ATO Interpretative Decision
ATO ID 2004/919
Income Tax
Portfolio transfer of general insurance liabilities: refund of exchange commissions by taxpayer in respect of cancelled reinsurance contractFOI status: may be released
This ATOID provides you with the following level of protection:
If you reasonably apply this decision in good faith to your own circumstances (which are not materially different from those described in the decision), and the decision is later found to be incorrect you will not be liable to pay any penalty or interest. However, you will be required to pay any underpaid tax (or repay any over-claimed credit, grant or benefit), provided the time limits under the law allow it. If you do intend to apply this decision to your own circumstances, you will need to ensure that the relevant provisions referred to in the decision have not been amended or repealed. You may wish to obtain further advice from the Tax Office or from a professional adviser.
Issue
Is a refund paid by a general insurance company to a reinsurance company in respect of exchange commissions relating to a reinsurance contract that is cancelled because of a portfolio transfer deductible under section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997)?
Decision
Yes. The amount of the refund paid by a general insurance company to a reinsurance company in respect of exchange commissions relating to a reinsurance contract that is cancelled because of a portfolio transfer is deductible under section 8-1 of the ITAA 1997.
Facts
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 has a reinsurance contract with a reinsurance company. The purpose of the reinsurance contract is to reduce the taxpayer's exposure to claims. Because the taxpayer incurred expenses in writing insurance contracts, the reinsurance company previously paid a proportion of the reinsurance premium as an exchange commission to the taxpayer.
The taxpayer entered into a portfolio transfer arrangement with the reinsurance company. Under the terms of the arrangement the reinsurance contract is to be cancelled.
The taxpayer intends to cease its insurance operation after the portfolio transfer.
The taxpayer, on cancellation of the reinsurance contract, refunds that part of the exchange commissions relating to the unexpired portion of the premium to the reinsurance company.
Reasons for Decision
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.
The deductibility of the reimbursement of the exchange commission can be determined in light of the High Court's decision in G.P. International Pipecoaters Pty Ltd v. Federal Commissioner of Taxation (1990) 170 CLR 124; 90 ATC 4413; (1990) 21 ATR 1 (Pipecoaters). In the Pipecoaters decision the court stated:
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.
In the context of subsection 51(1) of the Income Tax Assessment Act 1936, the predecessor of section 8-1 of the ITAA 1997, Hill J said in FC of T v. Broken Hill Pty Ltd Company Ltd 2000 ATC 4659; (2000) 45 ATR 507; [2000] FCA 1431:
In determining whether an outgoing falls for deductibility under s51(1), it will be critical to determine what the outgoing is paid for. The significance of that question, which is directed to ascertaining the advantage sought to be obtained, is essential to the determination of true characterisation of an outgoing.
The taxpayer had previously received an exchange commission in recognition of costs that it incurred in relation to the policies it reinsured. The exchange commission represents the reinsurance company's contribution to the costs that the taxpayer incurred in writing the business that it reinsured. The amount of exchange commission is determined on the expectation that the reinsurance contract would run for a given period of time.
As the reinsurance contract is not going to run its full term, the taxpayer will refund part of the exchange commission that it received from the reinsurer. The refund recognises the fact that the mutual obligations of the taxpayer and the reinsurer under the reinsurance contract will not be performed for the period that was initially agreed.
The entering into of reinsurance contracts, and the receipt of exchange commissions, is a normal incident of the business of an insurer. Therefore, where the reinsurance contract will not run for the period that was originally intended, a refund of part of the exchange commissions in relation to that contract is considered to have a revenue character and will be deductible.
Accordingly, the consideration paid by the taxpayer in respect of exchange commissions relating to a reinsurance contract that is cancelled because of a portfolio transfer is deductible under section 8-1 of the ITAA 1997.
Date of decision: 1 November 2004Year of income: Year ended 30 June 2004
Legislative References:
Income Tax Assessment Act 1997
section 8-1
paragraph 8-1(2)(a)
section 995-1
subsection 51(1) Insurance Act 1973
the Act
Case References:
G P International Pipecoaters Pty Ltd v. Federal Commissioner of Taxation
(1990) 170 CLR 124
90 ATC 4413
21 ATR 1
2000 ATC 4659
45 ATR 507 Related ATO Interpretative Decisions
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ATO ID 2004/917
ATO ID 2004/918
ATO ID 2004/920
ATO ID 2004/921
ATO ID 2004/922
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ATO ID 2004/924
ATO ID 2004/925
ATO ID 2004/926
ATO ID 2004/927
ATO ID 2004/928
ATO ID 2004/929
ATO ID 2004/930
Keywords
General insurance
General insurance industry
Reinsurance & reinsurers
ISSN: 1445-2782