ATO ID 2004/494: Payment for risk coverage to mutual entity
Date of decision: 2 April 2004
Year of income: Year ended 30 June 2004 Year ended 30 June 2005
Business line: Public Groups and International

Issue
Is the total amount of the payment to the mutual entity for risk coverage an allowable deduction under section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Decision
Yes. The total amount of the payment to the mutual entity for risk coverage will be an allowable deduction under section 8-1 of the ITAA 1997.

Facts
A mutual entity will offer risk coverage to a specific industry group, members of which carry on business for the production of assessable income. This mutual risk product is provided to members of the industry group by making subscriptions to a mutual entity. The risk cover is renewed annually by making further subscriptions. The mutual entity will reinsure a significant amount of the risk with established reinsurance companies but will also 'self-insure' a substantial amount of the risk. The motivation for entering into this arrangement is that suitable insurance coverage could not be obtained from established insurance companies at a reasonable cost. The mutual entity has relied on expert advice in establishing this arrangement and in maintaining the arrangement. The mutual entity has established extensive risk management processes which conform to quality standards.

Reasons for decision
Summary: To determine whether an amount is deductible under section 8-1 of the ITAA 1997 all the facts and circumstances of the case must be ascertained. This is clear from an examination of the following judicial decisions such as Colonial Mutual Life Assurance Society Ltd. v. Federal Commissioner of Taxation (1953) 89 CLR 428; (1953) 10 ATD 274; (1953) 5 AITR 597 ( Colonial ) and Hallstroms Pty. Ltd. v. Federal Commissioner of Taxation (1946) 72 CLR 634; (1946) 8 ATD 190; (1946) 3 AITR 436. In Colonial Fullager J., in discussing the advantage the taxpayer sought to obtain from the outlay, stated: The questions which commonly arise in this type of case are (1) What is the money really paid for? and (2) Is what is really paid for, in truth and substance a capital asset? To determine that a member is actually paying money for risk coverage for property damage and public liability one must establish that, on the facts, the mutual entity is in the business of risk coverage especially as the mutual entity will have significant self-insurance retention. The issue in W.D. & H.O. Wills (Australia) Pty Ltd v. Commissioner of Taxation (1996) 65 FCR 298; 96 ATC 4223; (1996) 32 ATR 168 was the tax deductibility of premiums paid to an associated company for risk cover which was not available from third party insurers at an acceptable rate. Sackville J stated that: In my view the premiums paid to Matila [the associated company] by Wills in respect of health risks should be characterised as necessarily incurred in carrying on Wills' business as a manufacturer and distributor of tobacco products. The composite policy was intended to and did provide coverage against major risks arising out of business operations. This follows from the terms of the policy and the circumstances which give rise to the perceived need to obtain coverage from a related company. The risks insured went to the very heart of Wills' business. The absence of available coverage through the open insurance market created a commercial need to develop a strategy for covering those risks. The connection between the premiums and the Wills' business is, in my opinion, clear. A critical issue to determine is whether the amount paid to the mutual entity for risk coverage is reasonable having regard to the nature of the risks undertaken and the state of the insurance market relating to such risks. The facts, as stated above, support the conclusion that the amounts that will be paid to the mutual entity are solely for risk coverage for property damage and public liability risk cover and are therefore an allowable deduction under section 8-1 of the ITAA 1997.

Legislative references: Income Tax Assessment Act 1997 section 8-1
Case references: Colonial Mutual Life Assurance Society Ltd. v. Federal Commissioner of Taxation (1953) 89 CLR 428 (1953) 10 ATD 274 (1953) 5 AITR 597
Subject references: Deductions & expenses Fire insurance General insurance General insurance industry Insurance expenses Public trading trusts Unit trust distributions Unit trusts