ATO ID 2004/919: Portfolio transfer of general insurance liabilities: refund of exchange commissions by taxpayer in respect of cancelled reinsurance contract
Date of decision: 1 November 2004
Year of income: Year ended 30 June 2004
Business line: Public Groups and International

Issue
Is a refund paid by a general insurance company to a reinsurance company in respect of exchange commissions relating to a reinsurance contract that is cancelled because of a portfolio transfer deductible under section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Decision
Yes. The amount of the refund paid by a general insurance company to a reinsurance company in respect of exchange commissions relating to a reinsurance contract that is cancelled because of a portfolio transfer is deductible under section 8-1 of the ITAA 1997.

Facts
The taxpayer is a general insurance company for the purposes of section 995-1 of the ITAA 1997 and the Insurance Act 1973. The taxpayer has a reinsurance contract with a reinsurance company. The purpose of the reinsurance contract is to reduce the taxpayer's exposure to claims. Because the taxpayer incurred expenses in writing insurance contracts, the reinsurance company previously paid a proportion of the reinsurance premium as an exchange commission to the taxpayer. The taxpayer entered into a portfolio transfer arrangement with the reinsurance company. Under the terms of the arrangement the reinsurance contract is to be cancelled. The taxpayer intends to cease its insurance operation after the portfolio transfer. The taxpayer, on cancellation of the reinsurance contract, refunds that part of the exchange commissions relating to the unexpired portion of the premium to the reinsurance company.

Reasons for decision
Summary: Section 8-1 of the ITAA 1997 states that a loss or outgoing is deductible provided that 'it is necessarily incurred in carrying on a business for the purpose of gaining or producing your assessable income.' A loss or outgoing is not deductible under section 8-1 of the ITAA 1997 if it is denied under paragraph 8-1(2)(a) of the ITAA 1997 because it is a loss or outgoing of a capital nature. The deductibility of the reimbursement of the exchange commission can be determined in light of the High Court's decision in G.P. International Pipecoaters Pty Ltd v. Federal Commissioner of Taxation (1990) 170 CLR 124; 90 ATC 4413; (1990) 21 ATR 1 ( Pipecoaters ). In the Pipecoaters decision the court stated: The character of expenditure is ordinarily determined by reference to the nature of the asset acquired or the liability discharged by the making of the expenditure, for the character of the advantage sought by the making of the expenditure is the chief, if not the critical, factor in determining the character of what is paid. In the context of subsection 51(1) of the Income Tax Assessment Act 1936 , the predecessor of section 8-1 of the ITAA 1997, Hill J said in FC of T v. Broken Hill Pty Ltd Company Ltd 2000 ATC 4659; (2000) 45 ATR 507; [2000] FCA 1431: In determining whether an outgoing falls for deductibility under s51(1), it will be critical to determine what the outgoing is paid for. The significance of that question, which is directed to ascertaining the advantage sought to be obtained, is essential to the determination of true characterisation of an outgoing. The taxpayer had previously received an exchange commission in recognition of costs that it incurred in relation to the policies it reinsured. The exchange commission represents the reinsurance company's contribution to the costs that the taxpayer incurred in writing the business that it reinsured. The amount of exchange commission is determined on the expectation that the reinsurance contract would run for a given period of time. As the reinsurance contract is not going to run its full term, the taxpayer will refund part of the exchange commission that it received from the reinsurer. The refund recognises the fact that the mutual obligations of the taxpayer and the reinsurer under the reinsurance contract will not be performed for the period that was initially agreed. The entering into of reinsurance contracts, and the receipt of exchange commissions, is a normal incident of the business of an insurer. Therefore, where the reinsurance contract will not run for the period that was originally intended, a refund of part of the exchange commissions in relation to that contract is considered to have a revenue character and will be deductible. Accordingly, the consideration paid by the taxpayer in respect of exchange commissions relating to a reinsurance contract that is cancelled because of a portfolio transfer is deductible under section 8-1 of the ITAA 1997.

Legislative references: Income Tax Assessment Act 1997 section 8-1 paragraph 8-1(2)(a) section 995-1
Case references: G P International Pipecoaters Pty Ltd v. Federal Commissioner of Taxation (1990) 170 CLR 124 90 ATC 4413 21 ATR 1
Related ATO interpretative decisions: ATO ID 2004/910 | ATO ID 2004/911 | ATO ID 2004/912 | ATO ID 2004/913 | ATO ID 2004/914 | ATO ID 2004/915 | ATO ID 2004/916 | ATO ID 2004/917 | ATO ID 2004/918 | ATO ID 2004/920 | ATO ID 2004/921 | ATO ID 2004/922 | ATO ID 2004/923 | ATO ID 2004/924 | ATO ID 2004/925 | ATO ID 2004/926 | ATO ID 2004/927 | ATO ID 2004/928 | ATO ID 2004/929 | ATO ID 2004/930
Subject references: General insurance General insurance industry Reinsurance & reinsurers