Ordinary Income: rebate of professional indemnity insurance premiums

Is a rebate of professional indemnity insurance premiums that were paid by a business taxpayer included in the assessable income of that taxpayer?

Yes. A rebate of professional indemnity insurance premiums is included in a taxpayer's assessable income under subsection 6-5(1) of the Income Tax Assessment Act 1997 (ITAA 1997).

The taxpayer carried on a professional business. In the course of this business, the taxpayer held professional indemnity insurance policies.

The taxpayer paid premiums in respect of those policies. Business forecasts for a particular period helped determine the premiums paid to the insurer for that period. Premium adjustments were calculated at the end of an insured period to reflect actual business, which from time to time resulted in the insurer crediting an amount for the taxpayer's benefit in determining the next premium.

The insurer later resolved to pay out premium rebates to the taxpayer, calculated in proportion to the premiums paid. The taxpayer was subsequently paid a sizeable rebate of the premiums it had paid.

The premium rebate is ordinary income of the taxpayer if it arose from an act done in what was truly the carrying on of a business (see Californian Copper Syndicate v. Harris (1904) 5 TC 159 at 166). To determine this, it is necessary to make both a 'wide survey' and an 'exact scrutiny' of the taxpayer's activities at the relevant times (see Western Gold Mines NL v. Commissioner of Taxation (WA) (1938) 59 CLR 729; (1938) 4 ATD 453, (1938) 1 AITR 248 per Dixon and Evatt JJ at CLR 740; ATD 461). At a fundamental level, the business activities of the taxpayer relate to carrying on a professional business. However, acts done in carrying on a business are not limited to acts in relation to a taxpayer's primary business (see, for example, Colonial Mutual Life Assurance Society Ltd v. Federal Commissioner of Taxation (1946) 73 CLR 604; (1946) 8 ATD 137; (1946) 3 AITR 450).

The acquisition of insurance for business purposes was an essential act of the taxpayer in the course of its business activity as much as the specific business activities that gave rise more directly to the taxpayer's assessable income (compare Hill J in Commissioner of Taxation v. Cooling (1990) 22 FCR 42; 90 ATC 4472; (1990) 21 ATR 13, at FCR 56; ATC 4484; ATR 26).

The business was carried on with a view to profit, and therefore a gain made in the ordinary course of carrying on that business is thereby stamped with the character of income (see Federal Commissioner of Taxation v. Myer Emporium (1986-1987) 163 CLR 199 at 209; 87 ATC 4363 at 4366; (1987) 18 ATR 693 at 697 ( Myer )).

Because the transaction which gives rise to the gain is itself a part of the taxpayer's ordinary business, the identification of the business activity itself stamps the transaction as one having a revenue character. The same can be said where the transaction is an ordinary incident of the business activity of the taxpayer, albeit not directly its main business activity (see Hill J in Westfield Ltd v. Commissioner of Taxation (1991) 28 FCR 333 at 342; 91 ATC 4234 at 4242; (1991) 21 ATR 1398 at 1407).

The unprecedented form of the specific gain does not prevent it from being revenue, because it results from a transaction incidental to the conduct of the taxpayer's business (see Stephen J, AL Hamblin Constructions Pty Ltd v. Federal Commissioner of Taxation (1974) 130 CLR 159; 74 ATC 4001; (1974) 4 ATR 208).

The premium rebate may be said to be consideration for past business between the taxpayer and the insurer, and so an incident of the taxpayer's business. It could be seen as a substitution for future premium reductions.

The premium rebate was directly related in a business sense to the insurance obtained from the insurer by the taxpayer. It effectively reduced the cost of obtaining that insurance by the entire amount of the premium rebate. In these circumstances, the premium rebate is revenue.

The insurance premium was paid by the taxpayer as consideration for insurance cover, there was no specific consideration given for the receipt of the premium rebate. Because no consideration was given, the character of the amount depends upon its quality in the hands of the taxpayer (see Scott v. Federal Commissioner of Taxation (1966) 117 CLR 514; (1966) 14 ATD 286; (1966) 10 AITR 367).

In determining the character of the receipt in the taxpayer's hands, the whole of the circumstances - 'how and why' it came about - must be considered ( Squatting Investment Co Ltd v. Federal Commissioner of Taxation (1953) 86 CLR 570; (1953) 10 ATD 126; (1953) 5 AITR 496).

The premium rebate (although unexpected and unsolicited) was paid because the taxpayer had (as an ordinary incident of its business) paid insurance premiums to the insurer. This indicates the income nature of the premium rebate.

Further, a 'chain of events' sufficiently connected the payment of the rebate with the insurance premiums paid as an incident of the taxpayer's ordinary business (see Federal Commissioner of Taxation v. Squatting Investment Co Ltd (1953-1954) 88 CLR 413 (PC); (1954) 10 ATD 361 (PC); (1954) 5 AITR 664 ( Squatting )). The payment of the premium rebates was ostensibly a discretionary act on the part of the insurer, but was in effect the final link in the chain, directly associating the payment by the insurer with the insurance premiums paid. The connection is further evident in the insurer directing such payments to its insureds in proportion to their respective premiums paid.

The premium rebate was a rebate of certain premiums that the taxpayer had claimed as a deduction, but this does not of itself determine whether the premium rebate is of an income nature (see Federal Commissioner of Taxation v. Rowe (1997) 187 CLR 266; 97 ATC 4317; (1997) 35 ATR 432). The character of the amount received depends upon its character in the hands of the recipient (see Squatting).

The courts and tribunals have held on the facts of particular cases that amounts which are refunds of previously deductible expenditure are assessable gains. Principles extracted from those cases and applied to the instant facts are discussed below: • The payments of insurance premiums protected the business of the taxpayer and had a trade purpose. Such a trade purpose would suggest that the refund of such premiums constituted ordinary income, even though it was different from fees derived from the taxpayer's professional business (see (1955) 5 CTBR (NS) Case 93). • The taxpayer's business necessitated professional indemnity insurance. It paid the premiums and received the rebate in the capacity of holder of the policies. The premium rebate was part of the proceeds of the business carried on by the taxpayer (see H.R. Sinclair Pty Limited v Federal Commissioner of Taxation (1966) 114 CLR 537; (1966) 14 ATD 194, (1966) 10 AITR 3 especially per Owen J). • The rebate arguably was not 'unusual' as it was similar, in essence, to the premium adjustments that had regularly been made under the insurance arrangements. Premium adjustments, like a premium rebate, effectively reduced the net premiums paid by the taxpayer

But even if the premium rebate was unusual, it does not follow that the gain made by the taxpayer is an abnormal gain. That would be to use the word 'abnormal' as meaning 'infrequent'. Although arguably unusual (if the premium adjustments are treated as being of a different nature from the premium rebate), the gain made from the rebate of insurance premiums that the taxpayer paid can be properly regarded as an incident of the taxpayer's professional business.

And even if the gain could be properly described as 'abnormal', it does not inevitably follow that the amount is of a capital nature. As noted above, the gain was so intimately connected with the taxpayer's professional business that it was an incident of that business: as such it is 'stamped' with the character of income (see Myer ).

Consider also Warner Music Australia Pty Ltd v. Commissioner of Taxation (1996) 70 FCR; 96 ATC 5046; (1996) 30 ATR 171 where Hill J held at FCR 211; ATR 182; ATC 5056: ... a gain made by a taxpayer by virtue of being relieved from a liability to pay sales tax is, in my view, properly to be regarded as an incident of the taxpayer's business of selling goods. ... Whether or not the gain itself was ordinary or abnormal, it was so intimately connected with Warner's business ... that it must be treated as being an incident of that business, even if not an ordinary incident of that business. As such it is, to use the words of the Full Court in Myer , "stamped" with the character of income.

First Provincial Building Society Ltd v. Commissioner of Taxation (1995) 56 FCR 320; 95 ATC 4145; (1995) 30 ATR 207 is distinguishable: the payment from Consolidated Revenue in that case lacked the necessary connection with the business activities of the taxpayer to constitute ordinary income (at FCR 326; ATC 4149; ATR 212).

Here, the receipt of the premium rebate is ordinary income: it is clearly and sufficiently connected to the taxpayer's business.

The premium rebate is therefore assessable to the taxpayer under subsection 6-5(1) of the ITAA 1997.