Between: Mutual Life and Citizens' Assurance Co Ltd
And: Commissioner of Taxation

Judges: Dixon CJ
McTiernan J
Fullagar J
Taylor J

Menzies J

Subject References:
Taxation and revenue
Assessable income
Exempt income
Income from sources outside Australia

Legislative References:
Income Tax Assessment Act 1936 (Cth) - s 23

SYDNEY

Judgment by:
Menzies J

The answer to the question whether PD71,427 4s. 11d., the interest received by the taxpayer in the United Kingdom from securities situated in the United Kingdom, or any part thereof, is exempt from income tax under the provisions of s. 23 (q) of the Income Tax Assessment Act 1936, which exempts income not exempt from income tax in the country where it is derived, requires in the first place an examination of the United Kingdom legislation to find out whether the interest or any part of it was exempt from income tax in the United Kingdom. If it was, what was exempt cannot fall within s. 23 (q).  

The interest in question is expressly declared to be exempt from income tax as to part by s. 46(1) of the Income  Tax Act 1918, and as to the rest by r. 2 (d) of schedule C of the Income Tax Act 1918 so that at first sight these provisions would seem to be conclusive that the income in question is exempt in the United Kingdom; but the income tax laws of the United Kingdom are not something to be understood at first sight; indeed, they seem to call for a measure of second sight. In this particular case the provision that creates the difficulty is r. 3 of the rules applicable to Case III of schedule D of the Income Tax Act 1918 which I will refer to more shortly as Case III, r. 3. This is a provision that was designed to facilitate the taxation of foreign assurance companies. Prior to its enactment such companies were taxable upon their United Kingdom gains under schedule D, Case I, and under other provisions as well. These provisions were, however, difficult to apply and to facilitate the collection of tax s. 15 of the Finance Act 1915 was introduced. Part of that section is now Case III, r. 3. It provides a formula for ascertaining the taxable income of such companies which may be expressed as follows:

(United Kingdom Premium Income / Total Premium Income) * Total Investment Income of Life Assurance Fund


The figure thus arrived at is deemed to be "profits comprised in this Schedule" and then, apparently because the provisions of s. 1 of schedule D to the effect that tax under the schedule shall be charged in respect of the annual profits accruing to a person from any trade exercised within the United Kingdom were thought not to apply, it is provided expressly that the calculated amount "shall be charged under this Case".  

In seeking to find out the character of what it is that is charged in the manner described it is necessary to keep in mind that annual profits which may be taxed under Case I of schedule D are ascertained by deducting expenditure from receipts. Such a calculation is not, of course, open in a case where it is provided in terms that a sum calculated without any regard to expenditure shall be deemed to be chargeable profits, and to meet this situation there was a further provision in s. 15 of the Finance Act 1915, which is now to be found in s. 33(4) of the Income Tax  Act 1918, to the effect that when a company is charged under Case III, r. 3, "the relief in respect of expenses of management shall be calculated by reference to a like proportion of its total expenses of management for the year estimated according to the provisions of this Act". The relief  there referred to is that now provided for by s. 33(1) which says, inter alia, that where an assurance company "has not been charged in respect of its profits in accordance with the rules applicable to Case I of Schedule D the company ... shall be entitled to repayment of so much of the tax paid by it as is equal to the amount of the tax on any sums disbursed as expenses of management (including commissions) for that year". This provision is of general application when an assurance company is charged on a basis other than annual profits; cf. Sun Life Assurance Society v  Davidson; Phoenix Assurance Co  Ltd  v  Logan. ^[F40]  

Case III, r. 3, and s. 33(4) therefore provide an additional means for taxing an assurance company not having its head office in the United Kingdom which carries on life assurance business there through any branch or agency. The provisions I have referred to,  however, do clearly contemplate that the taxation of such a company may still be differently based, e.g. on the basis of annual profits; cf. s. 33(1) and Case III, r. 3(4). See too Equitable Life Insurance Society of U.S.A. v  Hills. ^[F41]

It is not a matter for surprise that tax collectors and taxpayers alike have from time to time become lost in this elaborate labyrinth and it is hardly less surprising that the decisions of the Courts have not perfectly illuminated its darkest places. This is perhaps best illustrated by Inland Revenue Commissioners v  Australian Mutual Provident Society. ^[F42] In that case there had been a difference between the commissioners and the society about the way in which the exemption provided by s. 46 and r. 2 (d) of schedule C should be applied in determining the tax charged under Case III, r. 3. A number of hypothetical examples of the ways in which the provision might be applied were prepared for examination by the courts and of these the Court of Appeal chose an example which adopted the society's method of computation as illustrating the  proper operation of the various relevant provisions. Upon appeal by the commissioners the House of Lords, following an observation made by Viscount Simon in the course of the argument, decided that the sum to be taxed was not affected at all by the fact that one of the factors in the calculation contained as an element income from exempted investments. The basis of the decision was that the tax charged under Case III, r. 3, was not directly or indirectly a tax upon income from investments but, to use the language of Viscount Simon, "the thing to be taxed" is "a conventional or notional sum" ^[F43] deemed to be profits and to be charged as such. Lord Wright said: "In truth, as already observed, the charge under r. 3 was not a charge on the specified investments except in form: it was an artificial mode of charging the general profit of the British business. Rule 3 not being qualified except for sub-r. 4, and being a charging section must receive its appropriate effect from the court, notwithstanding an apparent but not real conflict between it and s. 46 of the Income Tax Act 1918". ^[F44] Lord Porter stated that exempt investments should not be taxed even indirectly and added that to include tax-free investments in assets the profits from which were to be taxed would be to tax what ought not to be taxed. Following this he said: "But it has no application to a case where the profits or income, the subject of charge, is a notional sum calculated in a conventional way nor do I think it matters whether it is or is not established that the tax-exempt investments are assets of the branch carried on in this country". ^[F45] This case, then, for the reasons indicated by the citations that I have made, decided that interest from  tax-exempt investments must be included in the total income from investments of the life assurance fund for the purpose of the calculation of that portion of the income from investments of the fund that is deemed to be profits and is charged with tax. The decision means that for the purpose of the exempting provisions already referred to the tax that is imposed by Case III, r. 3, is not to be regarded as a tax on investment income as such; it is rather a tax upon a calculated sum given the character of profits imposed by a provision which contains no exemption. To use Lord Porter's words: "The result must be looked on as the price which non-resident assurance companies have to pay for engaging in business in this country". ^[F46] This seems to me to be the view of the decision that was taken by Upjohn J. and by the Court of Appeal in Ostime (Inspector of Taxes) v  Australian Mutual Provident Society ^[F47] where a claim made by the Inland Revenue Commissioners that what was taxed under Case III, r. 3, was not profits was rejected. It was not decided in either case, however, that Case III, r. 3, charges all that goes to make up what are in strictness United Kingdom profits. Nor does the language of the rule require this conclusion; indeed it points the other way in providing that what is to be charged as profits comprised in the schedule is a portion of the total income from the assurance fund. When Case III, r. 3, provides an additional method for taxing the companies to which it relates there seems to me to be no justification for identifying what is taxed thereunder with what would be taxed if the other methods of taxing were to be adopted. The reason for disregarding the exemption provisions was that Case III, r. 3, makes chargeable a "notional" or "conventional" sum. When Lord Wright spoke of Case III, r. 3, as "an artificial mode of charging the general profits of the British business" ^[F48] he was not, I think, identifying what Viscount Simon and Lord Porter described as a "notional" or "conventional" sum with the net profits of the British business. The existence of s. 33 as I have pointed out indicates that something different from annual profits is taxed under Case III, r. 3.  

In the present case the taxpayer was taxed under Case III, r. 3, and in conformity with Inland Revenue Commissioners v  Australian Mutual Provident Society ^[F49] the PD71,427 4s. 11d. in question was included as part of the total investment income for the purpose of the calculation of tax. The fraction - United Kingdom Premiums\Total Premiums - produced a figure of 2.888 per cent and this was applied to PD820,182 being the total income of the company from the investments of its life assurance fund and which included the PD71,427 4s. 11d. in question, to arrive at a figure  of PD23,687. At this point in the calculation of tax it would seem correct to say that 2.888 per cent of every PD1 of the PD71,427 4s. 11d. was deemed to be profit and charged with tax. Section 33 had, however, to be applied which,as I have pointed out, did no more than entitle the company to repayment of so much tax paid by it as is equal to the amount of tax on any sum disbursed as expenses of management. This sum in the computation of the taxpayer's United Kingdom tax was calculated to be PD9,534. The company therefore had to pay tax on PD23,687 at 4s. 9d. in the PD1 and was entitled to repayment of 4s. 9d. in the PD1 upon PD9,534. This relief was given by deduction in the calculation of the tax payable, that is, PD9,534 was deducted from PD23,687 to produce a figure of PD14,153 which was taxed at 4s. 9d. in the PD1. In the result the PD71,427 4s. 11d. was included in the PD820,182 that formed an element in the calculation of United Kingdom tax; and of the PD71,427 4s. 11d. so much as was comprised in the sum of PD14,153 was charged with tax. This can be ascertained by calculation.  

It is now necessary to turn to s. 23(q) of the Income Tax Assessment Act 1936 to decide whether upon the basis I have just stated all or any part of the sum of PD71,427 4s. 11d. should for the purposes of s. 23 (q) be regarded as exempt from United Kingdom tax.  

The whole sum was not exempt because, as I see it, an ascertainable portion thereof was charged with tax under Case III, r. 3. What is taxed under any description is not exempt from tax. I think the argument for the commissioner that no part of the PD71,427 4s. 11d. was taxed pushes the House of Lords decision too far. That decision, as is perhaps seen most clearly from the speech of Lord Porter, really depended upon the view that Case III, r. 3, imposed tax upon an amount without embodying the exemptions provided by s. 46(1) and r. 2(d) of schedule C, not that it charged what was brought to tax by Case I, without the appropriate exemptions nor that the amount taxed thereunder must be regarded as entirely separate from the items going to make up the investment income.  

It was argued for the taxpayer, however, that not only was the whole sum not exempt but no part of it was exempt because the PD71,427 4s. 11d. was brought into the calculation of the tax that became payable and the words "income not exempt from income tax" amount to the same thing as "assessable income". The argument that "income not exempt from income tax" is equivalent to "assessable income" is, I think, substantially correct if what is meant is income brought to tax. The phrase "income ... exempt from income tax" in the beginning of s. 23 has been regarded as meaning "not assessable income": cf. Texas Co  (Australasia) Ltd  v  Federal Commissioner of Taxation, ^[F50] per Dixon J. ^[F51] but I cannot think this is conclusive as to like words in s. 23 (q) because the phrase in the opening words of s. 23 refers to Australian law which makes "assessable income" the basis of the imposition of tax by imposing tax upon assessable income less allowable deductions, i.e. taxable income, whereas the phrase in s. 23 (q) refers to non-Australian systems of taxation which operate differently and may not require any ascertainment of "assessable income". I have, however, reached the conclusion that s. 23 (q) is dealing with income of the character there described upon which the taxpayer in some way or another is liable to be taxed in the country where it is derived: see Texas Co  (Australasia) Ltd  v  Federal Commissioner of Taxation. ^[F52] How it is brought to tax is not important for the purposes of s. 23 (q).  

The final matter for determination is then whether the whole of the PD71,427 4s. 11d. is brought to tax in the United Kingdom. If United Kingdom tax was levied upon the PD820,182 with or without deduction I think that the whole PD71,427 4s. 11d. which forms part of the larger sum would have been charged but that is not the case. What is charged, however, is a fraction of the PD820,182 and therefore, as it seems to me, a fraction of each and every pound going to make up that sum, and accordingly, a fraction of the PD71,427 4s. 11d. To take a comparable case from the Income Tax Assessment Act 1936 itself I turn to s. 26 (d) which provides that the assessable income of a taxpayer shall include five per cent. of the capital amount of any gratuity paid in a lump sum in consequence of retirement from any employment. I regard that provision as saying in effect that five per cent of the gratuity is brought to tax and ninety-five per cent is not and that is the case notwithstanding that the whole gratuity must be used for the purpose of calculating what is assessable income. I think s. 26 (d) denies that the whole gratuity is assessable income by providing expressly that five per cent of the whole is assessable income. In the same way I think that Case III, r. 3, denies that the whole of the income from the investment of the life assurance fund is brought to tax by providing expressly that a specified calculable portion is to be charged with tax. Furthermore for the reasons given earlier I am not prepared to regard Case III, rule 3, as taxing actual British profits (which would include the PD71,427 4s. 11d.) without exemption.  

My conclusion is that the portion of the PD71,427 4s. 11d. that is included in the portion of the income from the investment of the life assurance fund of the taxpayer that is charged under Case III, r. 3, but only that portion of the PD71,427 4s. 11d., is brought to tax and accordingly that is the only portion which is exempt from tax under s. 23 (q). That portion is so much of the PD71,427 4s. 11d. as is included in the sum of PD14,153 which was charged with tax in the United Kingdom. That is exempt from tax under s. 23 (q) but the balance of the PD71,427 4s. 11d. is not exempt.