 432 and HR Sinclair & Son Pty Ltd v. Federal Commissioner of Taxation (1966) 114 CLR 537; (1966) 14 ATD 194; (1966) 10 AITR 3). Therefore, in determining the assessability of the reimbursement, it is immaterial whether the taxpayer was previously allowed a deduction for the deferred acquisition costs.

In Warner Music Australia Pty Limited v. Federal Commissioner of Taxation (1996) 70 FCR 197; 96 ATC 5046; (1996) 34 ATR 171 ( Warner Music ) the taxpayer was refunded an amount of sales tax. The Federal Court held that for an amount to be assessable two requirements must be satisfied: The first involves the question of whether the amount released involved a gain to Warner so as to constitute a profit. The second is whether this profit or gain was on revenue account.

In relation to the first requirement, the reimbursement of the deferred acquisition costs is clearly a gain to the taxpayer.

In relation to the second requirement, the characterisation of a receipt is determined by examining the receipt in the hands of the recipient. In Warner Music , Hill J stated that an amount will be assessable if it is in respect of an expenditure that is 'intimately connected' with the business even though it is outside the ordinary course of a taxpayer's business.

The reimbursement of deferred acquisition costs, whilst not necessarily a frequent aspect of the taxpayer's business, is nevertheless integral to the taxpayer's general insurance business. Accordingly, even though the reimbursement takes place in the context of a cessation of the taxpayer's insurance operation, an infrequent transaction, the reimbursement is regarded as an incident of the taxpayer's business of providing insurance. The reimbursement of the deferred acquisition costs is therefore 'intimately connected' to the ordinary business of the taxpayer.

Accordingly, the reimbursement of the deferred acquisition costs by the transferee will be assessable to the taxpayer under section 6-5 of the ITAA 1997.