Life insurance company: assessment of premiums 'paid' to the company

Is a life insurance risk premium that is due, but remains unpaid to a life insurance company at the end of the income year, included in assessable income under paragraph 320-15(1)(a) of the Income Tax Assessment Act 1997 (ITAA 1997) as an amount that has been 'paid to the company'?

Yes. A life insurance risk premium that is due, but remains unpaid to a life insurance company at the end of the income year, is included in assessable income under paragraph 320-15(1)(a) of the ITAA 1997 as an amount that has been 'paid to the company'.

A life insurance company entered into a contract for a life insurance policy providing risk cover on 29 May 2006. The premium on the policy was payable monthly in arrears, with the first premium being due on 29 June 2006. However, the premium was not paid by the policy holder until 4 July 2006.

The income tax year for the company ended on 30 June 2006.

The value of the net risk component of the policy under subsection 320-85(4) of the ITAA 1997 as at 30 June 2006 was calculated on an 'accruals' basis, with the first premium not being treated as an anticipated future cash flow in the liability calculation of the net risk component of the policy.

If the first premium had been treated as an anticipated future cash flow, this would have reduced the net risk component of the policy.

Paragraph 320-15(1)(a) of the ITAA 1997 provides that the assessable income of a life insurance company includes the total amount of life insurance premiums paid to the company in the income year.

Accordingly, in determining whether a life insurance premium is assessable it is necessary to determine the meaning of the word 'paid' in paragraph 320-15(1)(a) of the ITAA 1997.

As the word 'paid' is not defined in the ITAA 1997 it should be interpreted having regard to its ordinary meaning in the context in which it is used.

The meaning of the word 'paid' was considered in Allen v. Thorn Electrical Industries Limited [1968] 1 QB 487; [1967] 2 All ER 1137 ( Allen's case) in the context of the Prices and Incomes Act 1966 (UK) which had placed a freeze on wages. The employer company contended that the word meant 'actually paid' whilst the employees contended that it meant 'contracted to be paid'.

In Allen's case Lord Denning said at QB 503; All ER 1142: In my opinion, therefore, in these sections the words, "the rate of remuneration paid for the same kind of work" before a particular date, mean "the rate of remuneration contracted to be paid for the same kind of work done" before that date.

The word 'paid' is a descriptive term rather than a technical term that, as Allen's case demonstrates, can be interpreted in certain contexts to be broader than just amounts that have actually been paid.

In Newcastle City Council v. GIO General Limited (1997) 191 CLR 85; McHugh J observed at CLR 112 ...a court is permitted to have regard to the words used in the legislature in their legal and historical context and, in appropriate cases, to give them meaning that will give effect to any purpose of the legislation that can be deduced from that context.

The approach of interpreting words in their context so as to give effect to the purpose of a provision is given legislative support in section 15AA of the Acts Interpretation Act 1901 which provides: In the interpretation of a provision of an Act, a construction that would promote the purpose or object underlying the Act (whether that purpose or object is expressly stated in the Act or not) shall be preferred to a construction that would not promote that purpose or object.

The context in which the word 'paid' must be considered is Division 320 of the ITAA 1997. The object of the Division is given in section 320-5 of the ITAA 1997 as providing a basis for taxing life insurance companies in a way that is broadly comparable to the way that other entities that derive similar kinds of income are taxed. To achieve this object Division 320 identifies certain amounts that are included in the assessable income and certain amounts that a life insurance company can deduct.

The approach adopted in Division 320 of the ITAA 1997 to achieve this object includes matching cash flows with the corresponding changes in liabilities. The correct reflex of the year's activities for risk policies emerges from comparing premium income with the corresponding changes in policy liabilities, and policy benefits with the corresponding change in policy liabilities. Under the Division 320 model, paragraph 320-15(1)(a) of the ITAA 1997 operates to assess premiums, while movements in the net risk components of life insurance policies are assessable under paragraph 320-15(1)(h) of the ITAA 1997 or deductible under section 320-85 of the ITAA 1997.

This matching process was judicially recognised in RACV Insurance Pty Ltd v. Federal Commissioner of Taxation 74 ATC 4169; (1974) 4 ATR 610 as the appropriate basis for the taxation of insurance business prior to the enactment of specific rules for the taxation of insurance businesses. It is clear from the structure and scheme of Division 320 of the ITAA 1997 that these statutory rules were intended to preserve and reinforce, rather than vary or detract from, these principles.

The relevant provisions of Division 320 of the ITAA 1997 use terms such as 'paid' and 'received or recovered' in relation to cash flows. For risk business, the movements in liabilities under the net risk component of polices are deductible and assessable. It is the net effect of cash flows and liability changes in an income year which reveals the tax law outcome. Recognising amounts such as premiums, claims and recoveries only on a cash basis would mean that in some cases cash flows would be taken into account in a different income year from the related increases or decreases in the corresponding policy liabilities.

If cash flows and their related policy liability movements are recognised in different years, there could be significant distortions, and the taxable income would not be an appropriate reflex of the company's financial performance for a particular year.

A purposive and contextual interpretation of the word 'paid' in paragraph 320-15(1)(a) of the ITAA 1997 is therefore appropriate to ensure that the basis of recognising cash flows for income tax purposes is consistent with the basis for recognising the taxable income effects of the corresponding liability.

Division 320 of the ITAA 1997 does not require that either a cash or accruals recognition basis apply in all circumstances, but rather requires that cash flows such as premiums must be recognised for income tax purposes in a way which is consistent with the way that the corresponding changes in policy liabilities are recognised for income tax purposes.

Applying these principles to the life insurance company's risk policy, the appropriate taxable income position emerges when cash flows are recognised in a way that is consistent with the calculation of the corresponding liabilities under the net risk components of the policy.

The net risk component of the life insurance company's life insurance policy was calculated on an 'accruals' basis, and in particular, the premium that was due and payable to the life insurance company at the end of the income year was not included in the liability calculations as an anticipated future cash flow. Therefore, a correct reflex of the taxable income only arises when the life insurance premium that is due and payable at the end of the income year is included in assessable income of the life insurance company for the year ended 30 June 2006 under paragraph 320-15(1)(a) of the ITAA 1997.

Accordingly, the premiums paid to the life insurance company for the purposes of paragraph 320-15(1)(a) of the ITAA 1997 include the life insurance premium that was due and payable to the life insurance company at the end of the income year, as this results in an appropriate matching of the premium to the movement in net risk liabilities of the life insurance company under Division 320 of the ITAA 1997.