ATO ID 2010/15: Payments by a life insurance company to correct unit pricing errors
Date of decision: 21 December 2009
Year of income: Year ended 30 June 2008
Business line: Public Groups and International

Issue
Are payments by a life insurance company, to current and former policyholders to correct unit pricing errors, amounts paid in 'respect of claims' under life insurance policies for the purposes of subsection 320-80(3) of the Income Tax Assessment Act 1997 (ITAA 1997)?

Decision
Yes. Payments by a life insurance company, to current and former policyholders to correct unit pricing errors, are amounts paid in 'respect of claims' under life insurance policies for the purposes of subsection 320-80(3) of the ITAA 1997.

Facts
A life insurance company paid amounts to some of its current and former policyholders to correct unit pricing errors in relation to the investment-linked life insurance policies issued by the company. The life insurance company maintained one or more accounts in relation to each of the policies in order to determine its liability to the policyholder. The accounts recorded amounts such as premiums paid by the policyholder, investment earnings credited under the policy, fees charged under the policy and claims paid to the policyholder. Each of these accounts was maintained in units. The value of the policyholder's entitlement under the policy was determined by reference to the number of units and the value of these units. The life insurance company conducted a review of its unit pricing methodology and determined that the methodology adopted in the calculation of unit prices was inappropriate in some cases and should be changed as it did not treat policyholders fairly in relation to each other. The life insurance company determined that its failure to treat policyholders fairly in relation to each other gave rise to a breach of its common law duty to act in good faith towards the policyholders. The life insurance company notified the Australian Securities and Investments Commission (ASIC) that it considered that it had breached an obligation under Chapter 7 of the Corporations Act 2001 (Corporations Act), specifically its obligation under paragraph 912A(1)(a) of the Corporations Act which required the life insurance company to provide its financial services 'fairly'. The life insurance company was required by section 912B of the Corporations Act to have arrangements in place to compensate policyholders who suffered loss or damage because the life insurance company breached its obligations under Chapter 7 of the Corporations Act. The payments made to the policyholders to correct the unit pricing errors satisfied the life insurance company's obligations under section 912B. The payment to each policyholder will, as far as is possible, put the policyholder in the position they would have been in had the unit prices been determined appropriately in the first place. The amounts paid are not a risk component of a claim as defined in subsection 320-80(2) of the ITAA 1997.

Reasons for decision
Summary: Subsection 320-80(3) of the ITAA 1997 provides that, except as provided by subsection 320-80(1) of the ITAA 1997, a life insurance company cannot deduct amounts paid in respect of claims under life insurance policies. Subsection 320-80(1) provides that a life insurance company can deduct an amount paid in respect of the risk components of claims paid under life insurance policies. In order to determine whether subsection 320-80(3) of the ITAA 1997 applies, it is necessary to determine whether the amounts paid by the life insurance company can be characterised as amounts 'in respect of claims'. The word 'claim' is not defined for these purposes and should be interpreted having regard to its ordinary meaning in the context in which it is used. In Walton v. National Employers Insurance Association [1973] 2 NSWLR 73, Bowen JA considered a claim to be a demand for something as due, an assertion of a right to something. The Macquarie Dictionary defines the term 'claim' as including 'a payment demanded in accordance with an insurance policy, etc.' In Scully v. Commissioner of Taxation (1998) 84 FCR 41; 98 ATC 4671; (1998) 39 ATR 213, the term 'in respect of' was explained as follows: The words "in respect of personal injury" are to be given a meaning which extends beyond what would otherwise be included by use of the expression "for personal injury"... The question raised in the present case concerns the reach of the more comprehensive expression "in respect of". These words, construed according to their natural and ordinary meaning, have a very wide ambit but they must reflect the context in which they are used and therefore have limits... Accordingly, it is considered that the meaning of the term 'in respect of claims' is wider than the meaning of the word 'claims' and in the context of section 320-80 of the ITAA 1997 'in respect of claims' includes claims and also amounts in the nature of claims. In determining whether the amounts paid are 'in respect of claims' it is necessary to consider the context in which the term is used and the interaction of section 320-80 of the ITAA 1997 with the other provisions of Division 320 of the ITAA 1997. 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. Section 320-80 of the ITAA 1997 is a specific deduction provision for dealing with amounts paid to policyholders. In the context of the taxing mechanism in Division 320 of the ITAA 1997, an appropriate outcome only arises if amounts representing an obligation to policyholders in their capacity as policyholders are only deductible where the conditions of section 320-80 are satisfied. The obligation to pay the amounts arises because the life insurance company has entered into a contract with a policyholder and has breached its duty of good faith to the policyholder. However in making the payment the life insurance company is also able to meet its obligation under the Corporations Act to make arrangements to compensate the policyholder. This does not change the character of the payment, which is in the nature of a claim arising by virtue of the policy held by the policyholder. The amounts being paid to policyholders are directly connected with the obligations of the life insurance company under the life insurance policies and are in the nature of claims. Accordingly, in the context of Division 320 of the ITAA 1997, the amounts paid to policyholders by the life insurance company are considered to be amounts that are 'in respect of claims' for the purposes of subsection 320-80(1) of the ITAA 1997.

Legislative references: Income Tax Assessment Act 1997 Division 320 section 320-80 subsection 320-80(1) subsection 320-80(2) subsection 320-80(3)
Case references: Walton v National Employers Insurance Association [1973] 2 NSWLR 73
Other references: The Macquarie Dictionary, 2001, rev third edn, The Macquarie Library Pty Ltd, NSW
Subject references: Compensation claims Investment linked policies Life insurance company Life insurance policies