GRE INSURANCE LIMITED v FC of TJudges:
Full Federal Court
Northrop, Davies and Jenkinson JJ
These appeals are brought by GRE Insurance Limited (``GRE''), a general insurer, and its wholly owned subsidiary, Unitraders Investments Pty Ltd (``Unitraders'') from judgments of a single judge of this Court. His Honour held that certain profits which GRE and Unitraders had made on the realisation of securities were assessable income. His Honour further held that certain profits derived by GRE from bonds, some of which were sold at a profit and others of which were redeemed at maturity, were not exempted from assessable income by the provisions of s. 23J of the Income Tax Assessment Act 1936 (Cth) (``the Act'').
On the principal issue, the profits derived on the disposition of securities, the learned trial Judge preferred to consider the matter in the light of the judgments delivered in
London Australia Investment Co Ltd v. FC of T 77 ATC 4398; (1976-1977) 138 C.L.R. 106 rather than in the light of the authorities which have dealt specifically with the assessment of the profits of insurance companies. Thus, his Honour held, in the case of Unitraders:-
``In my view, London Australia points strongly to the conclusion that the profits made by Unitraders in the present case are assessable.''
His Honour took this course partly because he considered there was a conflict between the judgments of Davies and Gummow JJ. in
FC of T v. Equitable Life and General Insurance Co Ltd; Equitable Life and General Insurance Co Ltd v. FC of T 90 ATC 4438 and those of Lockhart, Jenkinson and Gummow JJ. in
CMI Services Pty Ltd v. FC of T 90 ATC 4428. Gummow J. has since explained in
FC of T v. Radnor Pty Ltd 91 ATC 4689 at 4691-4692 that there was no conflict. The trial Judge also thought that Unitraders was removed from the ``taint'' of insurance business.
For our part, it seems preferable that the present case be looked at, at least in the first instance, within the context of the many authorities which have laid down the principles upon which the profits of an insurance company are brought to tax. Those principles are not in any way inconsistent with what was enunciated in London Australia. But London Australia had special features which, in its case, led to the conclusion that the taxpayer was carrying on a business of dealing in securities. See per Gummow J. in FC of T v. Radnor at 4692. In the case of an insurance company, that conclusion is ordinarily drawn because the taxpayer is carrying on an insurance business and because of the nature of that business.
Northern Assurance Co v. Russell (1889) 2 T.C. 571 at 577-578, the Lord President of the Court of Exchequer (Scotland) laid down for the guidance of the Commissioners of Inland Revenue five precepts for the assessment of the profits of an insurance company. The fifth precept was that ``Where the gain is made by the Company... by realising an investment at a larger price than was paid for it, the difference is to be reckoned among the profits and gains of the Company''. That precept was discussed by Latham C.J., Dixon and Williams JJ. in
Colonial Mutual Life Assurance Society Ltd v. FC of T (1946) 8 A.T.D. 137; (1946) 73 C.L.R. 604. At A.T.D. 144; C.L.R. 618, their Honours expressed the same view in these terms:-
``the sounder view is that profits and losses on the realisation of investments of the funds of an insurance company should usually be taken into account in the determination of the profits and gains of the business.''
The reason for this view is that the profits of insurance companies, as with the profits of banks, are derived from the investment of their circulating capital, as was pointed out by Latham C.J., Dixon and Williams JJ. in Colonial Mutual Life at A.T.D. 142-143; C.L.R. 615-616 and by Kitto J. in
The National Bank of Australasia Ltd v. FC of T (1969) 15 A.T.D. 220 at 224-225; (1968-1969) 118 C.L.R. 529 at 537. Jacobs J. expanded on this aspect in London Australia when his Honour said at ATC 4410; C.L.R. 129-130:-
``The nature of a banking or insurance business, as part of its putting of money as circulating capital to use, involves not only occasional acquisition of property in satisfaction of advances, as in the situation to which Kitto J. was referring, but also and more commonly the purchase and sale of various kinds of property whereby moneys which are obtained as part of the business but which form no part of the original
ATC 4092capital structure of the bank or insurance company, or of that structure enhanced by accumulated net profits, are put to use short term or long term. All profits arising from that activity are profits of the business of banking or insurance.''
The factors leading to the circumstance that an insurance company has a fund which may be described as circulating capital was adverted to in Equitable Life at 4446-4447 and in
RAC Insurance Pty Ltd v. FC of T 90 ATC 4737 at 4742 and in
Employers' Mutual Indemnity Assoc Ltd v. FC of T 91 ATC 4850 at 4862-4863. See also Hill J. at first instance in
FC of T v. Employers' Mutual Indemnity Association Ltd 90 ATC 4787 at 4796-4800. An insurance company ordinarily receives premiums in advance. In respect of any accounting period, it must allocate part of the premiums it has received to an unearned premiums reserve. Likewise, in respect of the period for which premiums have been earned, there must be a reserve to meet the liabilities arising out of that period which have not been met in that period. In Employers' Mutual Indemnity at 4863, Gummow J. referred on this point to
RACV Insurance Pty Ltd v. FC of T 74 ATC 4169;
Insurance Commissioner v. Associated Dominions Assurance Society Pty Ltd (1953) 89 C.L.R. 78;
In Re Capital Annuities Ltd (1979) 1 W.L.R. 170. An insurance company ordinarily earns profits from the investment of the funds held in these reserves. This is an ordinary incident of the business.
The business of GRE was no different from other insurance businesses in this respect. Thus, in the 1979 calendar year, its Australian premium income was $50,335,263, the provision for unearned premiums at the end of the year was $19,455,742 and the outstanding claims provision at the end of the year was $38,018,717. For the calendar year 1983, its Australian premium income for the year was $143,933,078. As at 31 December 1983, its provision for unearned premiums stood at $55,216,649 and its provision for outstanding claims stood at $93,740,072. These two provisions, which in 1979 totalled $57,474,459 and in 1983 totalled $148,956,721 were represented by funds which were circulating capital of GRE. In stating the matter thus, we oversimplify the accounts which were more complex than that. But we wish to emphasise that an insurance company must hold funds which represent the ever-changing position as premiums are received and are earned and as liabilities arise under policies or as time passes without that liability being incurred. Particular assets held do not represent the funds of a particular insurance but form part of the reserves of the insurance company reflecting the fact that premiums are received in advance and that the liabilities which arise during the period of the insurance may not be settled or even notified until after that period has expired.
Another aspect of insurance business pointing to the same end is the requirement stated in s. 29(1)(b) of the Insurance Act 1973 (Cth) that an insurance company should maintain the solvency margin there specified. On the funds representing this margin, it is also an ordinary incident of the business of an insurance company that the funds be invested for profit.
Thus, whether or not there be a profit in the underwriting account, and it is common for an insurance company to make a loss on underwriting, an insurance business will ordinarily show a profit overall taking into account the rents, the interest and the dividends received from the investment of funds and also the profits made on the disposition or the coming to maturity of investments.
GRE was a member of the worldwide Guardian Royal Exchange Insurance Group. Its investment activities were controlled by the Investment Department in London. It was the practice of the Investment Department, in February or March of each year, to set out in broad terms the financial position of the Australian operations including investment strategies. For example, such a memorandum published in February 1983 stated, inter alia:-
``5. INVESTMENT STRATEGY
The main aims are:
(i) To achieve an acceptable compromise between income and capital appreciation consistent with reasonable security of capital, in the context of the anticipated insurance results.
(ii) The maintenance of adequate liquidity and marketability due to the short-term nature of the liabilities.
(iii) To achieve the highest possible return consistent with the above.
Equities: 15-20% of new money will normally be directed to the purchase of equities. However, timing will be subject to market conditions. Emphasis should be on marketability.''
Prior to 1978, Unitraders was a wholly owned subsidiary of the Union Insurance Society Canton Ltd, another member of the group. In that year, GRE acquired all the shares in Unitraders for the sum of $2.5m. At the time of its acquisition, Unitraders held a portfolio of shares. The sum payable by GRE for the shares in Unitraders represented the net value of the assets of Unitraders at the time. Over a period of time, between October 1980 and January 1982, GRE sold to Unitraders all the equities which it, GRE, held in its investment portfolio. This course of action, the acquisition of the shares in Unitraders and the sale to Unitraders of all the equities held by GRE, so that Unitraders thereafter held all the shares which otherwise would have formed part of the investment portfolio of GRE, was undertaken for the sole purpose of ensuring that the benefit of the rebates on dividends for which s. 46 of the Act provided was retained. GRE was expecting to enter a period when it might have no taxable income. In this event, it would not obtain the benefit of the rebate on dividends for which s. 46 of the Act provided. That rebate is a rebate against tax payable.
After the acquisition of Unitraders and the sales to that company of the equities, there was no relevant change in the investment strategies and operations. Decisions to buy and sell continued to be made by the Investment Department in London. The group treated GRE and Unitraders as one. Unitraders had no separate premises or staff of its own but paid annual management fees to GRE.
The trial Judge considered that the activities of Unitraders were to be treated as separate from the insurance business. His Honour held:-
``In the present case Unitraders was a separate entity. It did not carry on the business of an insurer and was not licensed to do so. Its assets were not required by its parent to meet statutory solvency ratios or any other requirements under the Insurance Act. While doubtless Unitraders' assets were available as a last resort, the evidence does not show that they were treated in any way as a reserve for the purposes of GRE's insurance business. About all that can be said really is that the assets of Unitraders formed part of the corporate wealth which GRE presented to the world and therefore might have been likely to play some part in generating confidence in GRE as a substantial insurer.''
In our respectful opinion, however, the activities of Unitraders were an integral part of the insurance business conducted by GRE. Although the equities were held by the wholly owned subsidiary rather than by GRE directly, the equities indirectly formed part of the funds representing the insurance reserves and part of the circulating capital of the business. Just as the prudent management of the investment portfolio of an insurance company ordinarily requires that some proportion of equities be held as well as government securities, mortgages and debentures, so in this present case, it was always an element of the investment strategy that a proportion of equities be held. And that strategy continued, the proportion varying whenever it seemed prudent from an investment point of view to vary the mix.
As the reason for holding the equities in Unitraders rather than GRE was to enhance the profits, the after tax profits, of the insurance business, we are unable to regard the activities of Unitraders as being other than an integral part of the insurance business, whose profits were by this technique increased.
The relevant profits of GRE arising from its sales of equities to Unitraders were as follows:-
1981 $1,156,589 1982 $562,106
Because of losses in those years, these profits were carried forward for consideration in the 1983 year.
Unitraders derived profits from the sale of equities as follows:
1983 $429,282 1984 $320,167
We have already discussed the principle that the profits from the realisation of investments of an insurance company should usually be taken into account in the determination of its assessable income for taxation purposes. Of course, such profits are not invariably taken into account.
Brice v. Northern Assurance Co (1911) 6 T.C. 327, an appeal was abandoned there being findings of the Commissioners that it was not part of the business or trade of the company to deal in investments or to vary investments or to make profits by doing so, that investments were rarely realised and only for special reasons and that any profits or gains so derived were not taken into account for dividend purposes but were carried to the capital investment reserve fund or used in writing off depreciation on other securities. In National Bank of Australasia, Kitto J. held that profits derived on the sale of certain assets were not assessable income but were of a capital nature. The assets in question had arisen out of a capital merger between the National Bank of Australasia Ltd and a Queensland bank and it was surplus assets arising from that transaction of a capital nature that were disposed of. In
The Chamber of Manufactures Insurance Ltd v. FC of T 84 ATC 4315; (1984) 2 F.C.R. 455, Bowen C.J., Woodward and Northrop JJ. said at ATC 4318; F.C.R. 460 that ``funds of an insurance company invested in the construction of a building to be used as a head office by that company will probably not attract income tax if the head office is subsequently sold for a profit''. In London Australia at ATC 4410-4411; C.L.R. 130, Jacobs J. pointed out that ``in so far as the original capital or that capital enhanced by accumulated profits is laid out in investments in property and not in the business activity of banking or insurance, the investments will have the character of capital and profits or losses on a sale thereof will not be profits of the business of banking or insurance''.
These cases illustrate circumstances where profits of an insurance company derived on the realisation of investments may constitute non- assessable profits of a capital nature. Equitable Life itself applied this principle for, in that case, although the taxpayer had previously carried on a life insurance business, it had sold the business prior to the years in question and the share portfolio did not represent the circulating capital of such a business.
In the present case, there was no element of that character. It is true that $2.5m was paid or payable for the shares in Unitraders. But this did no more than represent the value of the underlying assets of Unitraders, a company which was already part of the Guardian Royal Exchange Insurance Group and which had been a wholly owned subsidiary of The Union Insurance Society of Canton Ltd. The evidence did not suggest that the purchase price or the subsequent loans which GRE made to Unitraders and which by the 1984 year amounted to $30m came from a capital fund as distinct from the premiums received and the circulating capital we have discussed.
Unitraders held the equities which it owned at the time of its acquisition by GRE and the equities it later obtained from GRE as ordinary assets used in the day-to-day operations of the insurance business. The interposition of the wholly owned subsidiary between GRE and the portfolio of equities was not a capital transaction such as was under consideration by Kitto J. in the National Bank of Australasia case.
It is true that the sales from GRE to Unitraders were not ordinary transactions in that the shares remained within the group. The equities were not sold by GRE to Unitraders because it was a prudent time to dispose of or realise the investments. Nevertheless, profits were made on the sales of assets that formed part of the circulating capital in the sense we have described. Because these profits arose from equities which had been held as part of the investment portfolio of the insurance business, the profits made were in that sense normal and ordinary profits of the insurance business.
That is not to say that Unitraders should not be considered as a taxpayer in its own right. It was such a taxpayer and its activities should be so considered. Nevertheless, the part which a subsidiary plays in affairs which concern its holding company, or in the group in which both companies form a part, may throw light upon the character of the activities of the subsidiary. Thus, in Radnor, it was considered relevant that the taxpayer company was an instrument through which the holding company performed its obligations as a trustee. See the remarks of Hill J., 91 ATC at 4700. See also the remarks of Hill J. in
AGC (Investments) Ltd v. FC of T 91 ATC 4180 at 4190. In the present case, Unitraders was introduced into the affairs of GRE solely to ensure that the benefit of the s. 46 rebate would not be lost in the event that underwriting losses brought GRE to the position that it had no taxable income. Unitraders was a separate entity from GRE but its activities reflected, indeed formed part of,
ATC 4095the overall business in which GRE was engaged.
We need not discuss at any length the contention that, once the equities were put into the name of Unitraders, they formed a separate fund and there was no real prospect that that fund would be called upon to meet deficiencies resulting from the carrying on of the insurance business. Similar arguments were rejected in Chamber of Manufactures Insurance Ltd v. FC of T; RAC Insurance Pty Limited v. FC of T and Employers' Mutual Indemnity Association Ltd v. FC of T. As in those cases, the facts of the present case do not show that the portfolio of equities was sufficiently dissociated from the ordinary and regular operations of the insurance business to comprise a capital asset having a character dissimilar from that of the circulating capital of such a business.
We therefore agree with the trial Judge that the subject profits of GRE and Unitraders were assessable income. We have not thought it necessary or useful to consider whether, absent its connection with the insurance business of GRE, the activities of Unitraders had characteristics of regularity, trading and profit- making such as to give a business character to those activities.
It is not necessary to deal with the ground of appeal that an affidavit sworn by Robert David Evans, which was rejected by his Honour, should have been admitted. That ground was not pressed. The affidavit did not seek to gainsay the point that the new arrangement was put into place to obtain the benefit of the s. 46 rebate and that the investment of the whole portfolio, whether of governmental securities, bonds and mortgages or of equity shares, was managed by the Investment Department in the United Kingdom which maintained the policy that it was desirable to have capital growth as well as income in the nature of interest and therefore that an appropriate balance should be maintained between equity and non-equity investments.
The final issue is whether GRE was entitled to the benefit of s. 23J which provided, inter alia:-
``(1) Subject to this section, no part of an amount received by a person upon the sale or redemption of eligible securities purchased or otherwise acquired at a discount on or before 30 June 1982, other than any part of that amount received as accrued interest, shall, for any purpose of this Act, be taken to be income derived by the person.
(2) Sub-section (1) does not apply in relation to an amount received by a person by virtue of a transaction that is part of, or is incidental to, the carrying on by the person of a business that includes buying and selling eligible securities of any kind.
(4) In this section, `eligible securities' means-
- (a) bonds, debentures, stock or other securities; and
- (b) any other document evidencing or acknowledging the indebtedness of a person, whether or not the debt is secured.''
GRE made the following profits from holding bonds to maturity and from realising bonds prior to maturity:-
1982 $ 286,573 1983 $1,082,183 1984 $1,738,182
The trial Judge held that the business of GRE included the buying and selling of eligible securities. His Honour said:-
``on the facts of the present case, it is clear that GRE did engage in selling bonds in the course of its business, and to a significant degree. For example, the table appearing earlier in this judgment reveals that in 1984 of the 52 bonds realised, 18 were sold and the value of those sales ($28.6 million) was about twice the value of bonds redeemed at maturity.''
It is not necessary to determine the ambit of the expression ``buying and selling'' in relation to transactions in bonds, debentures, stock and like securities. The matter was considered by Lee J. in
RAC Insurance Pty Ltd v. FC of T 89 ATC 4780 and by Hill J. in
Lend Lease Corporation Ltd v. FC of T 90 ATC 4401. No doubt there is a question whether the acquisition of securities by way of original subscription constitutes the ``buying'' of securities and whether the realisation of securities on maturity is an act of ``selling''. But s. 23J requires there be buying and selling and that that activity constitute or be a constituent part of a business. Once a business has been identified, the nature of the business
ATC 4096may well give to transactions in the course of that business the character of ``buying'' or of ``selling'' which, had the transactions occurred otherwise than in the course of the business, they might otherwise not have had.
However that might be, GRE bought and sold eligible securities and did so as an ordinary and regular incident of its insurance business. In these circumstances, the exemption did not apply.
Senior counsel for GRE submitted that the word ``business'' in s. 23J has a meaning other than the meaning given to it in the insurance cases to which we have adverted. But the transactions of an insurance company such as GRE are transactions of a business not because of a special principle of law but because the law recognises that the nature of the activities carried on by an insurance company gives the character of business dealing to the type of activity in which GRE was engaged.
We agree with the trial Judge that the s. 23J exemption did not apply.
For these reasons, the appeals should, in our opinion, be dismissed with costs.
THE COURT ORDERS THAT:
The appeals be dismissed with costs.