FC of T v CLARKE
Judges:Lockhart J
Neaves J
Lee J
Court:
Full Federal Court
Lockhart, Neaves and Lee JJ
The question in this case is whether a sum of $4,443 constitutes assessable income of Denys Andre Leon Lennox Clarke, the respondent, for the year of income ended 30 June 1988.
Mr Clarke retired as a teacher on 17 July 1987, the day before his 60th birthday. He received a lump sum payout from the State Superannuation Fund on 27 July 1987 which was invested in securities by way of roll-over. Of that sum $50,000 was paid to Capita Financial Group Limited (``Capita''), which carried on the business of life insurance, for the acquisition of a participating policy termed a ``Variable Income Annuity''. Under s. 4 of the Life Insurance Act 1945 a participating policy is defined as a policy by the terms of which the owner of the policy is entitled to a share in surpluses or profits which may be distributed by a body corporate carrying on life insurance business. (See also s. 4 - ``life insurance business'', ``policy'', ``life policy'', ``owner''.) Whether the policy in this case is a participating policy as so defined was not a question argued before us, and thus it does not fall for decision.
The term of the policy was five years. The annuity payments were $833.34 per month ($10,000 per year), a total of $50,000.
During the year ended 30 June 1988 Mr Clarke received annuity payments totalling $8,333. In addition, the sum of $4,443 with which this case is concerned was credited by Capita to his ``investment account'' (to which reference shall be made later) and described as ``interest''.
The Administrative Appeals Tribunal (constituted by Mr B J McMahon, Deputy President) held that the sum of $4,443 was income derived by Mr Clarke and correctly included in his assessable income. The Tribunal affirmed the decision of the Commissioner disallowing Mr Clarke's objection to his income tax assessment for the 1988 year.
On appeal to this Court [
Clark v FC of T 92 ATC 4136], Davies J. held that the sum of $4,443 did not represent income derived by Mr Clarke, set aside the decision of the Tribunal and ordered that there be substituted for that decision a decision remitting the matter to the Commissioner to reassess Mr Clarke's taxable income for the year ended 30 June 1988 on the basis that the sum of $4,443 was not income derived by him during the year; and his Honour ordered the Commissioner to pay the costs of Mr Clarke of the appeal. It is from this decision that the appeal is brought to this Full Court.
ATC 4563
Whether the sum of $4,443 constitutes income derived by Mr Clarke turns essentially on the construction of his contract with Capita, so it is necessary to set out its relevant terms.
Mr Clarke paid Capita $50,000 as the purchase price for the policy. In return he was to receive monthly payments of $833.34 for five years (i.e. $50,000): see the statement of ``Annuity Payments'' in the Schedule to the policy and conditions 1 and 5 which provide as follows:
``1. In consideration of the payment of the purchase price specified in the schedule, Capita Financial Group Limited (hereinafter called `Capita') will provide the annuity payments and other benefits described herein.
This policy is an annuity certain policy and consists of the schedule and these Conditions.
...
5. Subject to the Conditions of this policy, Capita will pay to the annuitant(s), in accordance with details in the schedule, the annuity payments specified therein.
If at any time Capita is required to deduct income tax or other amounts from any or all of the annuity payments then such deductions will be made and the net amount paid as above.''
The $50,000 was to be credited to an account styled an investment account. Condition 8 provides:
``8. The purchase price paid will be credited to the Investment Account on the day received by Capita.''
The ``Investment Account'' is not an expression defined in the policy, but condition 7 provides:
``7. Capita will, in respect of this policy, maintain an Investment Account and a Capital Growth Account.''
What is described as an ``Important Note'' to the policy states as follows:
``The conditions of the policy provide for interest to be credited to the Investment Account at the end of each year. The basis on which the interest rate is calculated is defined in the policy. It is Capita's current practice to declare a minimum guaranteed interest rate each year which will apply for the following year.
The amount of interest actually credited in a given year will be at least the amount which would be credited if the minimum guaranteed interest rate applied for the year.''
In addition to receiving the monthly annuity payments, Mr Clarke was entitled to have interest credited to the Investment Account each year, as appears from the ``Important Note'' just mentioned. See also Conditions 15 and 16 of the policy which are in the following terms:
``15. Allocations of surplus to this policy will be primarily in the form of interest on the Investment Account, calculated on the daily balance and compounded annually at a rate declared by Capita each year on the advice of its Actuary less the ongoing expense charge referred to in Condition 11.
16. The rate of interest referred to in Condition 15 will be not less than 85% of the rate of investment income (exclusive of capital growth) earned by Capita in the relevant year, with respect to the appropriate class of business and net of all taxes, on the relevant asset portfolio within the Statutory Fund applicable to policies of this type. Capita may elect to apply the declared rate to a year ending up to four months later than that for which the earned rate was determined.''
Capita has the right to allocate ``further surplus'' by way of allocations to the Capital Growth Account: see clause 17 which is in the following terms:
``17. Capita may, in addition, allocate further surplus to this policy by way of allocations to the Capital Growth Account or by any other method which its Actuary certifies as equitable. Allocations previously made to the Capital Growth Account may be cancelled or reduced by Capita on the advice of its Actuary.''
ATC 4564
Condition 6 provides for an ``annuity review'' in these terms:
``6. The person holding title to this policy may, within three months prior to the next review date specified in the schedule, notify Capita in writing of revised annuity payment details and a new next review date. The revised details will, subject to Capita's agreement, be effective from the next review date previously applicable.''
Condition 9 deals with the application of the annuity payments in these terms:
``Each annuity payment will be debited proportionally between the balances of the Investment Account and the Capital Growth Account on the date the payment becomes due.''
Certain expenses and charges are dealt with in Conditions 10, 11, 12, 13 and 25 in the following terms:
``10. Administration charges (consisting of the initial expense charge and the policy fee specified in the schedule, varied from time to time, in accordance with Conditions 12 and 13) will be debited to the Investment Account on the policy commencing date and monthly thereafter.
11. An ongoing expense charge will be debited to the Investment Account by deducting 0.72% from the rate of interest referred to in Condition 15.
12. On each anniversary of the policy commencing date, the policy fee then current will be multiplied by a factor, determined by Capita, not exceeding the ratio of `current index' to `previous index'. `Current index' means the consumer price index published by the Australian Bureau of Statistics for a quarter, determined by Capita, ended not more than nine months before the date as at which the current index is to be used, and `previous index' means the corresponding consumer price index for the quarter one year earlier. However, if the previous index exceeds the current index, it will be taken as equal to the current index.
If the consumer price index ceases to be published regularly or ceases to be determined on a consistent basis Capita may substitute any other index as it may then determine.
13. Capita may vary the basis of the policy fee at any time provided it has given at least three months' notice in writing to the policyowner and provided the amounts applicable thereafter are no higher than would be charged for a similar new policy issued at the date of such variation.
...
25. Capita may vary the rate of ongoing expense charge in Condition 11 provided that the revised rate is no more than 1.5%.''
Condition 14 states that the policy is a participating policy and is entitled to share in distributions of surplus made by Capita.
Conditions 20 and 21 relate to the termination of the policy and they provide:
``20. This policy will terminate if at any time its cash value is negative.
21. At the end of the policy term this policy will terminate.''
Conditions 22 and 23 deal with the benefits payable on termination of the policy in the following terms:
``22. On termination of this policy at any time other than in the circumstances described in Condition 20, the benefit payable will be the policy's cash value at the date of termination.
23. Payment of a benefit in terms of Condition 22 will be in full satisfaction of any liability of Capita under this policy.''
Condition 24 refers to an annual statement to be sent to the policyowner in the following terms:
``24. Once each year a statement will be prepared and sent to the policyowner showing:
- (a) amounts credited and debited to the Investment Account and Capital Growth Account since the previous statement,
- and
- (b) the balances of the Investment Account and the Capital Growth Account
ATC 4565
at the end of the period to which the statement relates.''
Condition 18 relates to the cash value of the policy; it provides as follows:
``18. The cash value of this policy at any time is:
- (a) the balance of the Investment Account
- plus
- (b) the balance of the Capital Growth Account
Provided that Capita may vary or suspend this basis of determining the cash value subject to such terms and conditions as the Life Insurance Commissioner may think fit, if in the Commissioner's opinion the basis described above would be prejudicial to the financial stability of Capita or to the interests of the policyowner(s) of Capita.''
Davies J. held [at ATC 4140] that Mr Clarke's entitlement to the $4,443 was conditional in the sense that the operation of condition 18, which his Honour regarded as important, might mean that:
``the cash value of the policy may be reduced if, in the opinion of the Life Insurance Commissioner, the benefits provided in the policy would be prejudicial to the financial stability of Capita or to the interests of the policyowners of Capita. If Capita's Statutory Fund No. 1 suffered a loss, the condition could operate. Moreover, if the annuity were increased, any sum credited to the accounts could be taken out by way of annuity and not received by way of an increase to the cash value of the policy payable on termination. The position was analogous to that of the accounts maintained in the superannuation fund considered in
Constable v. FC of T (1952) 10 A.T.D. 93; (1952) 86 C.L.R. 402, in which Dixon C.J., McTiernan, Williams and Fullagar JJ. said at A.T.D 96; C.L.R. 418:`The fund existed as one to a share in which he (the superannuant) had a contractual, if not a proprietary, title. His title was future, and indeed contingent or, at all events, conditional.'
Similarly, in
Read v. The Commonwealth (1987-1988) 167 C.L.R. 57 at 67, Mason C.J., Deane and Gaudron JJ. said, `Until a gain is realized it is not "earned, derived or received".'Thus, the sum of $4,443 credited to the investment account in May 1988 was not derived by Mr Clarke during the year of income. It was not received in fact and was not derived in the circumstances for which s. 19 of the Income Tax Assessment Act provides, as s. 26AH(5) recognises.''
Counsel for the Commissioner argued that this finding of Davies J. was erroneous.
Counsel for the Commissioner argued that condition 18 did not deny that Mr Clarke had become entitled to the amount in the Investment Account; it simply provided for a circumstance in which that entitlement might later be defeated. It was not a condition precedent to entitlement. Counsel sought to distinguish the cases of Constable and Read.
Counsel for Mr Clarke contended that Davies J. was correct in holding that the sum of $4,443 credited to the investment account was not an amount paid to or received by Mr Clarke during the year of income and was not income derived by him in that year. Counsel argued that it was incorrect to treat credits and debits by Capita to an account in its books as debits and credits to Mr Clarke. Mr Clarke was not credited in fact with the amount of $4,443. A credit entry was made by Capita to one of the two accounts maintained in its books in respect of the policy, as part of the process of calculating the amount, if any, which might be paid to Mr Clarke on termination of the contract at some later time, after the end of year of income. It was argued that, in the circumstances, Mr Clarke was not entitled to the amount of $4,443 and the amount was not derived in the year of income ended 30 June 1988 pursuant to either s. 25 or s. 19 of the Income Tax Assessment Act 1936 (``the Act'').
Under the terms of the policy Capita promised to pay to Mr Clarke during the currency of the policy until its termination fixed monthly payments of $833.34 each (making a total of $50,000), thus corresponding to the amount paid by him for the purchase of the
ATC 4566
policy. Capita also promised to pay Mr Clarke upon termination of the policy an additional sum, namely, the policy's cash value at the date of termination (conditions 18, 22 and 23). Capita was required to maintain two accounts: an investment account and a capital growth account (condition 7). The purchase price was to be credited to the investment account on the day of its receipt from Mr Clarke (condition 8); and each annuity payment was to be debited proportionally between the two accounts (condition 9). Expenses and administration charges were to be debited to the investment account (conditions 10, 13 and 25); and allocations of surplus were to be credited to the investment account (conditions 14, 15 and 16).Thus, during the life of the policy there was to be a series of credits and debits made by Capita in its accounts which on the termination of the policy (otherwise than pursuant to condition 22) would give rise to an entitlement in Mr Clarke to receive a net amount from Capita. Until that time Mr Clarke had no entitlement to receive from Capita any moneys except the monthly payments of annuity of $833.34 each. Upon the termination of the policy there would be in effect a taking of accounts by Capita with a balancing of the benefits against the administrative and other expenses, producing a final figure as the policy's cash value at the date of termination, a figure which could not be ascertained prior to that time. Mr Clarke was not entitled to receive any of the gross amounts credited by Capita to either the Investment Account or the Capital Growth Account, nor was he under an obligation or liability to pay to Capita any of the amounts debited. Nor was the amount of $4,443 credited to Mr Clarke.
Capita issued to Mr Clarke an annual statement for the year ending 30 April 1988 which so far as material was in the following terms:
" Savings/Investment Capital
Account Growth
Account
Balance As At 28/07/87 0.00 0.00
Credits
Purchase Price 50000.00
Interest To 30th April 1988 4443.67
Capital Growth To 30th April 1988 1369.85
Debits
Initial Expense Charge 2500.00
Administration Charge 35.00
Withdrawals 7500.06 0.00
The Initial Expense Charge Is A
Once Only Charge Debited On Each
Purchase Price Received
Balance With Interest To 30th
April 1988 44408.61 1369.85
The Annuity Payments You Received May Be Less Than The Total Shown
Due To Tax Being Deducted And Forwarded To The Taxation Department"
The credit shown against the Savings/ Investment Account of $4443.67 and described as interest to 30 April 1988 was a book entry made by Capita, but that amount could not nor could any other amount, be called for by Mr Clarke from Capita. The book entries constituted a series of notional credits and debits, the purpose of which was to produce at
ATC 4567
the end of the policy's life a figure payable by Capita to Mr Clarke in accordance with conditions 22 and 23.It is helpful to remember what was said by Dixon J. in
C of T (SA) v Executor Trustee &c Co of SA Ltd (1938) 5 ATD 98 at 132; (1938) 63 CLR 108 at 155:
``Speaking generally in the assessment of income the object is to discover what gains have during the period of account come home to the taxpayer in a realised or immediately realisable form.''
In our opinion it is erroneous to describe the credit of the $4,443 in the Investment Account as income which ``came home'' (to use the language of Dixon J. in Carden's Case) to Mr Clarke during the year of income.
Nor is it correct to describe the $4,443 as income derived by Mr Clarke during the year of income within the meaning of s. 19. Rich J. said in
Permanent Trustee Co v FC of T (1940) 6 ATD 5 at 12-13, with respect to s. 19 of the Income Tax Assessment Act 1922 which, so far as presently relevant, is in substantially the same terms:
``The object [i.e. of s. 19] is to prevent a taxpayer escaping tax though his resources have actually been increased by the accrual of the income and its transformation into some form of capital wealth or its utilisation for some purpose.... But here the facts show that the deceased got nothing except a new obligation to pay in exchange for an existing obligation to pay. He was no nearer getting his money or of transferring it into anything of any value.... To see whether income has been derived one must look to realities.''
This passage was cited with approval by Gibbs J. in
Brent v FC of T 71 ATC 4195 at 4201; (1971) 125 CLR 418 at 430. His Honour said at ATC 4200; CLR 427-428:
``The Act does not define the word `derived' and does not establish a method to be adopted as a general rule to determine the amount of income derived by a taxpayer, although particular situations not relevant to the present case are dealt with. The word `derived' is not necessarily equivalent in meaning to `earned'. `Derive' in its ordinary sense, according to the Oxford English Dictionary, means `to draw, fetch, get, gain, obtain (a thing from a source)'. It has become well established that unless the Act makes some specific provision on the point the amount of income derived is to be determined by the application of ordinary business and commercial principles and that the method of accounting to be adopted is that which `is calculated to give a substantially correct reflex of the taxpayer's true income'...''
In no sense can it be said that Mr Clarke derived the sum of $4,443 during the year of income. He had a contractual right which required Capita to adhere to its obligations of crediting the Investment Account at the end of each year with the appropriate amount of interest and of crediting the Investment Account and the Capital Growth Account with various monies in accordance with the conditions of the policy. Capita was entitled to debit the Investment Account with various administrative charges, but until the termination of the policy Mr Clarke had no rights to receive or to have held on his behalf any monies except the annuity payments.
By condition 6 of the policy Mr Clarke, or a successor annuitant, could attempt to obtain a benefit from attached bonuses by notifying Capita of the wish to receive a revised annuity payment of an increased amount. Only if Capita agreed to such a request would a revised annuity payment become payable and entitlement to the payment of any part of a credited sum crystallize. Upon the receipt of such a revised annuity payment the amount of the undeducted purchase price of the annuity would need to be determined (see s. 27H). The amount of assessable income received would then be calculated.
Until such an event occurred, or the policy was terminated, Mr Clarke held no more than the expectation of a benefit. The account maintained by Capita recognized that expectation but did not in itself ``bring home'' to Mr Clarke the amount of the bonuses credited or attached to his policy.
ATC 4568
We would dismiss the appeal with costs.
THE COURT ORDERS THAT:
1. The appeal be dismissed.
2. The appellant pay the costs of the respondent of this appeal.
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