ATO ID 2004/911: Portfolio transfer of general insurance liabilities: deduction under Division 321 for consideration paid in respect of indirect settlement costs
Date of decision: 1 November 2004
Year of income: Year ended 30 June 2004
Business line: Public Groups and International

Issue
Can a general insurance company claim a deduction under section 321-25 of Schedule 2J to the Income Tax Assessment Act 1936 (ITAA 1936) for the indirect claims settlement component of the consideration given to cede its outstanding claims liabilities under a portfolio transfer?

Decision
No. A general insurance company cannot claim a deduction under section 321-25 of the ITAA 1936 for the indirect claims settlement component of the consideration given to cede its outstanding claims liabilities under a portfolio transfer.

Facts
The taxpayer is a general insurance company for the purposes of section 995-1 of the Income Tax Assessment Act 1997 (ITAA 1997) and the Insurance Act 1973. The taxpayer entered into a portfolio transfer arrangement whereby the whole of its insurance liabilities are to be transferred to another insurance company (the transferee). The taxpayer intends to cease its insurance operation after the portfolio transfer. The portfolio transfer is completed in accordance with the provisions of the Insurance Act. The transferee is also an authorised general insurer under the Insurance Act. Under the portfolio transfer, the taxpayer is required to give consideration to the transferee for assuming the outstanding claims liability under its general insurance policies as calculated for taxation purposes as well as a payment in respect of indirect claims settlement costs. Indirect claims settlement costs are the general expenses of running and administering a general insurance company's claims department

Reasons for decision
Summary: Under section 321-25 of the ITAA 1936, 'a general insurance company can deduct amounts paid during the year of income in respect of claims under general insurance policies.' The word 'claim', when used in an insurance policy has different meanings depending on the context ( Drayton and Ors v. Martin and Ors (1996) 9 ANZ Insurance Cases 61,322 at 76,590). Generally, the word is defined, amongst other things, as, 'submit a request for payment under an insurance policy' ( The Australian Oxford Dictionary , 1999, Oxford University Press, Melbourne). Therefore, a 'claim' entails a policyholder's legal right to be indemnified or compensated by the general insurance company in accordance with the terms of the insurance policy. A condition for deductibility under section 321-25 of the ITAA 1936 is that the amount paid must be 'in respect of claims under general insurance policies'. The words 'in respect of' which precede 'claims under general insurance policies' were interpreted by the High Court in Technical Products Pty Ltd v. State Government Insurance (Qld) (1989) 167 CLR 45 in the following passage: The words "in respect of" have a very wide meaning. Indeed, they have a chameleon-like quality in that they commonly reflect the context in which they appear...That nexus will not, however, exist unless there be some discernible and rational link... Therefore, an amount is paid 'in respect of claims' under general insurance policies, where, in the context in which section 321-25 of the ITAA 1936 appears, there is a sufficient nexus or material connection, and a discernible and rational link, between the amount and claims under general insurance policies. The consideration paid to the transferee in respect of indirect settlement costs that the transferee expects to incur in settling the liabilities under the policies is not an amount that is paid 'in respect of claims under general insurance policies' of the taxpayer because the consideration is not directly related to a claim under a policy of insurance. Accordingly, the taxpayer cannot claim a deduction under section 321-25 of the ITAA 1936 for the indirect claims settlement component of the consideration given to cede its outstanding claims liabilities under a portfolio transfer. | Detailed Reasoning - Application of this ATO ID from 1 July 2010: From 1 July 2010, the Tax Laws Amendment (Transfer of Provisions) Act 2010 repealed Schedule 2J of the ITAA 1936 and rewrote those provisions into Division 321 of the ITAA 1997. The wording was slightly altered to adhere to the drafting approach taken in the ITAA 1997, but as outlined in the explanatory memorandum, there has been no change in meaning of the rewritten provisions. Therefore, from 1 July 2010, all references to Section 321-25 of the ITAA 1936 should be read as referring to section 321-25 of the ITAA 1997.

Legislative references: Income Tax Assessment Act 1936 section 321-25
Case references: Drayton and Ors v. Martin and Ors (1996) 9 ANZ Insurance Cases 61,322
Related ATO interpretative decisions: ATO ID 2004/910 | 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 2004/919 | 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
Other references: The Australian Oxford Dictionary, 1999, Oxford University Press, Melbourne Explanatory Memorandum to the Tax Laws Amendment (Transfer of Provisions) Bill 2010
Subject references: General insurance General insurance industry