ATO ID 2004/918: Portfolio transfer of general reinsurance liabilities: receipt of refund of reinsurance premiums under 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 the amount of a refund received by a general insurance company from a reinsurance company in respect of reinsurance premiums paid under a reinsurance contract that is cancelled because of a portfolio transfer assessable under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Decision
Yes. The amount of the refund received by a general insurance company from a reinsurance company in respect of reinsurance premiums paid under a reinsurance contract that is cancelled because of a portfolio transfer is assessable under section 6-5 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 liability. The taxpayer, in reducing its risk exposure, paid a reinsurance premium to the reinsurance company for which it received a deduction for the whole of the expenditure incurred. The reinsurance premium is a 'relevant reinsurance premium' as defined under section 321-60 of Schedule 2J of the Income Tax Assessment Act 1936 (ITAA 1936). 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 reinsurance company, on cancellation of the reinsurance contract, refunds to the taxpayer that part of the reinsurance premium which relates to the unexpired risk period.

Reasons for decision
Summary: Section 6-5 of the ITAA 1997 states that 'your income includes income according to ordinary concepts, which is called ordinary income.' The characterisation of the consideration received by the taxpayer will determine whether the amount is assessable under section 6-5 of the ITAA 1997. In HR Sinclair & Son Pty Ltd v. Federal Commissioner of Taxation (1966) 114 CLR 537; (1966) 14 ATD 194; (1966) 10 AITR 3, the High Court considered whether a refund of royalties paid to the Forest Commission of Victoria should be taken into account in ascertaining the proceeds of the business in the year the refund of royalty was received. The Court held that the refund was assessable because it was directly related to the taxpayer's business operation or in the carrying on of that business operation. Owen J stated: The company's business was that of a saw-mill. It was in that capacity that it paid royalties for timber cut by it for the purpose of its business and it was in that capacity that it received the amount refunded. Similarly in Warner Music Australia Pty Limited v. Federal Commissioner of Taxation (1996) 70 FCR 197; 96 ATC 5046; (1996) 34 ATR 171 ( Warner Music ) the taxpayer was refunded sales tax. The Federal Court held that for a reimbursement or refund to be assessable, two requirements must be satisfied: The first involves the question of whether the amount released involved a gain to Warner so as to constitute a profit. The second is whether this profit or gain was on revenue account. In relation to the first requirement, the refund of the unearned component of the premium is clearly a gain to the taxpayer. In relation to the second requirement, the characterisation of a receipt is determined by examining the receipt in the hands of the recipient. In Warner Music Hill J stated that for a reimbursement or refund to be assessable it must be in respect of an expenditure that is 'intimately connected' with the business. Since the refund is received as an incident of the taxpayer's business of reinsuring some of its risks the refund of the reinsurance premium is 'intimately connected' to the taxpayer's ordinary business and is of a revenue nature. Accordingly, the refund received by the taxpayer in respect of the reinsurance premium as a result of the cancellation of the reinsurance contract is assessable under section 6-5 of the ITAA 1997. | 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 and format was altered to adhere to the drafting approach taken in the ITAA 1997, but as outlined in Chapter 6 of the Explanatory Memorandum to the Tax Laws Amendment (Transfer of Provisions) Bill 2010, there has been no change in meaning of the rewritten provisions. Therefore, from 1 July 2010, the reference to Section 321-60 of the ITAA 1936 should be read as referring to Section 321-60 of the ITAA 1997.

Legislative references: Income Tax Assessment Act 1997 section 6-5 section 321-60 section 995-1
Case references: H. R. Sinclair & Son Pty. Ltd. v. Federal Commissioner of Taxation (1966) 114 CLR 537 (1966) 14 ATD 194 (1966) 10 AITR 3
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 2004/919 | 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: Explanatory Memorandum to the Tax Laws Amendment (Transfer of Provisions) Bill 2010
Subject references: General insurance General insurance industry Reinsurance & reinsurers