ATO ID 2004/929: Portfolio transfer of general insurance liabilities: deduction for 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
Can a general insurance company claim a deduction under section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997) for a refund of reinsurance premiums to another general insurance company under a reinsurance contract that is cancelled because of a portfolio transfer?

Decision
Yes. A general insurance company can claim a deduction under section 8-1 of the ITAA 1997 for a refund of reinsurance premiums to another general insurance company under a reinsurance contract that is cancelled because of 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 has a reinsurance contract with another general insurance company (the reinsured). The purpose of the reinsurance contract is to reduce the reinsured's exposure to claims and to be indemnified against some part of the claims. The taxpayer entered into a portfolio transfer arrangement whereby it assumed the insurance liabilities of the reinsured. As a result, the reinsurance contract between the taxpayer and the reinsured was cancelled. The taxpayer, on cancellation of the reinsurance contract, is required to refund that part of the reinsurance premium that it previously received from the reinsured that relates to the unexpired period of the reinsurance contract.

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 refund of part of the reinsurance premium 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. It was held in that case that: 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 that: 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. As the reinsurance contract is not going to run its full term, the taxpayer will refund part of the reinsurance premium that it received from the reinsured. The refund recognises the fact the taxpayer will not be providing reinsurance cover for the period that was originally intended. The provision of a service such as reinsurance cover is of a normal incident of the business of a reinsurer. Therefore, where the service will not be provided for the period that was originally intended, a refund of part of the premium in respect of that service is considered to have a revenue character and will be deductible. Accordingly, the taxpayer can claim a deduction under section 8-1 of the ITAA 1997 for the refund of the reinsurance premium under a reinsurance contract that is cancelled.

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 2004/919 | 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 2004/930
Subject references: General insurance General insurance industry Reinsurance & reinsurers