Portfolio transfer of general insurance liabilities: deduction for amount paid by taxpayer in respect of deferred acquisition costs of a general insurance company

Is a general insurance company entitled to claim a deduction under section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997) for the consideration paid under a portfolio transfer to another general insurance company in respect of deferred acquisition costs of the other general insurance company?

Yes. The general insurance company is entitled to a deduction under section 8-1 of the ITAA 1997 for the consideration paid under a portfolio transfer to another general insurance company in respect of deferred acquisition costs of the other general insurance company.

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 it assumed the insurance liabilities of another general insurance company (the transferor).

The portfolio transfer is done in accordance with the provisions of the Insurance Act.

The transferor, in the course of issuing insurance policies to its policyholders, incurred costs commonly referred to in the industry as 'acquisition costs'. These costs are, for taxation purposes, referred to as 'apportionable issue costs' and were wholly deductible in the year they were incurred. However, for accounting purposes these costs were not wholly expensed but were deferred and recognised as they give rise to premium revenue. The deferred costs are recorded as an asset by the transferor.

Under the portfolio transfer, the taxpayer reimburses the transferor for the deferred costs.

Section 8-1 of the ITAA 1997 states that a loss or outgoing is deductible provided that 'it is necessarily incurred in carrying on a business for the purpose of gaining or producing your assessable income.' A loss or outgoing is not deductible under section 8-1 of the ITAA 1997 if it is denied under paragraph 8-1(2)(a) of the ITAA 1997 because it is a loss or outgoing of a capital nature.

Whether an amount paid is deductible under section 8-1 of the ITAA 1997 is a question of characterisation of the expense. It was held in G.P. International Pipecoaters Pty Ltd v. Federal Commissioner of Taxation (1990) 170 CLR 124; 90 ATC 4413; (1990) 21 ATR 1: The character of expenditure is ordinarily determined by reference to the nature of the asset acquired or the liability discharged by the making of the expenditure, for the character of the advantage sought by the making of the expenditure is the chief, if not the critical, factor in determining the character of what is paid.

Dixon J, in Hallstroms Pty Ltd v. Federal Commissioner of Taxation (1946) 72 CLR 634; (1946) 8 ATD 190; (1946) 3 AITR 436, held that the characterisation of a loss or outgoing must be considered from a practical and business point of view. Under a portfolio transfer, the payment from the taxpayer to the transferor is made to reimburse the transferor for the deferred acquisition costs it incurred in writing the insurance policies that are transferred to the taxpayer.

The advantage sought by the making of the expenditure is to place the taxpayer in the same position as the transferor. That is, the payment is made in recognition of the costs that the taxpayer would have incurred if it had written the policies directly with the policyholders rather than obtaining the policies through the portfolio transfer. The payment is in the nature of a normal expense incurred in the business of providing insurance risk cover to policyholders.

This is further supported by the High Court decision of Federal Commissioner of Taxation v. Morgan (1961) 106 CLR 517; (1961) 12 ATD 370; (1961) 8 AITR 421 where a purchaser of a property sought a deduction under subsection 51(1) of the Income Tax Assessment Act 1936 for the amount paid to the vendor of the property in respect of the apportioned rates. The High Court held that the reimbursement of an expense paid by the purchaser was deductible as it is an expense borne by the purchaser. Applying this reasoning to the taxpayer's situation, the expenditure is deductible as it reimburses amounts that would have been normal operating expenses of the taxpayer if they had been incurred directly by the taxpayer.

Accordingly, the taxpayer is entitled to a deduction under section 8-1 of the ITAA 1997 for the consideration it paid under a portfolio transfer in respect of deferred acquisition costs of the transferor.