CLARKE v FC of T

Judges:
Davies J

Court:
Federal Court

Judgment date: Judgment handed down 12 March 1992

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Davies J

This is an appeal from a decision of the Administrative Appeals Tribunal which affirmed the Commissioner's decision on an objection lodged by the applicant, Mr D.A.L.L. Clarke, with respect to an assessment of income tax for the year ended 30 June 1988.

A number of issues may have arisen out of the events with which we are concerned but the only one which was considered by the Administrative Appeals Tribunal (``the Tribunal'') was whether a sum of $4,443 was assessable income in the year of income as an annuity in accordance with s. 27H of the Income Tax Assessment Act 1936 (Cth) (``the Assessment Act''). If so, a deductible amount should have been assessed in accordance with the section and the amount of the assessable income thereby reduced. Section 27H(1) read:-

``The assessable income of a taxpayer of a year of income shall include-

• (a) the amount of any annuity derived by the taxpayer during the year of income excluding, in the case of an annuity that has been purchased, any amount that, in accordance with the succeeding provisions of this section, is the deductible amount in relation to the annuity in relation to the year of income; and
• (b) the amount of any payment made to the taxpayer during the year of income as a supplement to an annuity, whether the payment is made voluntarily, by agreement or by compulsion of law and whether or not the payment is one of a series of recurrent payments.''

Mr Clarke retired as a teacher on 17 July 1987, the day before his 60th birthday. He received a lump sum pay-out from the State Superannuation Fund. This sum was invested in securities by way of rollover. Of the sum, $50,000 was paid to Capita Financial Group Ltd (``Capita'') in respect of what was called a ``Variable Income Annuity''.

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Capita carried on a business of life insurance. Mr Clarke acquired a participating policy, the purchase price being $50,000 and the policy term being 5 years. Relevant provisions of the policy were as follows:-

``1 In consideration of the payment of the purchase price specified in the schedule, Capita Financial Group Limited (hereinafter called `Capita') will provide the annuity payments and other benefits described herein. This policy is an annuity certain policy and consists of the schedule and these conditions.

...

3 The assets of Capita's Statutory Fund No 1 shall alone be liable under this policy and the obligations arising out of this policy shall at all times and under all circumstances be subject to the Articles of Association of Capita.

4 Any benefit which become payable, other than an annuity payment, will, subject to the Conditions of this policy, be paid by Capita to the person then holding title to the policy within one calendar month after the policy has been delivered to Capita and proof of the happening of the event giving rise to the claim has been given to the satisfaction of Capita.

5 Subject to the Conditions of this policy, Capita will pay to the annuitant(s), in accordance with details in the schedule, the annuity payments specified therein.

If at any time Capita is required to deduct income tax or other amounts from any or all of the annuity payments then such deductions will be made and the net amount paid as above.

6 The person holding title to this policy may, within three months prior to the next review date specified in the schedule, notify Capita in writing of revised annuity payment details and a new next review date. The revised details will, subject to Capita's agreement, be effective from the next review date previously applicable.

7 Capita will, in respect of this policy, maintain an Investment Account and a Capital Growth Account.

8 The purchase price paid will be credited to the Investment Account on the day received by Capita.

9 Each annuity payment will be debited proportionally between the balances of the Investment Account and the Capital Growth Account on the date the payment becomes due.

...

15 Allocations of surplus to this policy will be primarily in the form of interest on the Investment Account, calculated on the daily balance and compounded annually at a rate declared by Capita each year on the advice of its Actuary less the ongoing expense charge referred to in Condition 11.

16 The rate of interest referred to in Condition 15 will be not less than 85% of the rate of investment income (exclusive of capital growth) earned by Capita in the relevant year, with respect to the appropriate class of business and net of all taxes, on the relevant asset portfolio within the Statutory Fund applicable to policies of this type. Capita may elect to apply the declared rate to a year ending up to four months later than that for which the earned rate was determined.

17 Capita may, in addition, allocate further surplus to this policy by way of allocations to the Capital Growth Account or by any other method which its Actuary certifies as equitable. Allocations previously made to the Capital Growth Account may be cancelled or reduced by Capita on the advice of its Actuary.

18 The cash value of this policy at any time is:

• (a) the balance of the Investment Account plus
• (b) the balance of the Capital Growth Account

Provided that Capita may vary or suspend this basis of determining the cash value subject to such terms and conditions as the Life Insurance Commissioner may think fit, if in the Commissioner's opinion the basis described above would be prejudicial to the financial stability of Capita or to the interests of the policyowner(s) of Capita.

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19 On the death of the annuitant or last surviving annuitant if more than one annuitant the person then holding title to this policy will provide Capita in writing the name of a person to become the new annuitant together with such other particulars as Capita may require and whose acceptance as annuitant shall be subject to Capita's agreement.

Should such a name not be provided or such agreement not be given within three months after the relevant date of death then this policy will terminate.

20 This policy will terminate if at any time its cash value is negative.

21 At the end of the policy term this policy will terminate.

22 On termination of this policy at any time other than in the circumstances described in Condition 20, the benefit payable will be the policy's cash value at the date of termination.''

The annuity payments specified, which could have been but were not varied in accordance with Condition 6, were $833.34 per month on and from 28 August 1987. Accordingly, it was proposed that there be 60 payments of $833.34 each, a total of $50,000. In the meantime, the policy provided that there would be maintained in the accounts of the Statutory Fund an investment account and a capital growth account in Mr Clarke's name. As the policy was a participating policy, it was proposed that there be distributions of surplus made by Capita in respect of its Statutory No. 1 Fund. The allocations of surplus to the policy were to be primarily in the form of interest on the investment account, the rate of interest to be not less than 85% of the rate of investment income earned by Capita in the relevant year with respect to the appropriate class of business net of all taxes on the relevant asset portfolio within the Statutory Fund. It was provided that Capita could, in addition, allocate further surplus by way of allocations to the capital growth account or by any other method which its actuary certified as equitable. Each annuity payment was to be debited proportionately between the balances in the investment account and the capital growth account. The cash value of the policy at any time would be the balance of the investment account plus the balance of the capital growth account. This balance would be arrived at by the crediting of the sum of $50,000 to the investment account, the crediting of interest thereon, the crediting of other surplus to the investment account or to the capital growth account and the debiting to these accounts of the monthly annuity. The policy was to terminate at any time when its cash value was negative, at the end of the policy term or three months after the death of the annuitant if the name of a person to become a new annuitant was not supplied.

In the year ended 30 June 1988, Mr Clarke received annuity payments totalling $8,333.00. In addition, a sum of $4,443 was credited to his investment account and given the description ``interest''. Both sums were at first included by the Commissioner of Taxation in Mr Clarke's assessable income. No deduction for the purchase price was allowed under s. 27H. Subsequently, the assessment was amended to exclude the sum of $8,333.00, apparently on the basis that the monthly payments were a part return of the capital, the sum of $50,000 which Mr Clarke had paid to Capita. In any event, the Tribunal was not concerned and this appeal is not concerned with the monthly payments. The issue relates solely to the sum of $4,443 which was described as interest and which was credited to the investment account maintained in Mr Clarke's name and taken into account for the purpose of calculating the cash value of the policy.

The issue debated before the Tribunal appears to have been the subject of a controversy which I need not discuss at length. In brief, a view had been accepted by the Taxation Office that an annuity for the purposes of rollover and of s. 27H need not be absolutely fixed in quantum but could have variables added to it, as indeed s. 27H itself recognises. However, based on this view, a number of life insurance companies developed investment packages which sought to take advantage of the provisions of s. 27H. Capita developed its Variable Income Annuity. Subsequently, on some date relevant to Mr Clarke's position, the Commissioner issued Income Tax Ruling IT 2480 which, though it did not name Capita, expressed the view that benefits such as those provided by the subject policy were not annuities for they were not benefits having the character of an annuity.

Mr Clarke entered into a lengthy correspondence with the Commissioner and his

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ATC 4140

objection is many pages in length. He appeared for himself before the Tribunal and submitted that he was entitled to the benefit of s. 27H. However, the Tribunal agreed with the view taken by the Commissioner and held that the crediting of $4,443 described as interest was not a payment in the nature of an annuity.

I need not deal with the issue of annuity at any length. I agree with the Tribunal that the sum credited to the investment account did not have the character of an annuity.

In my opinion, for the sum of $50,000, Mr Clarke bargained for benefits of two distinct types. In the first place, he bargained for a monthly annuity of $833.34. The monthly payments had all the necessary characteristics of an annuity. They were sums paid regularly in consideration of the receipt of the purchase price. Mr D. Jackson Q.C., with whom Mr S.W. Gibb and Mr S.A. Janes appeared for the Commissioner, faintly submitted that the $50,000 was merely a sum lent by Mr Clarke to Capita and that the payments of $833.34 per month were payments back of the capital which Mr Clarke had on deposit with Capita. In my view, that contention is untenable. Mr Clarke purchased a life insurance policy. Thereafter, he was entitled to benefits in accordance with the terms of the policy, benefits which included an entitlement to an annuity and an entitlement to the cash value of the policy as defined on its termination. In no sense was money lent by Mr Clarke to Capita and in no sense was the $50,000 on deposit with Capita. The payment of $50,000 to Capita might loosely be described as an investment but the reality of the transaction was that a life insurance policy was purchased for a lump sum. One of the benefits which Capita contracted to provide pursuant to the policy was the monthly annuity of $833.34.

The sum of $4,443 credited by Capita to Mr Clarke's investment account in May 1988 had characteristics quite different from that of the monthly annuity. The sum was not paid to or received by Mr Clarke during the period of the policy. This sum of $4,443 had a character analogous to that of the annual bonuses credited by a life insurance company to the value of a participating policy. Such sums are not ordinarily assessable income derived by a taxpayer. Section 26AH of the Income Tax Assessment Act provides that, if bonuses are received within the period of 8 years from the commencement of a policy of life insurance then, subject to certain exceptions, they are assessable income when received. A proportion of such sums is assessable income if received in the 9th and 10th years of the policy. No such sum received thereafter is assessable. The crediting of the sum of $4,443 to the investment account in May 1988 did not amount to the receipt of a bonus for the purpose of these provisions. See s. 26AH(5).

No sum is derived by the holder of a participating policy of the type with which we are concerned when a credit is made to his or her investment account or capital growth account. Any allocation to the capital growth account may be cancelled or reduced by Capita. Under Condition 18, the cash value of the policy may be reduced if, in the opinion of the Life Insurance Commissioner, the benefits provided in the policy would be prejudicial to the financial stability of Capita or to the interests of the policyowners of Capita. If Capita's Statutory Fund No. 1 suffered a loss, the condition could operate. Moreover, if the annuity were increased, any sum credited to the accounts could be taken out by way of annuity and not received by way of an increase to the cash value of the policy payable on termination. The position was analogous to that of the accounts maintained in the superannuation fund considered in
Constable v. FC of T (1952) 10 A.T.D. 93; (1952) 86 C.L.R. 402, in which Dixon C.J., McTiernan, Williams and Fullagar JJ. said at A.T.D. 96; C.L.R. 418:

``The fund existed as one to a share in which he [the superannuant] had a contractual, if not a proprietary, title. His title was future, and indeed contingent or, at all events, conditional.''

Similarly, in
Read v. The Commonwealth (1987-1988) 167 C.L.R. 57 at 67, Mason C.J., Deane and Gaudron JJ. said, ``Until a gain is realized it is not `earned, derived or received'''.

Thus, the sum of $4,443 credited to the investment account in May 1988 was not derived by Mr Clarke during the year of income. It was not received in fact and was not derived in the circumstances for which s. 19 of the Income Tax Assessment Act provides, as s. 26AH(5) recognises.

I agree with the view taken by the Tribunal on the issue which Mr Clarke raised before it. The sum of $4,443 was not an annuity and did not form part of an annuity. However, I would allow the appeal on the ground that the sum of

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ATC 4141

$4,443 credited to the investment account in May 1988 was not income derived by Mr Clarke in the year of income ended 30 June 1988.

This point was not argued by Mr Clarke before the Tribunal but was raised in the notice of appeal from the Tribunal's decision. During the course of the hearing, in case there might be no sentence in Mr Clarke's long objection which raised the issue, I ruled that the Court would hear the ground notwithstanding that it might not have been taken in the notice of objection and notwithstanding that it was not raised by Mr Clarke before the Tribunal. In a matter of fundamental taxation law such as this, a taxpayer inexperienced in taxation law ought not to be disadvantaged. Mr Clarke's attention understandably concentrated upon the taxation rulings issued by the Commissioner.

The decision of the Tribunal should be set aside and there should be substituted therefor a decision remitting the matter to the Commissioner to reassess Mr Clarke's taxable income for the year ended 30 June 1988 on the basis that the sum of $4,443 was not income derived by him during that year. The respondent should pay the costs of this appeal.

THE COURT ORDERS THAT:

1. The appeal be allowed.

2. The decision of the Administrative Appeals Tribunal be set aside and there be substituted therefor a decision remitting the matter to the Commissioner of Taxation to reassess the Applicant's taxable income for the year ended 30 June 1988 on the basis that the sum of $4,443 was not income derived by him during that year.

3. The Respondent pay the costs of this appeal.