ATO ID 2004/914: Portfolio transfer of general insurance liabilities: consideration paid by taxpayer for assumption of unearned premium liability
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 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997) for the consideration paid in respect of its unearned premium liability under a portfolio transfer?

Decision
Yes. A general insurance company can claim a deduction under section 8-1 of the ITAA 1997 for the consideration paid in respect of its unearned premium liability under a portfolio transfer.

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 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 done 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 pay the transferee consideration for assuming its unearned premium liability. The unearned premium liability is the accounting value of the gross premiums received or receivable by a general insurer that have not been recognised as earned at the time of the portfolio transfer.

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. In the case of the portfolio transfer, the payment in respect of the unearned premium liability is made so that the taxpayer's obligation to provide insurance cover to policyholders is met. The provision of insurance cover is a normal incident of an insurance company. Applying the principle stated in G.P. International Pipecoaters Pty Ltd v. Federal Commissioner of Taxation (1990) 170 CLR 124; 90 ATC 4413; (1990) 21 ATR 1, the 'advantage sought by the making of the expenditure' is of a revenue nature as the payment is made to discharge an obligation that had arisen in the normal course of the taxpayer's insurance business. Though a portfolio transfer may be undertaken in order to cease insurance operations of the taxpayer it is considered that authorities such as Modern Permanent Building and Investment Society (in liq) v. Federal Commissioner of Taxation (1958) 98 CLR 187; (1958) 11 ATD 438; (1958) 7 AITR 233 and Claire Douglas Peyton v. Federal Commissioner of Taxation (1963) 109 CLR 315; (1963) 13 ATD 133; (1963) 9 AITR 112 do not apply to characterise the payment as capital. The High Court decision in Federal Commissioner of Taxation v. Foxwood (Tolga) Pty Ltd (1981) 147 CLR 278; 81 ATC 4261; (1981) 11 ATR 859 provides authority for the principle that particular expenditure which was incurred in context of a cessation of business may nevertheless be an allowable deduction where it would have been incurred on revenue account if had it been made in the ordinary course of business. 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. In the present circumstances, whilst the payment is made against the backdrop of the cessation of the taxpayer's insurance business, the purpose of the expenditure is to discharge the taxpayer's obligation to provide risk cover as required under the insurance contracts. Thus, even though the portfolio transfer was not in the normal course of the taxpayer's business, the amount paid to the transferee will be deductible as it discharges the taxpayer's obligation to provide risk cover under insurance contracts that were entered into in the normal course of its business. Accordingly, the amount the taxpayer paid to the transferee in the portfolio transfer in respect of the unearned premium liability 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: Modern Permanent Building and Investment Society (In Liquidation) v. Federal Commissioner of Taxation (1958) 98 CLR 187 (1958) 11 ATD 438 (1958) 7 AITR 233
Related ATO interpretative decisions: ATO ID 2004/910 | ATO ID 2004/911 | ATO ID 2004/912 | ATO ID 2004/913 | 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
Subject references: General insurance General insurance industry