Commercial Union Assurance Company of Australia Limited v. Federal Commissioner of Taxation.

Judges:
Newton J

Court:
Supreme Court of Victoria

Judgment date: Judgment handed down 3 May 1977.

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Newton J.: These are appeals by Commercial Union Assurance Company of Australia Limited (which I shall call ``Commercial Union'') against its assessments of income tax for the years ended 30th June, 1973, and 30th June, 1974.

The questions in issue in the appeals relate to the extent to which provisions made for claims incurred but not reported were allowable deductions under sec. 51 of the Income Tax Assessment Act.

In
R.A.C.V. Insurance Pty. Ltd. v. F.C. of T. 74 ATC 4169; (1975) V.R.. I it was held that a provision for claims incurred but not reported, which had been made by R.A.C.V. Insurance Pty. Ltd. in relation to compulsory third party insurance, was an allowable deduction under sec. 51. Before me the Commissioner accepted the correctness of that decision. But he contended that in the present appeals there were features which had not existed in the R.A.C.V. Insurance case, and which prevented the allowance as a deduction of the whole of the amounts claimed by Commercial Union. There is no doubt that there are features in the present appeals which did not exist in the R.A.C.V. Insurance case, but nevertheless in my opinion in each of the two years in question the whole, or substantially the whole, of the amount claimed by Commercial Union was an allowable deduction under sec. 51. Both appeals will therefore be allowed.

A very large amount of evidence was adduced by Commercial Union, both oral and documentary. There was very detailed evidence about the insurance business carried on by Commercial Union and its subsidiary companies before, during and after the two years in question in these appeals. There was in addition evidence about insurance businesses carried on by other insurers, and about insurance business generally both in Australia and overseas. Some of the evidence was evidence of a theoretical or opinion character given by accountants, actuaries or other experts. I find it unnecessary to review the whole of the evidence adduced by Commercial Union, and indeed to much of it I shall not refer at all. But I wish expressly to say at this point that I accept in substance the whole of the evidence adduced by Commercial Union, both oral and documentary.

The facts out of which the present appeals arise are somewhat complicated. For present purposes it is sufficient to state them in a relatively short and somewhat simplified form.

During each of the two years in question, and also prior thereto, Commercial Union and a number of other insurance companies, each of which was a wholly owned subsidiary of Commercial Union, carried on insurance business in partnership through an underwriting pool in which each member had a specified share. During the year ended 30th June, 1972, the share of Commercial Union in the pool (which I shall call ``the Commercial Union Pool'') was 21.5 per cent. During the year ended 30th June, 1973, its share was 27.25 per cent, it having acquired as at 1st July, 1972, the shares of two other members of the Pool, totalling 5.75 per cent in all. During the year ended 30th June, 1974, the share of Commercial Union in the Commercial Union Pool was 42.5 per cent, it having acquired as at 1st July, 1973, the shares of three other members of the Pool, totalling 15.25 per cent in all.

The insurance business carried on through the Commercial Union Pool comprised practically all forms of insurance business except life assurance. Although policies were issued by individual members of the Pool in their own names, the policies were ordinarily headed ``Commercial Union Australia Group'', and a single administration and claims staff acted for all the members of the Pool, save that Dalgety Australia Ltd. carried out some administrative functions for one of

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the members of the Pool, namely Union Assurance Society of Australia Ltd., pursuant to power of attorney. Commercial Union had complete control over all the other members of the Commercial Union Pool, and over the operations of the Pool. Commercial Union did not carry on insurance business otherwise than as a member of the Commercial Union Pool, save that it carried on a life assurance business which is not relevant to the present appeals.

Accounts for the Commercial Union Pool were prepared for each year ended 30th June. By arrangement with the Commissioner of Taxation no partnership income tax returns, as required by sec. 91 of the Income Tax Assessment Act, were furnished by the Pool, but instead the relevant information for each year was supplied by Commercial Union when it furnished its own income tax return. However it was common ground that the Commercial Union Pool ought to be treated as a partnership for the purposes of the present appeals. I may add that in its own income tax returns Commercial Union did not simply show its own individual interest in the ``net income'' of the Commercial Union Pool as part of its assessable income (see sec. 92(1)); instead it set out a calculation of its own taxable income by reference, inter alia, to its own shares of the assessable income and allowable deductions of the Commercial Union Pool: see Folios 12, 13 and 63 of Exhibit ``F'', and also Exhibit ``F1''.

As is demonstrated by the R.A.C.V. Insurance case (supra), in order to ascertain the taxable income derived by an insurer for any year, it is necessary to deduct from the earned premiums (that is the premiums properly attributable to that year by the twenty-fourths method or by some other appropriate method), not only the payments actually made during the year in satisfaction of claims arising from the insurances with respect to which those premiums were earned, together with administration expenses and the like, but also an appropriate amount or provision, arrived at by reasonable estimate, in respect of claims outstanding at the end of the year. And outstanding claims for which provision must be made include not only claims which have been communicated to the insurer during the year in question but not yet been paid, but also claims which have not been communicated to the insurer before the end of the year, but which will later be communicated and paid, and in relation to which the event giving rise to the insurer's liability occurred before the end of the year. Claims of this latter type are commonly called ``claims incurred but not reported''.

The reasons why the taxable income of an insurer must be ascertained in the way just described were explained in the R.A.C.V. Insurance case. And it was made abundantly clear by oral and documentary evidence before me from persons having expert qualifications in this field that this is the only way in which the profit of an insurance business for any year can properly be ascertained, or indeed can lawfully be ascertained: as to the latter, see, for example, sec. 161(1) and (3) of the Victorian Companies Act 1961; sec. 40(1)(a), and 44(1) and (2)(e), (g) and (h) of the Commonwealth Insurance Act 1973;, and reg. 11 of the Insurance Regulations under the last-mentioned Act, and the various forms referred to therein, especially Form 6. Putting it broadly, the true profit of an insurance business in respect of any year can be no more than what remains after deducting from the premiums earned in that year, all the claims arising out of the insurances in respect of which those premiums were earned, and also of course the administration and like expenses referable to that year; and in the nature of things many of the claims arising out of the insurances in respect of which the premiums were earned will still be unpaid at the end of the year and will include claims incurred but not reported. The cost to an insurer of the earned premiums in any year is the amount of all claims arising out of the insurances in respect of which those premiums were earned, plus administration and like expenses referable to that year.

Prior to the year ended 30th June, 1973, a deduction in respect of outstanding claims was made in each year by the Commercial Union Pool for the purpose of ascertaining its profit for that year, and this deduction appears to have been accepted by the Commissioner of Taxation in ascertaining the taxable incomes of Commercial Union and the other members of the Pool. But the deduction was based simply on estimates of outstanding claims which had in fact been communicated to the Pool. It was appreciated that there would also be claims which arose out of events which had occurred before the end of the year, but which had not been communicated to the Pool, that is claims incurred but not reported. However it was sought to make provision for this category of outstanding claims by ensuring that the estimates of claims already communicated to the Pool, which made up the deduction in respect of outstanding claims, were on the high

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ATC 4190

side by between 5 per cent and 10 per cent, and also by keeping the accounts open for two or three weeks after 30th June, so as to enable there to be taken into account claims which were received during that period but which arose out of events occurring before 30th June. It was considered for a long time that claims incurred but not reported were sufficiently provided for in this way, and a rough manual check carried out during the year ended 30th June, 1971, was thought to confirm that this was so.

But during the year ended 30th June, 1973, it became apparent that this method of providing for claims incurred but not reported was no longer satisfactory, having regard particularly to inflation, and to retrospective workers' compensation legislation. This was confirmed by calculations which were carried out with the aid of computers. And the necessity for a change in the method was emphasized by the fact that by 30th June, 1973, the provision for outstanding claims, which had been made as at 30th June, 1972, and which amounted to $39,559,704, had been found to be an inadequate provision, even for the communicated outstanding claims at that date, by an amount of more than three and half million dollars.

It was therefore decided that in calculating the outstanding claims of the Pool as at 30th June, 1973, a separate calculation should be made in respect of claims incurred but not reported at that date, which would be added to the estimate of the outstanding claims which had been communicated to the Pool at that date. And this was done. The estimate of claims incurred but not reported as at 30th June, 1973, produced an amount of $5,864,866, and the estimate of outstanding claims which had been communicated to the Pool as at 30th June, 1973, produced an amount of $54,155,259, making a total of $60,020,125.

I shall later give some explanation of the method by which the estimate of $5,864,866 in respect of claims incurred but not reported as at 30th June, 1973, was calculated. But I should here refer to a tiresome, although unimportant, complication, which was discussed and explained at a supplementary hearing on 18th and 19th April, 1977.

One of the members of the Commercial Union Pool, namely Union Assurance Society of Australia Ltd. (which I shall call ``the Union company'') carried on insurance business on a small scale in Fiji, as well as insurance business on a much larger scale in Australia. The Union company was a member of the Pool in relation to its Australian business, its share being 19.5 per cent at all presently material times. But the Fiji business of the Union company was entirely excluded from the partnership constituted by the Commercial Union Pool. However for reasons of practical convenience the Fiji business of the Union company was treated as part of the business of the Pool in the calculation of the sum of $5,864,866. But the effect of this irregularity was marginal only, perhaps adding a sum of the order of $16,000 to what would otherwise have been the result of the calculation. As will later be seen, the irregularity was ignored in the preparation of Commercial Union's own income tax return for the year ended 30th June, 1973. It was also ignored in the preparation of the Union company's income tax return for the year ended 30th June, 1973, in that the Union company claimed as a deduction in respect of claims incurred but not reported as at 30th June, 1973, simply 19.5 per cent of the sum of $5,864,866, that is $1,143,649. Hence, if it matters at all, the revenue could lose nothing overall by reason of the irregularity. And counsel for the Commissioner did not seek to rely on the irregularity before me. Of the sum of $1,143,649, being the Union company's share of the sum of $5,864,866, a sum of $16,004 appears to have been allocated to the Union company's business in Fiji, and the balance of $1,127,645 to the Union company's Australian business. Thus the correct view may be that the claims incurred but not reported of the Commercial Union Pool itself as at 30th June, 1973, were treated as being not $5,864,866, but $5,848,862, that is $5,864,866 less $16,004. But throughout the hearing before me the relevant sum was taken as being $5,864,866, and for convenience I shall so treat it in this judgment. Reference may be made generally to Folio 13 of Exhibit ``F''.

There was evidence, which I accept, that later events established that the estimate of $54,155,259 in respect of outstanding communicated claims as at 30th June, 1973, was approximately correct, and probably indeed a slight over-estimate, but that the estimate of $5,864,866 in respect of claims incurred but not reported at that date was an under-estimate by an amount of more than $2,400,000. Hence the total provision of $60,020,125 in respect of all claims outstanding at 30th June, 1973, was

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ATC 4191

insufficient by an amount in excess of two million dollars. I may refer to Exhibits ``P'', ``U'', ``CC'' and ``TT1''. The detailed figures are in some cases complicated, and they depend to some extent on estimates or on periodical revisions of past estimates, and there are some minor arithmetical discrepancies; and the figures relating to the accuracy of the estimate of $54,155,259 include a relatively insignificant additional sum which represents the outstanding communicated claims of the Union company's business in Fiji as at 30th June, 1973, and which ought to have been excluded. But I am satisfied that the overall position is as I have just stated it.

I now turn to give some explanation of the manner in which the sum of $5,864,866 was calculated. In this explanation I shall for the sake of convenience of expression ignore the circumstance that for the purposes of the calculation the Fiji business of the Union company was treated as part of the business of the Commercial Union Pool. The manner in which the calculation was made was explained in detail in the evidence: see for example Folios 5 to 11 of Exhibit ``F''. I shall therefore do no more than set out in simplified form a summary of the method which was used.

The calculation was made with the help of computers. An analysis was made of the claims which had been communicated to the Commercial Union Pool for the first time during the year ended 30th June, 1973, but which had arisen from events insured against which had occurred before 1st July, 1972. With respect to each such claim its amount was ascertained or estimated and the year in which the event insured against had occurred was identified. Each claim was allocated to the particular major class of insurance to which it belonged, that is fire, liability, other accident, motor or marine. With respect to each class of insurance it was ascertained in relation to each of the three years prior to the year ended 30th June, 1973, what was the percentage of the total premiums received for that class in that year which was represented by claims which had been communicated for the first time during the year ended the 30th June, 1973, but which had arisen out of events occurring in that earlier year. The sum of $5,864,866 was calculated upon the hypothesis that these percentages would remain constant, and by applying the appropriate percentages to the relevant premium incomes derived during the years ended 30th June, 1971, 30th June, 1972, and 30th June, 1973, respectively. Thus, for example, since the amount of all fire insurance claims, which were communicated for the first time during the year ended 30th June, 1973, but which arose out of events occurring during the year ended 30th June, 1972, was found to equal 1.39 per cent of the total fire insurance premiums received during the year ended 30th June, 1972, it was assumed for the purposes of the calculation that the amount of the fire insurance claims which would be first communicated during the year ended 30th June, 1974, but which arose out of events which had occurred during the year ended 30th June, 1973, would be 1.39 per cent of the total fire insurance premiums received during the year ended 30th June, 1973. And since the amount of all fire insurance claims, which were communicated for the first time during the year ended 30th June, 1973, but which arose out of events occurring during the year ended 30th June, 1971, was found to equal.03 per cent of the total fire insurance premiums received during the year ended 30th June, 1971, it was assumed for the purpose of the calculation that the amount of the fire insurance claims which had arisen from events which had occurred during the year ended 30th June, 1972, but which would be first communicated during the year ended 30th June, 1974 would be.03 per cent of the total fire insurance premiums received during the year ended 30th June, 1972; and likewise it was assumed that the amount of the fire insurance claims which had arisen from events occurring during the year ended 30th June, 1973, but which would be first communicated during the year ended 30th June, 1975, would be.03 per cent of the total fire insurance premiums received during the year ended 30th June, 1973.

There was evidence, which I accept, that this method of calculating the sum of $5,864,866 was a proper method to have adopted in the circumstances. In fact, as earlier indicated, the method produced a sum which later proved to be an under-estimate by an amount of more than $2,400,000.

As earlier stated, during the year ended 30th June, 1973, the share of Commercial Union in the Commercial Union Pool was 27.25 per cent. Therefore in its income tax return for that year Commercial Union claimed the sum of $1,598,177 as an allowable deduction, being

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27.25 per cent of the sum of $5,864,866, which had been the provision made by the Pool for claims incurred but not reported as at 30th June, 1973. (In fact 27.25 per cent of $5,864,866 is not $1,598,177, but $1,598,175.98. But, as was explained by Mr. Miller in his evidence at the supplementary hearing on 19th April, 1977, this discrepancy arose in the rounding out of even dollar sums in apportioning the sum of $5,864,866 between the members of the Commercial Union Pool, and I propose to disregard it.)

In making his assessment of the taxable income of Commercial Union for the year ended 30th June, 1973, the Commissioner of Taxation disallowed the whole of this sum of $1,598,177 as a deduction. The question in issue in the appeal concerning the year ended 30th June, 1973, is whether this sum of $1,598,177, or any and what part thereof, ought to have been allowed as a deduction. In my opinion the whole, or substantially the whole, of the sum of $1,598,177 ought to have been allowed as a deduction.

It is, I think, convenient at this point to state my reasons for this conclusion, before proceeding to explain the facts relating to the appeal concerning the year ended 30th June, 1974.

The question in fact depends upon whether the sum of $5,864,866 was an allowable deduction in calculating the ``net income'' (i.e. in effect, the taxable income) of the Commercial Union Pool partnership for the year ended 30th June, 1973: see sec. 90, 91 and 92 of the Income Tax Assessment Act. And the matter was argued before me on that footing. For convenience of expression I shall refer to the ``taxable income'' of the Commercial Union Pool, although the technically correct expression is of course ``net income'' in the sense defined in sec. 90.

As earlier stated, the sum of $5,864,866 was in fact a very inadequate estimate of the Pool's claims incurred but not reported as at 30th June, 1973. And in the end it was accepted by counsel for the Commissioner of Taxation that, having regard to the R.A.C.V. Insurance case (supra), part of the sum of $5,864,866 was very likely an allowable deduction in calculating the taxable income of the Commercial Union Pool for the year ended 30th June, 1973. But it was contended on behalf of the Commissioner that the whole of that sum could not be an allowable deduction. Three arguments were advanced in support of this contention, and it was submitted that if I accepted any one or more of them, then there should be a further hearing for the purpose of deciding what part of the sum of $5,864,866 was an allowable deduction in calculating the taxable income of the Commercial Union Pool for the year ended 30th June, 1973. However I do not accept any of the three arguments. I shall deal with each in turn.

In the first place counsel for the Commissioner relied on the circumstance that at all material times many, although by no means all, of the insurance policies which were issued by the members of the Commercial Union Pool, contained conditions requiring notice of the occurrence of an event insured against to be given to the insurer within a specified time, or ``forthwith'', or ``as soon as possible'', or the like; in some cases the condition was coupled with a further condition which in substance required particulars of claim to be furnished promptly or within a specified time. And there is no doubt that in the case of many at least of the policies which contained conditions of this kind, the condition was a condition precedent, in the sense that if it was not complied with, then the insurer would never become liable under the policy unless the insurer chose to waive the breach of the condition or became estopped from relying upon it. See, for example, MacGillivray and Parkington on Insurance Law 6th ed. (1975) para. 1781-1782, and 1792-1793; and Ivamy, General Principles of Insurance Law 3rd. ed. (1975) pp. 373-382. The compulsory third party policies which were the subject of the R.A.C.V. Insurance case (supra) did not contain conditions precedent as to notice, as was pointed out in the judgment: see 74 ATC at p. 4178; (1975) V.R. at p. 10.

It was made clear by the evidence that in nearly all cases arising under policies containing conditions precedent of the kind just described, where the event insured against had occurred before 30th June, 1973, but no claim was communicated to the particular member of the Commercial Union Pool who was the insurer until after 30th June, 1973, there was a breach of the condition by the insured; indeed in the great majority of cases the condition had been broken before 30th June, 1973. But the evidence also established

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that at all material times the almost invariable practice of all the members of the Commercial Union Pool was to pay claims in full, notwithstanding non-compliance by the insured with conditions precedent as to notice. Only in a case where some grave prejudice to the insurer had arisen from non-compliance with the condition would consideration be given to disclaiming liability in reliance upon the condition; such cases were very rare and even in such cases liability was not always disclaimed. The reason for the practice, which at all material times has been followed by other insurers in Australia, is to be found principally in considerations of business expediency. Insurance is a very competitive business, and an insurer who chose to rely on conditions precedent as to notice would soon go out of business. Accordingly the sum of $5,864,866, which represented the provision made by the Commercial Union Pool for claims incurred but not reported as at 30th June, 1973, was calculated on the assumption that, in the case of policies containing conditions precedent as to notice, liability existed as at 30th June, 1973 in all, or almost all, cases where the event insured against had occurred before the 30th June, 1973, although not communicated until afterwards, notwithstanding that there had not been, and in most cases never would be, compliance with the condition as to notice. This followed from the method of calculation which was used, and of which I have earlier given some explanation. For the calculation was based on claims which were communicated for the first time during the year ended 30th June, 1973, but in relation to which the event insured against had occurred before 1st July, 1972, and those claims had included numerous claims which arose under policies containing conditions precedent as to notice that had not been complied with, and which had nevertheless been paid in full.

It was contended on behalf of the Commissioner that the method of calculation of the sum of $5,864,866 was incorrect, in that it proceeded on the assumption that liability existed as at 30th June, 1973, in respect of cases where, although the event insured against had occurred, nevertheless there had already been a breach of a condition precedent as to notice, or at all events a condition precedent as to notice had not yet been complied with. It was submitted that in such cases there could be no allowable deduction in respect of the claim before the year during which the claim was actually paid, or during which the insurer became legally liable to pay the claim, if this should occur before actual payment (for example by compliance with the condition, or by waiver or estoppel). Strong reliance was placed by counsel for the Commissioner upon the judgment of the High Court in
F.C. of T. v. James Flood Pty. Ltd. (1953) 88 C.L.R. 492. It was submitted that this judgment established that an unpaid liability could never be a loss or outgoing which had been ``incurred'' within the meaning of sec. 51, unless, at the least, the taxpayer had completely subjected itself to the liability, in the sense that the liability was no longer inchoate or contingent, although it might in some cases be defeasible. It was submitted that in the case of policies which contained a condition precedent as to notice, the occurrence of the event insured against at most gave rise to an inchoate liability under the policy, and the insurer could not be completely subjected to liability until the condition was complied with, or there was a waiver or estoppel with respect to the condition.

But in my opinion this contention on behalf of the Commissioner ought not to be accepted. I consider that the situation as at 30th June, 1973, with respect to cases where the event insured against had already occurred, but had not been communicated to the insurer, and where the relevant policy contained a condition precedent as to notice, was that the insurer had become completely subjected to liability under the policy for the purposes of sec. 51 of the Income Tax Assessment Act, subject only to one presently insignificant qualification to which I shall later refer. For the event insured against had occurred, and the position therefore was that the insurer was under a liability to indemnify the insured as provided by the policy, unless the insurer should choose to rely upon any failure to comply with the condition precedent as to notice. But the long established policy and practice of all the members of the Commercial Union Pool made it certain, subject to the aforesaid presently insignificant qualification, that the claim would be paid, whether or not the condition as to notice was complied with. Payment was a matter of commercial certainty, and was not subject to any contingency which would be regarded as such in the world of ordinary business affairs. This policy and practice was based on business

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expediency, and it is well established that payments made for reasons of business expediency, although otherwise voluntary, are not excluded from the category of allowable deductions under sec. 51, because not not made in pursuance of any legal obligation: see, for example,
F.C. of T. v. Gordon (1930) 43 C.L.R. 456 at pp. 462 per Dixon J., and 470 per Starke J.; and
Sun Newspapers Ltd. v. F.C. of T. (1938) 61 C.L.R. 337 at p. 352 per Latham C.J. Indeed, an acceptance of the Commissioner's first argument would be quite out of accord with the realities of the situation. It may be observed that although the High Court in Flood's case (supra) indicated that an unpaid liability cannot be a loss or outgoing, which has been ``incurred'' for the purposes of sec. 51, unless the taxpayer ``has completely subjected himself'' to it, nevertheless the Court proceeded to say: ``It may be going too far to say that he must have come under an immediate obligation enforceable at law whether payable presently or at a future time'' (emphasis is mine): see 88 C.L.R. at p. 506.

It is also of importance, in my opinion, to bear in mind that the policies which contained conditions precedent as to notice were nevertheless contracts of insurance (not being contracts of life assurance), that is contracts to indemnify the insured against loss from events which might or might not occur: see, for example,
The National Mutual Life Association of Australasia Ltd. v. F.C. of T. (1959) 102 C.L.R. 29 at p. 45 per Windeyer J.; and
Department of Trade and Industry v. St. Christopher Motorists' Association Ltd. (1974) 1 W.L.R. 99, especially at pp. 103-106. It would in my opinion be wrong to regard them as contracts to pay money to the insured, or for his benefit, upon the reporting to the insurer within a specified time of the occurrence of an event. On the contrary they were insurance contracts subject to a condition precedent as to notice, and since it was certain that the condition as to notice would never be relied on by the insurer, the liability of the insurer was ``incurred'' within the meaning of sec. 51 upon the happening of the event insured against.

The presently insignificant qualification to which I have earlier referred is that as at 30th June, 1973, it was at least theoretically possible that liability in respect of some of the claims in question would be disclaimed in reliance upon the notice condition, if the insurer considered that grave prejudice had been caused to it by non-compliance with the condition. But past experience made it certain that if this occurred at all, then it would occur only in an insignificant minority of cases: compare
Southern Railway of Peru Ltd. v. Owen (1957) A.C. 334 at pp. 346-347 per Lord MacDermott, and pp. 355-358 per Lord Radcliffe. And the method by which the sum of $5,864,866 had been calculated had taken this qualification into account, because, as earlier pointed out, the calculation was based only on claims first reported in the year ended 30th June, 1973, although arising out of events prior to 1st July, 1972, which had in fact been paid, or in relation to which liability had been accepted.

As I have earlier emphasised, the profit of an insurance business in any year can only be properly ascertained after bringing into account against the earned premiums of that year, inter alia all the claims outstanding at the end of the year which arose out of the insurances in respect of which those premiums were earned. And this principle necessarily requires that all claims incurred but not reported at the end of the year, which arose out of those insurances, and which will later be paid, should be included in the outstanding claims which are brought into account, whether or not the relevant policies contain conditions precedent as to notice. The correctness of this conclusion was indeed emphasised by the evidence of witnesses who were well qualified to speak upon the matter. And in Flood's case (supra) the Court said that ``commercial and accountancy practice may assist in ascertaining the true nature and incidence of the item as a step towards determining whether it answers the test laid down in sec. 51(1)'', although of course, as the Court also said, ``it cannot be substituted for the test.''

I now turn to the second argument which was advanced on behalf of the Commissioner of Taxation with respect to Commercial Union's appeal for the year ended 30th June, 1973.

In a case where a provision for claims outstanding at the end of a year is an allowable deduction in calculating the taxable income of an insurer for that year, then when those claims come to be paid in the future, they must for income tax purposes be debited against the amount of that provision, so far as it is sufficient for the purpose. The claims cannot

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be treated as allowable deductions from the premiums earned by the insurer in the year in which the claims are paid for the purpose of calculating the insurer's taxable income of that later year, except insofar as the provision proves insufficient to meet them. Otherwise claims would be treated as allowable deductions twice over.

A convenient method of achieving the result just referred to, is to treat the amount of the provision for outstanding claims at the end of one year as part of the insurer's assessable income of the following year together with the earned premiums of that year, and then to calculate the insurer's taxable income for that second year by deducting all the claims in fact paid during that year, plus a provision for outstanding claims at the end of that year, plus, of course, administration and like expenses attributable to that year. Many of the claims paid during the second year will of course have been claims which were outstanding at the end of the first year, and they will thus in fact be debited against the provision for outstanding claims at the end of the first year, because that provision is treated as part of the assessable income of the second year. This method is perhaps technically incorrect, because the provision for outstanding claims at the end of the first year was part of the assessable income of that year, and cannot therefore also be part of the assessable income of the second year, except insofar as the provision may prove to have been excessive (as to which see the R.A.C.V. Insurance case (supra) at ATC pp. 4176-77; V.R. pp. 8-9). But, however this may be, the method nevertheless produces the correct result, and it was adopted by the Commercial Union Pool, and also by Commercial Union in its own income tax returns. A shorthand way of applying the method is to compare the provision for claims outstanding at the end of one year with the provision for claims outstanding at the end of the following year, and to treat any increase as an allowable deduction for the second year, and any decrease as part of the assessable income of the second year. This was the way in which the method was applied by Commercial Union in its own income tax returns: see Folios 12 and 63 of Exhibit ``F''.

The provision for outstanding claims which was made by the Commercial Union Pool as at 30th June, 1972, was $39,559,704 (after certain presently immaterial adjustments). And this sum was brought into account by the Pool as part of its assessable income for the year ended 30th June, 1973. But, as earlier indicated, this sum was made up of estimates of outstanding claims as at 30th June, 1972, which had been communicated to the Pool. It did not include any specific sum in respect of claims incurred but not reported as at 30th June, 1972, although such claims were in fact intended to be provided for in the way earlier explained. As also earlier indicated, the provision for outstanding claims which was made by the Pool as at 30th June, 1973, comprised $54,155,259 in respect of communicated outstanding claims, and $5,864,866 (if the Fiji complication be ignored) in respect of claims incurred but not reported, that is a total provision of $60,020,125. I should perhaps expressly say that this figure of $60,020,125 is not to be found in any account which was put in evidence: compare Folio 13 of Exhibit ``F''. But it is arithmetically consistent with the figures in Commercial Union's own income tax return for the year ended 30th June, 1973. In that return a sum of $8,505,336, which represented 21.5 per cent of the sum of $39,599,704, was in effect treated as part of Commercial Union's assessable income for the year ended 30th June, 1973, the share of Commercial Union in the Commercial Union Pool during the year ended 30th June, 1972 having been 21.5 per cent as earlier stated. And there was treated as an allowable deduction for the year ended 30th June, 1973, the sum of $16,355,485, which represented 27.25 per cent of $60,020,125, that is $14,757,308 (being 27.25 per cent of $54,155,259) plus $1,598,177 (being 27.25 per cent of $5,864,866). The share of Commercial Union in the Commercial Union Pool during the year ended 30th June, 1973, was 27.25 per cent as earlier stated. I may refer especially to Folio 12 of Exhibit ``F''.

It was contended in substance on behalf of the Commissioner that if in fact the provision of $5,864,866 in respect of claims incurred but not reported as at 30th June, 1973, was an allowable deduction in calculating the taxable income of the Commercial Union Pool for the year ended 30th June, 1973, as part of the total deduction of $60,020,125 for all outstanding claims as at 30th June, 1973, then for the purpose of calculating the taxable income of the Pool for the year ended 30th June, 1973, an appropriate amount in respect of claims incurred but not reported as at 30th June, 1972, should be added to the sum of

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ATC 4196

$39,559,704 which, as earlier stated, had been included in the assessable income of the Pool for the year ended 30th June, 1973, as representing the provision for outstanding claims as at 30th June, 1972. If this were done, then of course the allowance of the sum of $5,864,866 as a deduction would be offset by a substantial amount; and there would be a proportionate offset to the deduction of $1,598,177 claimed by Commercial Union.

But in my opinion this contention on behalf of the Commissioner is not correct. It may incidentally be observed that if the contention were correct, then no deduction under sec. 51 could ever be allowed in calculating the taxable income of the Commercial Union Pool for any year, in respect of claims which were incurred but not reported as at 30th June, 1972, and which had been notionally provided for by the sum thus added to the sum of $39,559,704, not even when the claims were actually paid.

A sufficient answer to this contention by the Commissioner of Taxation is, in my opinion, that there was no material difference between the character of the sum of $39,559,704, which represented provision for outstanding claims as at 30th June, 1972, and the character of the sum of $60,020,125, which represented provision for outstanding claims as at 30th June, 1973, notwithstanding that the sum of $60,020,125 included the amount of $5,864,866, which had been specially calculated as a provision for claims incurred but not reported. The character of each sum was that of a total provision for outstanding claims as at 30th June. As indeed was emphasised by witnesses who were well qualified to speak upon the matter, claims which have been communicated but not paid, and claims which have been incurred but not reported, are all of them outstanding claims for which provision must be made before the profit, or the taxable income, of an insurer for any particular year can be ascertained: see too the R.A.C.V. Insurance case (supra) at ATC pp. 4183-84; V.R. pp. 16-17. Furthermore, as earlier explained, the sum of $39,559,704 was intended to include claims incurred but not reported as at 30th June, 1972, as well as claims which had been communicated but not paid as at 30th June, 1972, although in fact it proved inadequate. There was therefore no relevant change in accounting methods in the year ended 30th June, 1973, as compared with the year ended 30th June, 1972. There was merely a refinement in the method of calculation or estimation of the component of the provision for outstanding claims at the end of the year, which was intended to represent claims incurred but not reported. This conclusion, too, was supported by the evidence of witnesses who were well qualified to speak upon the matter.

Having regard to the conclusions just expressed, it is unnecessary for me to consider the question whether this second argument of the Commissioner would be correct, if in fact there had been a material difference between the character of the sum of $39,559,704 and the character of the sum of $60,020,125, so that in the year ended 30th June, 1973, there was a relevant change in accounting methods as compared with the year ended 30th June, 1972. If an insurer were to carry on business for five years without making any provision for outstanding claims in its annual accounts, and if its taxable income for each of those five years were to be assessed on that footing without objection, would the insurer be entitled in the sixth year to make a provision for claims outstanding at the end of that year and to have the amount of that provision treated as an allowable deduction under sec. 51 in the calculation of its taxable income for that year, without bringing into account any notional provision for claims outstanding at the beginning of that year? I express no views upon this question. Reference may be made to
A.G.C. (Advances) Ltd. v. F.C. of T. 75 ATC 4057 at pp. 4063-66; (1975) 132 C.L.R. 175 at pp. 185-189 per Barwick C.J., and at ATC pp. 4070-72; C.L.R. pp. 195-199 per Mason J.; and to
Henderson v. F.C. of T. 70 ATC 4016 at pp. 4018-20; (1970) 119 C.L.R. 612 at pp. 648-650.

I should perhaps expressly state that the question raised by the Commissioner's second argument did not arise in the R.A.C.V. Insurance case (supra), because the Court was there concerned with what was in substance the first year in which the taxpayer had carried on business as an insurer.

I next turn to the third argument, which was advanced on behalf of the Commissioner of Taxation with respect to Commercial Union's appeal for the year ended 30th June, 1973.

This argument was based on the circumstance that the sum of $5,864,866 included not only provision for claims

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ATC 4197

incurred but not reported as at 30th June, 1973, where the event insured against had occurred during the year ended 30th June, 1973, but also a provision for claims incurred but not reported where the event insured against had occurred prior to 1st July, 1972, that is in an earlier year. This of course follows from the method by which the sum of $5,864,866 was calculated. It was submitted on behalf of the Commissioner that on no view could provision for claims incurred but not reported, where the event insured against had occurred before 1st July, 1972, be an allowable deduction in calculating the taxable income of the Commercial Union Pool for the year ended 30th June, 1973.

I do not accept this submission.

As I have earlier indicated, the provision for outstanding claims, which was made by the Commercial Union Pool in each of the years preceding the year ended 30th June, 1973, ought to be regarded as including a provision for claims incurred but not reported, which arose out of events which had occurred during that particular year. Insofar therefore as the sum of $5,864,866 included provision for claims incurred but not reported as at 30th June, 1973, where the event insured against had occurred prior to 1st July, 1972, it represented simply a re-estimate as at 30th June, 1973, of the Pool's liability in respect of those claims.

In my opinion it must now be accepted that the words ``the assessable income'' in sec. 51 mean assessable income of the taxpayer generally without regard to division into annual accounting periods: see A.G.C. (Advances) Ltd. v. F.C. of T. (supra) at ATC pp. 4063-66; C.L.R. pp. 185-189 per Barwick C.J., and at ATC pp. 4070-72; C.L.R. pp. 195-199 per Mason J. Hence, in my opinion, just as an estimated provision for outstanding claims, including claims incurred but not reported, arising from insurances current in one year, is an allowable deduction under sec. 51 in calculating the insurer's taxable income for that year (see the R.A.C.V. Insurance case (supra)), so an increase in the estimate at the end of any subsequent year for any of those claims which are then still outstanding, is an allowable deduction in calculating the insurer's taxable income for that subsequent year. The increase in the estimate constitutes a new loss or outgoing which was incurred for the first time in the year when the revised estimate was made: compare Southern Railway of Peru Ltd. v. Owen (supra), especially at p. 353 per Lord Radcliffe. As to estimates generally, reference may be made to the R.A.C.V. Insurance case (supra) at ATC pp. 4176-77; V.R. pp. 8-9 and the authorities there cited; and Henderson v. F.C. of T. (supra) at ATC pp. 4018-19; C.L.R. pp. 647-648 per Barwick C.J.

I may add that any other conclusion would give to sec. 51 an operation which would be quite out of accord with practical realities, having regard, inter alia, to inflation. The problem of course is relevant not only to provision for claims incurred but not reported, but also to provision for communicated but unpaid claims, especially claims arising out of compulsory third party insurance and workers' compensation insurance, which often are not paid, or paid in full, for some years after the event giving rise to the insurer's liability has occurred, and reasonable estimates of which may well increase throughout the intervening period. It is true that if the Commissioner's argument be correct, then in a case where an inadequate provision for outstanding claims was made in one year, the amount of the deficiency would be an allowable deduction under sec. 51 as the claims came to be paid. But if there were a substantial delay in paying the claims, then during the intervening years the insurer's taxable income would, in my opinion, be calculated on an unreal basis. For income which ought to be set aside to meet an increase in past estimates of still outstanding claims would be treated as part of the insurer's taxable income. No doubt provision for outstanding claims ought ideally to be made out of the premiums earned from the insurances out of which the claims arose. But where an original estimated provision which was deducted from those premiums is found on a later revised estimate to be insufficient, the amount of the deficiency ought to be deducted from the premiums earned in the year when the revised estimate is made, if the insurer's accounts are to give a true and fair view of the profit of the insurer for that year.

It may be observed that if I am right in the conclusion that for income tax purposes an estimated provision in one year for claims outstanding at the end of that year, including claims incurred but not reported, may be revised during following years, the result

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ATC 4198

would not necessarily be that the insurer's taxable income would be reduced in those later years. For a revised estimate might be less than the original estimate, in which case the amount of the excess would be part of the insurer's taxable income in the year in which the revision was made: compare the R.A.C.V. Insurance case (supra) at ATC pp. 4176-77; V.R. pp. 8-9.

Since the Court in the R.A.C.V. Insurance case (supra) was concerned only with the taxpayer's first full year, the problem raised by the Commissioner's third argument did not arise for decision, although it was referred to in the judgment: see ATC at pp. 4184-85; V.R. at pp. 17-18.

I may add that even if the provisions for outstanding claims which had been made by the Commercial Union Pool in each of the years preceding the year ended 30th June, 1973, could not be regarded as including provision for claims incurred but not reported, there would still be a serious question whether the Commissioner's third argument was correct: compare A.G.C. (Advances) Ltd. v. F.C. of T. (supra) at ATC pp. 4063-66 and 4072; C.L.R. pp. 185-189 and 198-199; and Henderson v. F.C. of T. (supra) at ATC pp. 4018-20; C.L.R. pp. 648-650. But it is unnecessary for me to express any conclusion upon this question.

Since I do not accept any of the three arguments advanced on behalf of the Commissioner with respect to the appeal of Commercial Union relating to the year ended 30th June, 1973, the appeal must be allowed, and there ought, I think, to be an order that the assessment be amended so as to reduce the taxable income of Commercial Union as assessed by the amount of $1,598,177, or perhaps by some slightly smaller amount. In relation to this proposed order, three further matters require mention.

In the first place, the sum of $1,598,177 was the specific amount which was claimed by Commercial Union as an allowable deduction in its return, and which was disallowed by the Commissioner. As earlier explained, this sum of $1,598,177 represented Commercial Union's 27.25 per cent share of the sum of $5,864,866. But as also earlier explained, this sum of $5,864,866 exceeded by some relatively trifling amount, perhaps of the order of $16,000, the sum which ought to have been produced by the method of calculatation which was used, because in the calculation of the sum of $5,864,866 the Fiji business of the Union company was treated as part of the business of the Commercial Union Pool. Perhaps the proper sum to be ordered to be deducted from the taxable income of Commercial Union as assessed would be a sum equal to 27.25 per cent of the sum of $5,848,862, to which I have earlier referred when discussing this irregularity in the calculation of the sum of $5,864,866. But I have heard no submissions upon this question, and I have reached no conclusion upon it. I propose to leave it to the parties to try to arrive at agreement upon the question. The amount involved is of course relatively very small indeed. Failing agreement the matter will have to be decided at a further hearing. I shall not pronounce any final order upon either appeal today.

In the second place, I wish expressly to state that it was not suggested by counsel for the Commissioner that the calculation of the sum of $5,864,866 was incorrect, because no allowance was made for a discount for future payment: compare Southern Railway of Peru Ltd. v. Owen (supra). Indeed no such allowance was made in the estimate of $54,155,259 in respect of communicated claims against the Commercial Union Pool, which were unpaid as at 30th June, 1973, although some of those claims could reasonably be expected not to be settled for a considerable time. However since, as earlier stated, there was an overall underestimate of outstanding claims against the Pool as at 30th June, 1973, (including both communicated claims and claims incurred but not reported) by an amount of more than two million dollars, it appears to me that this question is not of practical importance in the present case.

In the third place, it was submitted by counsel for the Commissioner that if I rejected the three arguments put on behalf of the Commissioner, as I have done, then I ought simply to set aside the present assessment and send the whole matter back to the Commissioner for re-assessment. It was submitted that the Commissioner ought to be given the opportunity to investigate, or to re-investigate, all the relevant figures relating to the provision made by the Commercial Union Pool for outstanding claims as at 30th June, 1973, both outstanding communicated claims, and claims incurred but not reported, in the light of the conclusions of law expressed in my

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ATC 4199

reasons for judgment. This submission was opposed by counsel for Commercial Union, and I do not accept it. The Commissioner had the opportunity during the hearing before me of challenging all the figures put forward regarding claims outstanding against the Commercial Union Pool as at 30th June, 1973, both communicated claims and claims incurred but not reported. For it was open to the Commissioner to seek to uphold his assessment on any ground which might be available: see
F.C. of T. v. Wade (1951) 84 C.L.R. 105 at pp. 116-117 per Kitto J. But I am satisfied on the evidence which has been placed before me that the only substantial criticism which could be made of the figures is that overall they represented a marked underestimate.

I now turn to Commercial Union's appeal in respect of the year ended 30th June, 1974. I shall for convenience of expression call this appeal ``the second appeal''. The second appeal raises exactly the same issues as the appeal in respect of the year ended 30th June, 1973, except that the issue raised by the Commissioner's second argument does not arise. It was common ground that if Commercial Union was completely successful in the appeal in respect of the year ended 30th June, 1973 (as it has been), then it must also be completely successful in the second appeal.

It will therefore, I trust, be sufficient to set out the relevant facts in as concise and simplified form as possible.

As at 30th June, 1974, the total provision made by the Commercial Union Pool in its accounts for then outstanding claims was an amount of $77,088,215. This amount comprised a sum of $66,797,616 in respect of outstanding claims which had been communicated to the Pool as at 30th June, 1974, and a further sum of $10,290,599 in respect of claims incurred but not reported as at that date. This sum of $10,290,599 was calculated in a similar manner to the manner in which the estimate of $5,864,866 in respect of claims incurred but not reported as at 30th June, 1973, had been calculated, except that the calculation was based on claims which were communicated to the Pool for the first time during the year ended 30th June, 1974, and which had arisen out of events which had occurred prior to 1st July, 1973, instead of upon claims which had been communicated to the Pool for the first time during the year ended 30th June, 1973, and which had arisen out of events which had occurred prior to 1st July, 1972. Again the calculation did not exclude the Fiji insurance business of the Union company, but this irregularity is of little practical significance.

There was evidence, which I accept, that later events established that the estimate of $10,290,599 in respect of claims incurred but not reported as at 30th June, 1974, was an underestimate by a relatively small amount only, but that the estimate of $66,797,616 in respect of outstanding communicated claims as at 30th June, 1974, was a substantial underestimate, probably by an amount of at least four million dollars. Hence the total provision of $77,088,215 in respect of all claims outstanding as at 30th June, 1974, was itself insufficient by a substantial amount, probably in excess of four million dollars. I may refer to Exhibits ``P'', ``U'' and ``TT2''. The relevant figures are subject to similar comments to those which I earlier made regarding the figures put forward in the evidence about the inadequacy of the provision for outstanding claims as at 30th June, 1973. But once again I am satisfied that the overall position is as I have just stated it.

As earlier stated, during the year ended 30th June, 1974, the share of Commercial Union in the Commercial Union Pool was 42.5 per cent; it had acquired as at 1st July, 1973, the shares of three other members of the Pool, totalling 15.25 per cent. Accordingly in its return for the year ended 30th June, 1974, it showed its provision for outstanding claims as at 30th June, 1974, as $32,762,491 (being 42.5 per cent of $77,088,215), comprising $28,388,986 (being 42.5 per cent of $66,797,616) in respect of claims which had been communicated as at 30th June, 1974, and $4,373,505 (being 42.5 per cent of $10,290,599) in respect of claims incurred but not reported at that date. See Folio 63 of Exhibit ``F''.

In his original assessment for the year ended 30th June, 1974, the Commissioner of Taxation added to the taxable income of Commercial Union as returned the whole of the sum of $4,373,505. But it was later appreciated that this was incorrect, because the part of the provision for outstanding claims as at 1st July, 1973, which represented claims incurred but not reported as at 30th June, 1973, namely $1,598,177, ought to have been deducted from the sum of $4,373,505,

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ATC 4200

and later an amended assessment was issued for the purpose of making this correction. It produced the result that only $2,775,328 was added to the taxable income of Commercial Union as returned.

The question in issue in the second appeal is whether this sum of $2,775,328, or any and what part thereof, ought to have been added to the taxable income of Commercial Union as returned.

I should say at the outset that in the end it was common ground that on the view most favourable to the Commissioner a sum of only $1,880,936 ought to have been added to the taxable income of Commercial Union as returned, not the sum of $2,775,328. The difference of $894,392 represents the aggregate share of the provision made by the Commercial Union Pool as at 30th June, 1973, for claims incurred but not reported, which had been borne by the three members of the Pool whose shares in the Pool had been acquired by Commercial Union as at 1st July, 1973: i.e. 15.25 per cent of $5,864,866. As part of this acquisition Commercial Union had taken over the technical reserves of those three members of the Pool, which had included the sum of $894,392, and it had assumed liability for their shares of all claims against the Pool which had been outstanding on 30th June, 1973. During the year ended 30th June, 1974, Commercial Union had in fact borne a 42.5 per cent share of all claims paid by the Commercial Union Pool in that year, and those claims had included many claims which had been outstanding as at 30th June, 1973. But in its return for the year ended 30th June, 1974, Commercial Union claimed as an allowable deduction only its 42.5 per cent share of the claims paid, less $894,392 (and also less $8,258,677, being the aggregate 15.25 per cent share of the three former members of the Pool in the Pool's provision of $54,155,259 for communicated unpaid claims as at 30th June, 1973): see Exhibits ``F1'' and ``R'', and Folio 63 of Exhibit ``F''. The sum of $894,392 had therefore already been taken into account as an addition to Commercial Union's taxable income in calculating its taxable income as returned, and one effect of the amended assessment was that the sum was added twice over.

The issue which was ultimately in controversy in the second appeal therefore relates to a sum of $1,880,936: i.e. $2,775,328 less $894,392.

As earlier indicated, the Commissioner's second argument upon the appeal with respect to the year ended 30th June, 1973, is inapplicable to the second appeal. This is because the taxable income of Commercial Union as returned for the year ended 30th June, 1974, was calculated on the footing that in the calculation of the taxable income of the Commercial Union Pool for that year, the provision for outstanding claims as at 30th June, 1973, which had to be brought into account as part of the assessable income of the Pool, included the sum of $5,864,866 in respect of claims incurred but not reported as at 30th June, 1973: see Folio 63 of Exhibit ``F''. This was common ground.

It was also common ground, as I have in fact earlier indicated, that if I rejected the first and third arguments put on behalf of the Commissioner in relation to the appeal for the year ended 30th June, 1973 (as I have done), then those arguments must be rejected in relation to the second appeal also.

The second appeal must therefore be allowed, and there ought, I think, to be an order that the amended assessment be amended so as to reduce the taxable income of Commercial Union by the amount of $2,775,328, or perhaps by some slightly smaller amount, since the calculation of the sum of $10,290,599 as the Commercial Union Pool's provision for claims incurred but not reported as at 30th June, 1974, took into account the Fiji business of the Union company. Once again I propose to leave it to the parties to try to reach agreement upon this last matter. Failing agreement the matter will have to be decided at a further hearing.

In relation to the second appeal also, no question of discount for future payment was raised by counsel for the Commissioner, and since the total provision for outstanding claims of the Commercial Union Pool as at 30th June, 1974, was insufficient by an amount probably in excess of four million dollars, it appears to me that this question is of no practical importance.

In relation to the second appeal counsel for the Commissioner once again submitted that if his other arguments were rejected, the whole matter should be sent back for re-assessment. But I reject this submission for similar reasons to my reasons for rejecting the submission in relation to the appeal for the year ended 30th June, 1973.

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ATC 4201

Since Commercial Union has succeeded in both appeals, I think that in each appeal there should be an order that the costs of Commercial Union, including the costs of shorthand or recorded transcript, be taxed, and when taxed paid by the respondent, the Commissioner of Taxation.

The document tendered on behalf of Commercial Union during Mr. Miller's evidence on 19th April, 1977, was incorrectly marked Exhibit ``EEE''. For there was already an Exhibit ``EEE'', namely the list of agreed corrections to transcript. I shall therefore now have it made Exhibit ``FFF''.

Subject to any comments which counsel may now wish to make, I propose to adjourn these appeals to Monday, 23rd May, 1977, at 10.30a.m., so as to enable the parties to try to reach agreement on the precise sum by which the taxable income of Commercial Union ought to be reduced in relation to each appeal. I should be grateful if not later than Thursday, 19th May, 1977, counsel for Commercial Union would give to my Associate complete minutes of the formal orders which they submit ought to be made in each appeal. I should also be grateful if counsel for the Commissioner would inform my Associate not later than the same date whether they agree with those minutes, and if they do not agree, then what are the alterations which they submit ought to be made. I would hope to pronounce the final orders on Monday, 23rd May. The reasons why I have suggested an adjournment as far ahead as 23rd May, which is a period of nearly three weeks, is that it may be about a week before my reasons for judgment become available to the parties.