R.A.C.V. Insurance Pty. Ltd. v. Federal Commissioner of Taxation.Judges:
Supreme Court of Victoria
Menhennitt J.: This is an appeal by R.A.C.V. Insurance Pty. Ltd., to which I shall refer as the taxpayer, against an assessment made in respect of the year of income ended on 28 February 1971 by the respondent, the Commissioner of Taxation, pursuant to the provisions of the Income Tax Assessment Act.
The taxpayer is a company which has since 1 January 1970 carried on insurance business. In the period up to 28 February 1971 the only kind of insurance business which it carried on was motor car insurance, both compulsory and comprehensive. As to the compulsory insurance, the taxpayer has at all times been an authorised insurer for the purposes of Part V of the Motor Car Act 1958, which deals with compulsory third party insurance. In respect of the year of income ended 28 February 1971 it submitted a return and an assessment was made by the Commissioner. The taxpayer objected against the assessment in respect of various matters, some of which were disallowed by the Commissioner. The taxpayer thereupon appealed to this Court pursuant to sec. 187(b) of the Income Tax Assessment Act.
The appeal raised two issues. One involved the basis upon which premiums should be brought in as income. Both the Commissioner and the taxpayer proceeded upon the basis that having regard to the fact that premiums cover the twelve months' period of a policy and that in almost every instance the period of the policy and the taxpayer's financial year would not correspond, some portion of the premium should be treated as income of the financial year and some portion should be treated as income of the succeeding year. There was a dispute as to the method of apportioning the premiums. The Commissioner had taken the stand that there should be applied an old practice of bringing into account in the year of income 60 per cent of each premium received and carrying forward into the next year 40 per cent of each premium received. The taxpayer adopted a more precise method termed the 24ths method, which has regard to the actual half month of the year in which each premium is paid in calculating what portion of each premium shall be included in the year of income and what portion shall be carried forward to the next year. This method was at first disputed by the Commissioner but subsequently conceded by him in an amended assessment made on 22 January 1974 and it was agreed that I should make a declaration confirming that amendment. I have referred to this issue because the concept that premium income is to be apportioned as between the two tax years (whichever method is adopted) is not, I think, irrelevant to the matter in issue on the appeal.
The taxpayer's first financial year was confined to the period from 1 January 1970 to 28 February 1970 and the taxpayer claimed in respect of the year of income ended 28 February 1971 losses and outgoings incurred in the previous year and made an objection in respect thereof and this was thought by the taxpayer to be an issue on the appeal. However, calculations revealed that the taxpayer's claim for this deduction had been allowed by the Commissioner so this was not an issue on the appeal.
Accordingly there remained on the appeal before me only one issue. In the course of dealing with this issue it is necessary to refer to the evidence and to make findings of fact. The witnesses called for the taxpayer were its general manager, Mr. Robinson, its claims manager, Mr. Kaye, its accountant, Mr. Mitchelson, a member of its auditors, Mr. Burrows, Mr. Carver, the Insurance Commissioner in Victoria appointed by the Governor in Council under the provisions of the Motor Car Act and the Workers Compensation Act, Mr. Buckley, a chartered
ATC 4172accountant familiar with the accounts of insurance companies and with accounting standards generally and Mr. Sawkins, a consulting actuary who is familiar with insurance companies and gives advice to them. No witnesses were called for the Commissioner. There was no matter really in controversy in the evidence. There were a few minor insignificant adjustments in the figures given in evidence by the officers of the taxpayer as to certain calculations. I accept the whole of the evidence including these adjustments in the figures and the findings of fact I make are based upon the evidence.
The issue which remained on the appeal arises in this way. The expression liability insurance is used in the insurance industry and was used by the witnesses to comprehend any form of insurance whereby the insurer indemnifies the insured against a liability to a third person. It comprehends compulsory third party insurance, workers compensation insurance, insurance against liability for supply of defective goods, public liability insurance and the like. As to liability insurance, in insurance parlance a claim means the occurrence of circumstances giving rise to the likelihood of a claim by a third person against the insured which is indemnified under the policy whether or not an actual claim has been made by the third party against the insured and whether or not the insured has made a claim against the insurance company for indemnity. In respect of compulsory third party insurance particularly, an insurance company commonly becomes aware of a claim not through notification by the insured but by a claim being made direct against it by the injured third person and in a significant proportion of cases the insurance company becomes aware of a claim, in the sense in which the expression is used in the insurance industry, without a claim for compensation being even made by an injured person. There is in operation a system administered through a body called the Road Accident Hospital Accounts Committee whereby authorized insurers meet hospital accounts of injured persons irrespective of liability. A prerequisite of payment is that the matter has to be first reported to the police and the Committee thereby knows the names of the injured persons and the authorized insurers. The taxpayer searches the records of the Committee and thereby often learns for the first time that a person insured by it is involved in a road accident. Where a claim is made direct against the insurance company by the injured third person, that person will have been able to ascertain the name of the authorized insurer either from the driver or, where he has the registered number of the vehicle, by a search at the Motor Registration Branch where the authorized insurer of each registered vehicle is recorded. Sometimes an authorized insurer becomes aware of an injury to a third person by the driver of a vehicle insured with it under a third party policy because a claim is made under a comprehensive policy for indemnity in respect of damage to a motor vehicle and it is revealed that a third person has been injured. Where the notification is from an injured third party personally the taxpayer contacts him immediately to endeavour to estimate his case.
The taxpayer, in accordance with the practice of insurance companies generally, brought into its accounts as losses or outgoings incurred in gaining or producing assessable income what are termed claims paid and outstanding. Claims paid means claims which arose during the year of income and were paid during the year. Claims outstanding means claims in the sense in which it is used in the insurance industry of which the insurance company has notice during the year but which have not been in fact paid during that year. What the taxpayer did and what insurance companies generally do in respect of such claims is to make and record, within a relatively short time of becoming aware of the claim, an estimate of the amount which, after enquiry on all the information available, is the amount which the insurance company will have to pay in respect of the claim including legal costs. In the case of the taxpayer the evidence establishes that these estimates including those for the year in question were made by competent experienced claims officers. The more important claims are referred to more senior officers before an estimate is made. There was nothing to suggest that the estimates were not reasonable and I conclude
ATC 4173on the whole of the evidence that they were reasonable. In respect of the taxpayer's compulsory third party claims approximately 60 per cent involve no real issue as to liability and the only matter to be estimated is the quantum of the damages. As to the remaining 40 per cent the estimate takes into account both the element of liability and the element of damage. The great majority of claims are settled by compromise and it is only in a very small percentage of cases that a court judgment or order finalises the claim.
These estimates are revised from time to time in the light of the information then available. These revised estimates as they stand at the end of each financial year are brought into account in the annual profit and loss accounts by both the taxpayer and other insurance companies.
The taxpayer brought into account as losses in respect of the year of income in issue the sum of $8,797,222 for claims paid and outstanding, which represented the total of claims in respect of both comprehensive and third party policies of which the taxpayer had notice in the year and were either paid in that year or estimated as at 28 February 1971. The evidence establishes that what the taxpayer did has been the longstanding practice of other insurance companies. Mr. Burrows, the company's auditor and an experienced accountant gave evidence that this has been the manner in which insurance companies generally have kept their accounts for at least thirty years to his personal knowledge and, he believes, since company accounts generally have been kept on an accrual basis as distinct from a cash basis since the late 19th century and Mr. Sawkins the actuary said that Lloyds of London, by keeping their accounts open for three years to permit of more accurate estimates and to bring in claims not notified during the year of income, have prepared their accounts on the basis of estimates of claims for two hundred years or more.
When the Commissioner assessed the taxpayer he accepted this concept of claims paid and outstanding as being losses and outgoings incurred and allowed it in the full amount claimed by the taxpayer.
However, in respect of compulsory third party insurance, the taxpayer included in its return a separate and additional amount of $1,420,424 claimed as a loss or outgoing incurred. This was termed in its accounts and its return ``unreported claims''. This is the amount which is the subject of the appeal.
The evidence of all the witnesses establishes that, particularly in the field of compulsory third party insurance, the experience of insurance companies generally has been that at the end of a financial year there will be a number of instances in which events have occurred which will give rise to an actual claim but where either no actual claim has been made by the third person against the insured or the insured has not reported to the insurance company either a claim or the events giving rise to a probable claim. This is particularly so in the case of third party personal injury claims where the insurance company sometimes first hears of the claim otherwise than from its insured in the various ways I have referred to above. Even although the insured gives no notice to the insurance company, its liability to indemnify still arises and is in effect absolute, leaving it with rights of recovery back from the insured in very limited circumstances. The evidence of Messrs. Robinson, Carver, Burrows, Buckley and Sawkins establishes that this category of cases has come to be well recognised by insurance companies in more recent years and they are known in the parlance of insurance companies as claims incurred but not reported. They occur in respect of all classes of insurance but they are more common in relation to compulsory third party insurance and are more significant having regard to the liability to indemnify in the absence of notice by the insured.
The evidence of the witnesses to whom I have just referred also is that, whilst this concept of claims incurred but not reported has been recognised by insurance companies generally for a number of years, before the year in question in this case a separate deduction has not been claimed in respect of them although regard has been had to them in a general way in the making of estimates by making them on a conservative basis in
ATC 4174the sense of including a higher rather than a lower figure. However, the State Insurance Office which is exempt from the provisions of the Income Tax Assessment Act and does not submit taxation returns has not adopted any such unscientific approach. It has since 1951 included in its accounts, in the outstanding claims figure, claims incurred but not reported. However, since 1963 it has applied a very complicated statistical analysis to estimate claims incurred but not reported and brought them into its annual accounts as losses. The appellant taxpayer did not adopt the unscientific approach previously adopted by other insurance companies. What it did in its published annual accounts for the year in question was to make the best estimate it could of what those unreported claims would amount to and it acted on actuarial information available to it that a claim was made in respect of approximately one policy out of 80, which produced a figure of 660 claims, and that the average amount paid out in respect of claims was estimated to be $2,000, thereby producing a figure of $1,320,000. This was the amount included in its annual accounts. At the time it was made, this estimate was, I conclude, for reasons I give later, a reasonable one. By the time the taxpayer came to make its return it had already been notified in fact of 785 claims arising out of events which occurred in the financial year but which had not been reported in the year. These had by this time been estimated case by case at figures which totalled $1,420,424 and this was the figure which it included in its return as a deduction. The evidence before me was that by the time the appeal came on for hearing 660 of these 785 claims arising out of events which occurred in the financial year ended 28 February 1971 but not reported in that year had in fact been paid, that the total of the amounts estimated at 31 July 1971 in respect of these 660 claims was $970,953 but that by the time of the hearing the amounts in fact paid in respect thereof totalled $1,030,833. The evidence also was that at the date of the hearing there remained outstanding 125 of the original total of the 785 claims notified between 28 February 1971 and 31 July 1971 in respect of events happening in the year ended 28 February 1971 and that at the date of hearing the total of the amounts paid by way of progressive payments in respect of these outstanding 125 claims plus the amounts of the estimated further liabilities in respect thereof was $1,074,826. (The evidence of Messrs. Robinson, Carver, Kaye and Mitchelson is that the claims that take longer to dispose of are the more costly ones.) This all means that by the time of the hearing the total amount paid or estimated in respect of the 785 claims upon which the deduction of $1,420,424 was claimed in the return was $2,105,659. In addition to these 785 claims a further 559 claims arising out of events which happened prior to 28 February 1971 had by the date of the hearing been notified to the taxpayer and it was estimated that a further 13 were likely. In the 14 months to 28 February 1971 2400 claims had been notified to the taxpayer and, in respect of happenings prior to 28 February 1971, those notified since 28 February 1971 plus the 13 anticipated total 1357, which is more than half of the number notified in the 14 months to 28 February 1971. The overall total is 3757 and, of these, the 2400 notified up to 28 February 1971 represent 63.9 per cent, 1069 (28.5 per cent) were notified in the 12 months ending 28 February 1972, 203 (5.4 per cent) were notified in the 12 months ending 28 February 1973, 65 (1.7 per cent) were notified in the 9 months ending 30 November 1973 and 20, including the 13 estimated, (0.5 per cent) cover the period since 30 November 1973. A run-off table of compulsory third party claims prepared by the taxpayer shows that, bringing into account all the notified claims up to 30 November 1973 in respect of occurrences in the 14 months prior to 28 February 1971, the total of claims paid ($5,301,819) plus estimates of claims outstanding ($3,317,915) less recoveries ($805,842) is $7,813,892, whilst the earned premiums for that 14 month period were $6,704,272, showing a loss ratio of 116.6 per cent before any administration costs are taken into account. All this evidence establishes in my view, among other things, that the amount of $1,420,424 claimed by the taxpayer in respect of claims incurred but not reported by 28 February 1971 has proved to be quite inadequate to cover its total liabilities in respect thereof.
In his assessment the Commissioner whilst allowing the full amount of $8,797,222 for claims paid and outstanding disallowed the amount of $1,420,424 termed unreported claims and he subsequently disallowed the taxpayer's objection thereto. As I have said, this is the amount which is the subject matter of the appeal.
The issue thus raised appeared to be a relatively confined one. However, when the appeal came on for hearing, counsel for the Commissioner, at an early stage during the opening by counsel for the taxpayer, intimated on behalf of the Commissioner that his prime submission would be that no amount is a loss or outgoing incurred in the year of income unless the liability of the insurance company to indemnify the insured has been quantified by either a settlement of the claim or a judgment or order. It was acknowledged that (subject to questions of the power to reopen the assessment in respect to the year in question) this would have the effect of disallowing as a deduction all those amounts included in claims paid and outstanding which represented claims not quantified in the year of income by settlement or court order, which would mean practically all of the outstanding claims. In the case of the taxpayer the evidence is that it would mean disallowing all except $186,856 out of a total of about $4.500.000 in respect of reported claims. It was also acknowledged that this contention would apply to all insurance companies and in respect of all forms of liability insurance.
Counsel for the taxpayer informed me that counsel for the Commissioner conceded that the acceptance of this prime submission would involve upsetting long assessing practice. If what the Commissioner contends for accords with the Act, it is of course to be applied whatever its consequences. However, what I have said reveals that the issue thus raised on the appeal is a very important and far reaching one and that the acceptance of the Commissioner's prime submission would affect the liability to taxation of all insurance companies which conduct liability insurance business and the form their accounts would have to take in returns for income tax purposes.
The Commissioner's prime submission is that under liability insurance there is no liability to indemnify the insured until it has been determined by settlement or court order that the insured is liable to pay to a third person a quantified sum and that, within the meaning of sec. 51(1) of the Income Tax Assessment Act, no loss or outgoing has been incurred until this happens. For this proposition strong reliance was placed upon the English decisions in
Weld-Blundell v. Stephens (1919) 1 K.B. 520 particularly at p. 529,
West Wake Price & Co. v. Ching (1957) 1 W.L.R. 45 particularly at p. 49 and
Post Office v. Norwich Union Fire Insurance Society Ltd. (1967) 2 Q.B. 363 particularly at p.372, 373 to 374 and 377 to 378.
In West Wake Price & Co. v. Ching the question was whether under a professional negligence indemnity policy a particular claim by a third person was comprehended by a clause requiring payment by the insurer unless Queen's Counsel advised that the claim could be successfully contested and the assured consented to it being contested, their consent not to be unreasonably withheld. Devlin J. held that as the claim was in respect of alleged fraud it was not covered by the clause. He was concerned with the question whether the proximate cause of any loss was the dishonesty of the assureds' servant or on the other hand the assureds' own neglect and in the course of his reasons he said at p. 49 that the essence of any indemnity clause is that the assured must prove a loss and that the assured could not recover anything under the main indemnity clause or make any claim against the insurer until the assured had been found liable and so sustained a loss. He said that if judgment were given against the assured for the sum claimed they would undoubtedly have suffered a loss.
In Post Office v. Norwich Union Fire Insurance Society Ltd, the Court of Appeal had under consideration the provisions of the English Third Party (Rights against Insurers) Act 1930 which provided that where under a contract of insurance an insured is insured against liability to third parties, in the event of the insured becoming bankrupt or being wound up, if before the bankruptcy or winding up any such liability
ATC 4176is incurred by the insured, his rights against the insurer under the contract in respect of the liability should be transferred to and vest in the third party to whom the liability was so incurred. The Court of Appeal held that the rights of the insured against its insurers which vested in a third party by virtue of the Act of 1930 were transferred subject to the conditions in the contract of insurance and that, since the insured could not have claimed to be indemnified by its insurers until its liability had been established, the third party was in no better position and was not entitled to sue the insurance company direct until the insured's liability was determined, especially where liability was disputed. An examination of the reasons in that case reveals that what the court was considering was whether the rights of the insured against the insurer had been transferred to a third party so as to entitle the third party to sue the insurance company direct. The decision was based partly on the meaning of the word ``Rights'' in the context of that legislation (see per Lord Denning M.R. at p. 373) and partly on a condition of the insurance policy which provided that no admission offer promise payment or indemnity should be made or given by or on behalf of the insured without the written consent of the insurance company which was entitled to take over the conduct of the defence or settlement of any claim.
However, it does not, I think, follow from those decisions or the reasoning in any of those cases that, within the meaning of legislation of a different kind from that under consideration in the last mentioned case and in relation to an issue very different from that with which Devlin J. dealt, a loss or outgoing has not been incurred within the meaning of sec. 51(1) of the Income Tax Assessment Act until the liability of the insured to the third party has been determined by settlement or court order.
The Income Tax Assessment Act in imposing liability to income tax adopts the basic method of imposing taxation in respect of annual periods of time. This necessarily involves assigning to a period of a year both income and losses or liabilities. (See
Commissioner of Taxes (S.A.) v. Executor Trustee and Agency Co. of South Australia Ltd. 63 C.L.R. 108 at p. 152 to 153,
Texas Co. (Australasia) Ltd. v. F.C. of T. 63 C.L.R. 382 at p. 465 to 466 and
Henderson v. F.C. of T. 69 ATC 4049; 119 C.L.R. 612 at p. 649 to 650.) I have earlier pointed out that so far as income is concerned it is recognised that although premiums are received in a tax year it is inappropriate to treat the total thereof as being income of that year and an apportionment is made between that year and the subsequent year.
When there has to be considered the question whether an insurance company has incurred a loss or outgoing in a particular year that question comes to be considered in relation to the nature of the business being carried on. The essence of insurance business is that, in respect of each class of risk insured against, the insurance company aims to satisfy its liabilities to the policy holders who actually experience the risk primarily out of the total of the premiums paid by all the policy holders, most of whom normally do not experience the risk. In relation to liability insurance the insurance company is bound to indemnify its insured against his liability to a third person. Once events have occurred out of which a liability to indemnify an insured arises, it appears to me that within the meaning of sec. 51(1) of the Income Tax Assessment Act a loss or outgoing has been incurred. Events have occurred which have subjected it to a liability to indemnify its insured against his liability to a third person and the extent of that liability is capable of reasonable estimate. Where there is no real question of the liability of the insured to the third party and the only question is one of estimating damages, the fact that the quantum of the loss or outgoing is a matter of estimate and that the amount may have to be adjusted in the light of later events does not stand in the way of it being a loss or outgoing (see
New Zealand Flax Investments Ltd. v. F.C. of T. 61 C.L.R. 179 at p. 199 and Texas Co. (Australasia) Ltd. v. F.C. of T. 63 C.L.R. 382 at p. 465 to 466) and in a case where the liability of the insured to the third party is in issue but the amount which is likely to be payable can be reasonably estimated, it is still I think true to say that within the meaning of sec. 51(1) a loss or outgoing has been incurred by the insurance
ATC 4177company. In
Ballarat Brewing Co. Ltd. v. F.C. of T. 82 C.L.R. 364 Fullagar J. said at p. 369 -
``It is common ground that the account must, almost of necessity, proceed upon an `accrual' or `earnings' basis. It is the appropriate figure for book debts that is in question. This is in essence a matter of estimation, and (apart from express provision in the Act) it would be proper to make an allowance for bad and doubtful debts. In
Sun Insurance Office v. Clark (1912) A.C. 443, at p. 454, Lord Loreburn said: - `There is no rule of law as to the proper way of making an estimate. There is no way of estimating which is right or wrong in itself. It is a question of fact and figures whether the way of making the estimate in any case is the best way for that case.'''
The passage I have referred to in Texas Co. (Australasia) Ltd. v. F.C. of T. also leads to the conclusion that where an adjustment of an estimate is necessary in the light of later events it is permissible to take the amount of the adjustment into account in the year when it is made.
The conclusions I have stated are I think reinforced by the consideration that under sec. 51(1) a loss or outgoing is a deduction to the extent to which it is incurred in gaining or producing the assessable income. The liability to indemnify in respect of events occurring in the year of income is it seems to me properly to be regarded as incurred in gaining or producing the assessable income of that year because it is out of that year's premiums that the liability is to be met.
The clearest demonstration of this is, I think, to take the theoretical case of an insurance company which carried on insurance business for one financial year only and issued policies which were current only up to the end of that year. If the liability to meet claims which arose out of events which occurred in that year were not a loss or outgoing incurred in gaining or producing the assessable income of that year it would never be deductible out of premium income even although the vast majority of claims would be satisfied in subsequent years because it would have no subsequent premium income out of which the amounts paid would be deductible. This being so for one year, the basic position seems to me to be no different if an insurance company carries on business for a number of successive years.
The point is also demonstrated I think by taking the case of a new insurance company which commenced to carry on liability insurance business such as compulsory third party insurance business and carried it on for a period of say five or six years and then decided not to renew any policies or issue any new policies but to remain in existence until all claims had been satisfied. The evidence establishes that it takes up to about eight years after a road accident to finalise some claims and that many claims are not disposed of by settlement or judgment for some three or four years after the death or personal injury of the third party has occurred. If the submission for the Commissioner were correct, in the early years of the company's trading it would have relatively small amounts by way of deductions because a relatively small proportion of the claims would have been quantified in settlement or judgment so that its taxable income would be very considerably higher than if the estimates of claims were allowed as deductions. This would incidentally affect greatly its capacity to build up reserves to meet claims because of the substantial amounts of its taxable income particularly at the present rates of company tax. (In the case of the present taxpayer instead of a revenue loss of $154,535 as returned, the taxpayer would show a profit of more than $5 million.) More significant however would be the fact that once the insurance company discontinued business it would thereafter have no premium income from which to deduct the amounts of claims paid out when finally disposed of by settlement or judgment but would incur substantial losses for which it could claim no deduction out of premium income. It is I think no answer to say, as was said on behalf of the Commissioner, that it would have some income from reserves out of which losses could to some extent be deducted. As I have already pointed out, the size of the reserves would be significantly reduced by the taxation in the early years. It
ATC 4178would have to meet administration expenses out of income from reserves and the evidence is that investment income does not marry up with inflation but lags far behind it. More significantly, however, the income from those reserves, whatever its size, would have been part of its taxable income in any event and the real source of income from which its losses and outgoings are to be deducted would be premiums because it is paying for losses primarily out of premiums, but it would have no premium income.
All I have said appears to me to apply to all forms of liability insurance although in the case of a policy under which a right of indemnity is subject to conditions such as the giving of notice there may well be a question whether a loss or outgoing is incurred before notice of a claim is given or before the insurance company by its conduct admits liability to indemnify its insured or whether on the other hand the loss or outgoing is incurred upon the happening of the events giving rise to the claim by the third person if liability to indemnify is subsequently acknowledged by the company.
However, in the case of compulsory third party insurance none of these considerations is significant. The position is covered by the provisions of Division 1 of Part V of the Motor Car Act 1958 dealing with compulsory third party insurance. By sec. 40 to 42 every owner of a motor car is required to insure with an authorized insurer against any liability which may be incurred by him or any person who drives such motor car in respect of the death of or bodily injury to any person caused by or arising out of the use of such motor car. By sec. 46(1) the contract of insurance is required to cover that liability including the liability of an unauthorized driver. Although by sec. 56 the owner is required to notify the authorized insurer of any accident affecting the motor car and resulting in the death of or bodily injury to any person and is prohibited from entering upon or incurring expenses of litigation or compromising any matter in respect of which he is insured without the written consent of the authorized insurer, non-compliance with those provisions does not in any way limit or qualify the liability of the authorized insurer to indemnify the owner or driver but merely gives the authorized insurer the right to recover from the owner damages reasonably attributable to any failure to comply with the section. In the case of unauthorized or intoxicated drivers there is again no limit on the liability of the authorized insurer to indemnify the driver but only a right by sec. 59 to recover from a driver in certain circumstances any sum paid by the authorized insurer in discharge of its liability to indemnify the driver. By sec. 47 of the Act a third party who has obtained an unsatisfied judgment against an owner or driver is entitled to recover the amount of the judgment against the authorized insurer. All those provisions make it clear that the liability of the authorized insurer to indemnify the owner or driver arises immediately upon the happening of the events which cause the death of or bodily injury to a third person and they all appear to me to reinforce the conclusion that in the case of compulsory third party insurance a loss or outgoing is incurred by the authorized insurer upon the happening of the events which cause the death of or bodily injury to any person. This aspect may be stated another way. In relation to compulsory third party insurance, if an authorized insurer denied liability to indemnify an insured driver the driver could always obtain a declaration from a court that he was entitled to be so indemnified because there could be no answer to a claim for such a declaration. The features of the legislation to which I have referred were adverted to when the Full Court said in
Pullin v. Insurance Commissioner (1971) V.R. 263 at p. 270 -
``The policy of Division 1 of Part V of the Motor Car Act 1958 is to ensure that victims of motor car accidents obtain the fruits of their judgments rather than to provide a statutory indemnity to drivers of motor cars. The provisions relating to uninsured, unidentified, intoxicated and unauthorised drivers manifest the policy of the Division.''
That a loss or outgoing has been incurred by an authorized insurer upon the happening of the events giving rise to a liability to indemnify is further demonstrated I think by what happens when it has notice of those events. It immediately opens a file,
ATC 4179investigates the facts and as soon as possible makes an estimate of its liability. The evidence also is that the ultimate payment is always made to the third party or his representative and never to the insured. It is I think inverting the true position to say, as was submitted on behalf of the taxpayer, that it is because the taxpayer becomes involved and takes control that it becomes a loss or outgoing incurred. Rather it is because it is loss or outgoing incurred that it incurs this expense in meeting its liability. The same is true I think of the evidence that the taxpayer endeavours to settle claims as soon as possible.
The conclusions I have stated appear to me to accord with the authorities. What do and do not constitute losses and outgoings incurred is dealt with in the following passage from the judgment of Dixon C.J., Webb, Fullagar, Kitto and Taylor JJ. in
F.C. of T. v. James Flood Pty. Ltd. 88 C.L.R. 492 at p. 506 to 508 -
``For under our law the facts must satisfy the expression `losses and outgoings incurred'. These words perhaps are but little more precise than the word `established' or the expression used above `definitively committed'. But they do not admit of the deduction of charges unless, in the course of gaining or producing the assessable income or carrying on the business, the taxpayer has completely subjected himself to them. It may be going too far to say that he must have come under an immediate obligation enforceable at law whether payable presently or at a future time. It is probably going too far to say that the obligation must be indefeasible. But it is certainly true that it is not a matter depending upon `proper commercial and accountancy practice rather than jurisprudence'. Commercial and accountancy practice may assist in ascertaining the true nature and incidence of the item as a step towards determining whether it answers the test laid down by sec. 51(1) but it cannot be substituted for the test.
To repeat what has been said before in relation to an analogous provision in the Act of 1922-1934: `To come within that provision there must be a loss or outgoing actually incurred. `Incurred' does not mean only defrayed, discharged, or borne, but rather it includes encountered, run into, or fallen upon. It is unsafe to attempt exhaustive definitions of a conception intended to have such a various or multifarious application. But it does not include a loss or expenditure which is no more than impending, threatened, or expected.'; New Zealand Flax Investments Ltd. v. F. C. of T. (1938) 61 C.L.R. 179 at p. 207. Nothing that was decided in
W. Nevill & Co. Ltd. v. F. C. of T. (1937) 56 C.L.R. 290 was intended to imply that a liability to pay an ascertained sum is never incurred until the sum becomes due and payable..... But whatever be the rationale of the decision of the point, clearly enough it is not based on a view that no outgoing could be incurred until actual payment was made. It is one thing, however, to say that it is not necessary, for the purposes of sec. 51(1), that an actual disbursement should have taken place. It is another thing to say that in the present case the taxpayer had incurred a loss or outgoing in the year of income in respect of the pay of its men during the annual leave to be taken in the ensuing accounting period by employees whose service had not as yet qualified them for annual leave. In respect of these employees there is no debitum in praesenti solvendum in futuro. There was not an accrued obligation, whether absolute or defeasible. There was at best an inchoate liability in process of accrual but subject to a variety of contingencies.''
The decision in that case was that there was no loss or outgoing incurred in respect of payment for annual leave pursuant to an award until the leave became due. Considerable significance was placed by the Court upon the provisions of the award which made it clear that nothing was payable until twelve months had been served and it was held that no loss or outgoing had been incurred in respect of an incomplete portion of a twelve months period which arrived at the end of a financial year. It was in relation to that situation that the Court said that
ATC 4180there was no debitum in praesenti solvendum in futuro and no accrued obligation whether absolute or indefeasible.
But in relation to compulsory third party insurance, once the events have occurred which give rise to a liability to indemnify it seems to me that, within the meaning of the passage I have cited, a loss or outgoing has been encountered, run into or fallen upon. It is more than a loss or expenditure which is no more than impending, threatened or expected. The Court said that it may be going too far to say that the taxpayer must have come under an immediate obligation enforceable at law whether payable presently or at a future time and that it is probably going too far to say that the obligation must be indefeasible.
The only authority of which I am aware which is directly in point on this whole matter is the decision of the Full Court of the Supreme Court of New South Wales in
C. of T. (N.S.W.) v. Manufacturers' Mutual Insurance Ltd. (1931) 31 S.R. (N.S.W.) 575. In that case the Court had under consideration a taxation provision substantially the same as sec. 51(1) of the Commonwealth Income Tax Assessment Act and it concerned claims under workers' compensation insurance, which is a form of liability insurance. Ferguson J. in delivering the reasons of the court concurred in by Street C.J. and James J. said at p. 585 -
``In the case of the item under discussion there is no legal obligation in the sense of a cause of action immediately enforceable against the company; but from a practical business point of view, and that is the point of view from which these questions should be regarded, it is just as certain that some money will have to be paid in respect of pending claims as in respect of claims which have gone to judgment. the amount is uncertain, but apparently it is susceptible of more or less accurate estimate. Any statement of the affairs of the company professing to show the result of the year's operations, which neglected to take into account this liability, would be grossly inaccurate and misleading. In my opinion, therefore, it is an obligation standing on the same footing as an actual expenditure, which the company is entitled to deduct as a loss or outgoing actually incurred in producing the assessable income, subject of course to any necessary future adjustment.''
I respectfully agree with and apply this decision and the reasons the reasons of the Court.
In Ballarat Brewing Co. Ltd. v. F. C. of T. 82 C.L.R. 364, Fullagar J. had under consideration the question whether discounts and rebates should be taken into account in determining gross profit. The provisions of sec. 51(1) of the Act were not the basis of the decision but the issue concerned the allowability of a deduction from gross profits. Fullagar J. decided that the discounts and rebates were to be deducted in determining gross profit and at p. 370 cited with approval the decision in C. of T. (N.S.W.) v. Manufacturers' Mutual Insurance Ltd. and applied it mutatis mutandis when he said at p. 370 -
``The case of C. of T. (N.S.W.) v. Manufacturers' Mutual Insurance Ltd. (1931) 31 S.R.(N.S.W.) 575; 48 W.N. 215 was a case in which the calculation of an `allowable deduction' was in question. The company's true position at the end of the accounting period could not be ascertained without bringing into account some amount in respect of liabilities under worker's compensation policies. which liabilities had not matured because, although accidents had happened, claims had not been made or, if made, had not been adjusted. The Commissioner maintained that only claims which had been paid during the year should be brought into account. The argument was rejected. Ferguson J. (with whom Street C.J. and James J. concurred) said `Any statement of the affairs of the company professing to show the result of the year's operations, which neglected to take into account this liability, would be grossly inaccurate and misleading.' The present case is not, in my opinion, a case in which any question of allowable deductions arises, but the sentence which I have quoted, and indeed the whole of the paragraph in which it
ATC 4181occurs, appear to me to be, mutatis mutandis, entirely appropriate to this case.''
These decisions of the Full Court of the Supreme Court of New South Wales and of Fullagar J. draw attention to a further matter which I think supports the conclusion I have reached. In F.C. of T. v. James Flood Pty. Ltd. 88 C.L.R. 492 at 506 the High Court said that although the question whether a loss or an outgoing had been incurred is not a matter depending upon proper commercial or accountancy practice rather than jurisprudence, commercial and accountancy practice may assist in ascertaining the true nature and incidence of the item as a step towards determining whether it answers the test laid down by sec. 51(1) but it cannot be substituted for the test. In C. of T. (N.S.W.) v. Manufacturers' Mutual Insurance Ltd. (1931) 31 S.R. (N.S.W.) 575 the Court, in the passage I have cited, had regard to the practical business point of view and, in the passage cited by Fullagar J., said that any statement of the company's affairs professing to show the result of the year's operations, which neglected to take into account the liability in respect of pending claims, would be grossly inaccurate and misleading. What was said in the three cases makes it proper I think to have regard to the long established practice of insurance companies of including among losses in each year's accounts the estimates of liabilities in respect of claims arising out of events which occur in that year in order to ascertain the true nature and incidence of the items as a step towards determining whether they are losses or outgoings incurred within the meaning of sec. 51(1). That long established practice reinforces the conclusion that the true nature and incidence of these estimates is that they are losses and outgoings incurred within the meaning of that section.
Further, the provision in sec. 51(1) that a loss or outgoing is an allowable deduction to the extent to which it is incurred in gaining or producing assessable income appears to me to be a statutory recognition and application of the accountancy principle which all the accountants who gave evidence referred to as the matching principle. Mr. Buckley said that this principle is almost universally accepted among Western accountants. The principle as stated by Mr. Buckley and with which the other accountants who gave evidence in substance agree is that you endeavour as far as possible in preparing or drawing up accounts to bring to account in the same year in which you bring in revenue from a particular transaction the expenditure or anticipated losses directly related to that revenue. He further said that applying that principle he believed that it is proper and necessary to bring to account by way of debit to the profit and loss account in the year in which you bring a certain premium income resulting from contracts of the kind of compulsory third party insurance estimates of the amounts likely to have to be paid out on account of claims which have been notified and also the best estimate that can be made of claims that have not yet been notified so that they will be matching the claim against the revenue. In my view not only is this in accordance with accepted accountancy principles but it is also what sec. 51(1) of the Income Tax Assessment Act contemplates.
Other evidence called for the taxpayer also I think reinforces the conclusions I have reached. The accountants who gave evidence said that in their opinion it would not give a true and fair view of an insurance company's accounts if there were not included in the profit and loss account as a debit estimates of claims estimated but not paid. It was said further that for an insurance company carrying on business for profit to declare profits and pay dividends without taking such claims into account would not be proper and that if dividends were paid out without taking such estimated claims into account it could well lead to the company having insufficient moneys with which to pay outstanding claims and might lead to insolvency. It would also appear from the evidence that the insolvency in recent years of a large overseas insurance company was mainly due to inadequacy of estimates of outstanding claims.
Another matter was relied upon by the taxpayer but it is I think equivocal. The Insurance Act 1973 provides in Part IV
ATC 4182(which was not in operation at the date of the hearing) for accounts of insurance companies. Section 44(1) provides that a body corporate authorised under the Act to carry on insurance business shall, in respect of each financial year of the body corporate, lodge with the Insurance Commissioner the accounts and statements specified in sub-sec. (2). In sub-sec. (2) the accounts so specified include a statement of claims and a statement of provision made for claims. It does not appear to follow therefrom that for the purposes of a specific provision of another Act, namely the sec. 51(1) of the Income Tax Assessment Act claims are an allowable deduction. It is however I think a proper conclusion that the word claims is there probably used in the sense in which it is used in the insurance industry as comprehending circumstances giving rise to a claim against the insured person which is indemnified by the insurance company. The evidence which was given of the mode in which the Insurance Commissioner under that Act has indicated he will require a statement of claims to be prepared does I think reinforce the evidence as to the mode in which insurance companies have commonly kept their accounts. It cannot I think be otherwise used in support of the construction of sec. 51(1) contended for by the taxpayer.
In support of the Commissioner's prime submission, counsel relied upon the decisions in F.C. of T. v. James Flood Pty. Ltd. 88 C.L.R. 492. Jolly v. F.C. of T. 50 C.L.R. 131, W. Nevill & Co. Ltd. v. F.C. of T. 56 C.L.R. 290 and Emu Bay Railway Co. Ltd. v. F.C. of T. 71 C.L.R. 596 but in my view none of those decisions nor the reasons therein leads to a conclusion to the contrary of the one I have reached or is inconsistent therewith.
In F.C. of T. v. James Flood Pty. Ltd. 88 C.L.R. 492 the taxpayer company sought to deduct in the year of income in question amounts in respect of annual leave. The annual leave in question was not due in that year of income, nothing was payable in that year of income and, under the award, an employee who did not serve for twelve months might in a variety of circumstances not become entitled to anything. What the company sought to do was to deduct in respect of the year of income the proportion equivalent to the period of service in that year of the amount which would become payable if the employee did in the next year complete twelve months. The Court held that no loss or outgoing was incurred until the twelve months had in fact been served. This is in marked contrast with the position where an absolute liability to indemnify arises under an insurance policy upon the happening of events which result in the death of or bodily injury to a third person.
Jolly v. F.C. of T. 50 C.L.R. 131 what Dixon J. held at p. 136 to 137 and the Full Court affirmed was that no liability to pay interest had been in fact incurred in the year in question.
In W. Nevill & Co. Ltd. v. F.C. of T. 56 C.L.R. 290 the Court held that a loss or outgoing was incurred in respect of promissory notes payable in the year in question but not in respect of those payable in later years and it was pointed out that it was not possible to incur a loss or outgoing by the device of giving a promissory note in respect of a liability which did not accrue until some later year.
Emu Bay Railway Co. Ltd. v. F.C. of T. 71 C.L.R. 596 it was held that under the terms of a debenture trust deed interest was payble only out of income and that as there was no income in the relevant year no interest was payable and accordingly a loss or outgoing had not been incurred in respect of any interest which might become payable in the future if there were then interest.
Reliance was placed on the passage in the judgment of Dixon C.J. in
Caltex Ltd. v. F.C. of T. 106 C.L.R. 205 at p. 218 where his Honour referred to and relied upon the decision of the Full Court in F.C. of T. v. James Flood Pty. Ltd. 88 C.L.R. 492 at p. 506 to 507. I do not understand the learned Chief Justice in the Caltex case to be qualifying or limiting what had been said by the Full Court in Flood's case. What his Honour did at p. 218 was to refer to those parts of the tests enunciated in Flood's case which were apposite to the Caltex case but he did not I think intend thereby to qualify or limit
ATC 4183anything said in the joint judgment to which he had been a party in the earlier case.
For all of the reasons I have given I am unable to accept the prime submission advanced for the Commissioner before me and I conclude that the Commissioner was correct when in his assessment he accepted the concept of losses and outgoings incurred upon which the return was based and allowed in full the sum of $8,797,222 claimed by the taxpayer.
The Commissioner advanced an alternative submission in relation to the amount directly involved in the appeal namely the sum of $1,420,424 claimed as unreported claims or as claims incurred but not reported. The submission was that even if the Commissioner's main submission were not accepted no amount should be allowed until the taxpayer has had notice of a claim and that accordingly as none of the accidents in respect of which these amounts were claimed had been reported to the taxpayer in the financial year in question nothing should be allowed as a deduction in respect of this item.
I have concluded that in respect of compulsory third party insurance claims a loss or outgoing is incurred by the authorized insurer when the events occur which impose on the authorized insurer a liability to indemnify the driver of the vehicle in respect of a claim by a third person for personal injury. Having regard to the fact that there is an unanswerable liability to indemnify the driver of the vehicle once the personal injury occurs, it seems to me that a loss or outgoing is incurred within the meaning of sec. 51(1) of the Act once the events giving rise to a liability occur and that the incurring of the loss or outgoing is not dependent on notice of the injury or of the accident or upon a claim being made by the driver for indemnity. Indeed, the evidence establishes that the driver and owner not infrequently never report the accident or make a claim for indemnity and the first knowledge the authorized insurer has of the matter is when the third party makes a claim direct on the authorized insurer for compensation in respect of the injury or it learns about the matter in the other ways I have referred to. If two separate events giving rise to two separate claims occur on the last day of a financial year. I can see no logical reason why, in relation to compulsory third party insurance, one should be a loss or outgoing incurred if it is notified by the driver to the authorized insurer that day and the other should not because it is not notified by the driver until the first day of the next financial year.
It is significant that, although in C. of T. (N.S.W.) v. Manufacturers' Mutual Insurance Ltd. (1931) 31 S.R. (N.S.W.) 575 the Full Court appears to have had under consideration only claims which had in fact been made, when Fullagar J. adopted and applied the decision in Ballarat Brewing Co. Ltd. v. F. C. of T. 82 C.L.R. 364 at p. 370 he treated the decision as comprehending cases where ``although accidents had happened, claims had not been made''. His Honour apparently could see no logical distinction between those cases and cases where claims had been made but not adjusted nor, with respect, can I.
The evidence called for the taxpayer was to the effect that these claims are indistinguishable in principle from claims notified and are comprehended by the matching principle. As to the practice of insurance companies, the evidence is that they have been brought into their profit and loss accounts by Lloyds brokers for more than 200 years by them keeping their accounts open for three years, that the State Motor Car Insurance Office has taken them into account in its profit and loss accounts in respect of the year in which the accident occurs since 1951 and done so by making a complicated statistical estimate of them since 1963, that insurance companies generally have brought them into account in their annual profit and loss accounts in the general way to which I have referred and that in the case of one other insurance company a separate estimate thereof has been included in its most recent accounts. Mr. Buckley said that in his view it is not only proper but necessary to make provision for them in the profit and loss accounts. Further the evidence is that it would not give a fair and true view of an insurance company's profit and loss account for a year unless they are
ATC 4184brought into account as losses in respect of the year in which the events giving rise to the claim occur.
In the result it appears to me that the taxpayer is entitled to claim a deduction in respect of the claims incurred in the year of income but not reported. The question remains as to the appropriate amount to be included. In its annual accounts the taxpayer included a statistical estimate of $1,320,000 upon the basis I have referred to, Mr. Sawkins the actuary said that in his opinion this was a reasonable estimate in the circumstances of the taxpayer at that time. By the time it lodged its return the taxpayer had made estimates case by case of the claims by then reported and arising out of events happening in the year ended 28 February 1971 and this is the amount it claimed in its return, namely $1,420,424. I am satisfied on the evidence that this amount represented the total of reasonable estimates of the taxpayer's liability in respect of claims of which it in fact had notice by that date. It seems to me in principle that events after the close of a financial year can be relied upon to support a case by case estimate in substitution for an earlier statistical estimate made at the time of its published accounts on the basis that the later estimate is more accurate than the earlier one. As to the adequacy and reasonableness of the estimate of $1,420,424, the evidence is that the amount claimed is more than justified. The taxpayer's auditors qualified their published accounts because they considered that the estimate of $1,320,000 was inadequate and should have been $1,950,000 which they calculated on a loss ratio basis. However, in evidence the auditor said that, in the light of the subsequent experience, his present opinion was that the figure should have been much greater than $1,950,000. Mr. Carver, with a background of the experience of the State Motor Car Insurance Office, considered that the figure included in the taxpayer's annual accounts was inadequate. He said that the experience of his office for the years 1969 to 1973 was that the proportion of cases in which claims were made ranged from one in 72 to one in 80 and that in 1971 the average estimated amount for each claim was $2371. In addition, there is all the evidence to which I have earlier referred which establishes that the amount of $1,420,424 claimed by the taxpayer in respect of claims incurred but not reported by 28 February 1971 has proved to be quite inadequate to cover its total liabilities in respect thereof. The opinions to which I have referred and this evidence lead. I think, to the conclusion that the taxpayer is entitled to the deduction of the amount of $1,420,424 claimed by it.
The question was raised during argument whether the taxpayer was entitled to a deduction of an even larger amount based upon the fact that at the date of the appeal the total of its estimated liability on the 785 claims reported up to the date of its return was $2,105,659 and that a further 559 claims had been notified. I leave open the question whether in the light of my decision this question can be opened up by the taxpayer. The only matter directly before me on the appeal is whether the taxpayer is entitled to a deduction of the amount of $1,420,424 claimed by it in its return and I confine my decision to that matter.
I have referred to the fact the annual accounts of insurance companies including the taxpayer bring into account year by year the revised estimates of claims which are still outstanding. I have also referred to the justification for making an adjustment of the original estimate in the accounts of the year in which the claim is finalised. Whether it is justifiable to bring these revised estimates into account in the intervening years before the claim is finalised is a matter which does not arise for decision on this appeal (which relates only to the taxpayer's first full financial year) and accordingly I say nothing about it one way or the other.
For the reasons I have given I am of the opinion that the taxpayer is entitled to succeed on the appeal. I also make the consent order which I was asked to make.
The orders of the Court are as follows -
By consent the Court confirms the amended assessment issued on 22 January 1974.
The Court declares that the taxpayer is entitled to the deduction of the amount of $1,420,424 claimed by it as unreported
ATC 4185claims and it is ordered that the taxable income of the taxpayer for the year ended 28 February 1971 be reduced to nil.
It is ordered that the taxpayer's costs of the appeal be taxed and paid by the respondent the Commissioner of Taxation, such costs to include transcribed notes and the costs of and incidental to the notice of objection herein.
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