COMMERCIAL UNION AUSTRALIA MORTGAGE INSURANCE COMPANY LIMITED v FC of T
Judges:Lindgren J
Court:
Federal Court of Australia
Lindgren J
Introduction
The applicant (``CUAMIC''), being dissatisfied with an appealable objection decision of the respondent (``the Commissioner''), appeals to the Court in exercise of its right of appeal given by s 14ZZ of the Taxation Administration Act 1953 (``TAA''). The decision in question is a decision of the Commissioner made on 27 June 1995 disallowing CUAMIC's objection dated 23 December 1994 against the Commissioner's assessment of the taxable income of CUAMIC for the year ended 30 June 1993. CUAMIC complains that the Commissioner has wrongly included in its assessable income for that year a sum of $3,249,612. CUAMIC has the burden of proving that the Commissioner's assessment is excessive: TAA s 17ZZO(b)(i).
Facts
At all material times CUAMIC carried on an insurance business in Australia. It did so pursuant to an authority granted under the Insurance Act 1973. More than 99% of its business is in the nature of ``mortgage insurance'': it indemnifies mortgagees against the risk of loss. Although the risk of loss extends over the term of a mortgage, CUAMIC receives the whole of the premium ``up front'', that is to say, prior to or during the first year of the term of the mortgage.
For accounting and income tax purposes, mortgage insurers such as CUAMIC ``apportion'' premiums received so that they are treated as being earned, not in the year of receipt, but progressively over the term of the mortgage (or over part of that term - a qualification which I will henceforth ignore). In general, a premium is treated as being earned by reference to the extent of exposure to risk in the respective years of the term of the mortgage.
The respondent Commissioner is not the only authority interested in the system of apportionment adopted by an insurer. So is the Insurance and Superannuation Commission. As well, Approved Accounting Standard ASRB 1023 (``Financial Reporting of General Insurance Activities'') issued by the Accounting Standards Review Board addresses the subject.
By letter dated 16 October 1985 from the Insurance Commissioner (the predecessor of the Insurance and Superannuation Commission) to CUAMIC (then called ``Australian Mortgage Insurance Corporation Limited''), the Insurance Commissioner, pursuant to s 24 of the Insurance Act 1973, authorised CUAMIC to carry on insurance business conditional on, inter alia, the following term:
``(4) That in relation to mortgage guarantee business the body corporate make in its accounts provision for unearned premiums of an amount that is not less than the amount that results from:
- • in the case of mortgage guarantee insurance contracts with a term in excess of 10 years, the apportionment of premium income over a period of 11 years or more on a basis calculated to reflect expected claims incidence and cost over the said term and approved by the Commissioner;
- • in all other cases, the apportionment of net premium income equally over the life of the policy.''
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Paragraph 9 of ASRB 1023, issued in December 1990, is as follows:
``9. Over the period of insurance, premium revenue shall be brought to account in accordance with the pattern of the incidence of risk or, where the result will not be materially different, evenly over the period of the policy (for direct insurance) or period of indemnity (for reinsurance).''
For the four years of income ended 30 June 1989, 1990, 1991 and 1992, CUAMIC had accounted for the earning of premiums over the respective years of a mortgage on the basis of an estimated exposure to risk which is indicated by the percentages under the heading ``Existing Basis'' in the table below (``the Existing Basis'' and ``the Table'' respectively). However, a firm of consultants and actuaries named ``Trowbridge Consulting'' (``Trowbridge''), which was retained by CUAMIC early in 1993 to review the Existing Basis, reported to CUAMIC on 10 February 1993 that analysis of CUAMIC's claims experience over the preceding 11 years (1982 to 1992 inclusive) indicated that the spread of risk differed from that indicated by the Existing Basis. Trowbridge reported that the spread of risk was more accurately reflected by the percentages appearing in the Table under the heading ``Recommended Basis'' (``the Recommended Basis''):
`` THE TABLE
Recommended Existing
Year Basis Basis
1 10% 8.0%
2 22% 16.7%
3 26% 15.1%
4 23% 13.4%
5 11% 39.8%
6 2% 2.0%
7 2% 1.7%
8 2% 1.3%
9 1% 1.0%
10 1% 0.7%
11 - 0.3%''
As can be seen, and as Trowbridge pointed out in its report, the main change recommended was that more of the premium should be treated as being earned in years 2, 3 and 4 and less in year 5.
The issue which divides the parties is this: CUAMIC contends that the Recommended Basis is applicable, not only to premiums received during the year ended 30 June 1993, but also to premiums which had been received in earlier years and had not, by 30 June 1992, been treated as having been fully earned.
As can be seen from the Table, the differences between the ``Existing Basis'' and the ``Recommended Basis'' for years 1 and 6 to 11 are not great. But they are for years 2 to 5. Under the ``Existing Basis'' 45.2% of the premium received is treated as being earned in years 2, 3 and 4, but under the Recommended Basis 71% of a premium is treated as being earned in those years. Let it be assumed that the year ended 30 June 1993 is the fifth year of a mortgage. According to the Existing Basis, 39.8% of the premium originally received is treated as earned in that year and only 53.2% as having been earned in previous years. But according to the Recommended Basis, only 11% of the premium is treated as being earned in that year and 81% is treated as having been earned in previous years.
CUAMIC contends that, in the given illustration, for the year ended 30 June 1993 its assessable income would include only 11% of the premium which had been originally received, even though only 53.2% rather than 81% of that premium would have been returned as assessable income in earlier years. The difference of 27.8% would escape the tax net unless the Commissioner was entitled to issue, and did issue, amended assessments in respect of those earlier years.
Richard Gerald Nott, the General Manager of CUAMIC, who joined the company on 28 October 1991, gave evidence that CUAMIC's claims experience (he was a signatory of cheques and of ``authorities to pay'' ) had suggested to him that the incidence of claims was higher during the early years of the term of a mortgage and decreased over time, and that this difference might not have been adequately reflected in the Existing Basis. He said that his experience had prompted him to join with CUAMIC's chairman of directors in retaining Trowbridge in early 1983 to review the position.
The first page of Trowbridge's report was as follows:
``You have asked us to review the `spread of risk' component of the premium earning method used for residential mortgage insurance by Commercial Union Australia
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Mortgage Insurance Corporation (CUAMIC).We understand that you are considering changing the basis currently used by CUAMIC in preparing its accounts, and that the change would also apply for income tax purposes. We also understand that you will need the ISC's approval before making any change.
Summary of Conclusions
Our analysis of CUAMIC'S claims experience over the last eleven years indicates that the existing spread of risk basis is conservative.
In our opinion, the nature of mortgage insurance business makes it appropriate that premiums be earned in a conservative manner. The degree of conservatism is, necessarily, a matter for judgement.
On the basis of our investigation of the claims experience and our knowledge of residential mortgage insurance, we believe a change in CUAMIC's spread of risk basis is justified, and we recommend the basis shown in Table 1 below.''
There followed in the report the Table.
After receiving Trowbridge's report dated 10 February 1993, CUAMIC decided, in March 1993, to adopt the Recommended Basis. On 27 April 1993 Mr Ian Parmenter, the then chairman of directors of CUAMIC, met with the Deputy Commissioner of the Insurance and Superannuation Commission (``the Commission''). The Commission gave its approval to CUAMIC's use of the Recommended Basis by a letter dated 27 April 1993. Apparently, due to an oversight, one aspect of the approval remained to be clarified and this was attended to in a subsequent letter dated 26 August 1993 from the Commission.
In its financial report for the year ended 30 June 1993, CUAMIC showed the amount of $3,249,612 referred to earlier as an abnormal operating profit item. (The report showed $3,293,000 rather than $3,249,612 but the discrepancy, apparently arising from a currency exchange rate difference, can be ignored.) CUAMIC included the amount in controversy ($3,249,612) in its income tax return for the year ended 30 June 1993 as part of an amount of $13,575,064 representing premium income earned in that year, rather than $10,325,452 which, however, it contends is the correct figure arrived at for that year in accordance with the Recommended Basis.
Two further factual matters remain to be noted. Firstly, by an earlier report dated 27 August 1992 to CUAMIC, Trowbridge had recommended use of the Existing Basis. In that report, Trowbridge had referred to paras 23, 43 and 44 of Taxation Ruling IT 2663 (see later) as requiring a spread of the kind referred to in the Existing Basis ``to be used consistently provided it is soundly based and produces reasonable results''. The report stated that CUAMIC had supplied it with an analysis of its claims experience for the seven financial years to 1987/1988; that it was clear from that experience that most of the claim activity occurred in the first few years of a mortgage; that Trowbridge had analysed the CUAMIC experience in order to calculate the average spread of risk observed in the period of experience available; and that its conclusion was as follows:
``The spread of risk adopted by CUAMIC is supported by the company's own claims experience, in particular the reduced spread after year 5. It still maintains a prudent bias relative to the past experience, which we believe to be appropriate in view of the uncertainties with this business.
We are satisfied that the spread of risk adopted is reasonable and soundly based, and that it would be appropriate for each of the years under review with the implementation of IT 2663.''
In cross-examination, Mr Atkins of Trowbridge confirmed that the paragraph last quoted above had correctly stated his position at the time of the writing of Trowbridge's earlier report dated 27 August 1992. In re-examination he said that by the time of his second report he had available to him ``claims information from 1988 complete through to 1992'' which he had not had when writing his earlier report.
The second factual matter referred to above is that although CUAMIC received Trowbridge's report dated 10 February 1993 shortly after its date and resolved in March 1993 to adopt the Recommended Basis, its return of income dated 9 May 1993 for the year ended 30 June 1992 was founded on the Existing Basis. Mr Nott explained that because of the outstanding issue referred to earlier on
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which the approval of the Insurance and Superannuation Commission was still awaited as at 9 May 1993, CUAMIC had not been entitled to utilise the Recommended Basis until that approval was given (on 26 August 1993).Outline of submissions
Outline of CUAMIC's submissions
The sole issue is what CUAMIC's assessable income was in the year ended 30 June 1993. The answer is to be arrived at by inquiring whether the abnormal profit of $3,249,612 made by CUAMIC as a consequence of the change in the actuarial basis of calculating its unearned premium accounts as at 1 July 1992 ought to have been included in its assessable income.
Taxable income and income tax are assessable in respect of a particular year of income regarded in isolation and not by combining the results of more than one year (CUAMIC refers to
Henderson v FC of T 70 ATC 4016 at 4018, 4019; (1970) 119 CLR 612 at 647, 649). The derivation of income is identified according to the ``general understanding among practical business people of what constitutes a derivation of income'' and according to ``the vocabulary of business affairs'' (CUAMIC cites
Arthur Murray (NSW) Pty Ltd v FC of T (1965) 14 ATD 98 at 99-100 and 101; (1965) 114 CLR 314 at 318 and 320 respectively) and ``the principles recognised or followed in business and commerce'' (it refers to
Commissioner of Taxes (SA) v The Executor Trustee and Agency Company of South Australia (Carden's case) (1938) 5 ATD 98 at 130; (1938) 63 CLR 108 at 152). The amount of income derived by CUAMIC in any given year of income is that which reflects the risk borne in that year, and on the evidence, the amount of $3,249,612 reflects exposure to risk in years preceding the year ended 30 June 1993.
Outline of Commissioner's submissions
Once CUAMIC had adopted, as it did, the Existing Basis as reasonable and sound, it was not permissible for it to depart from it retrospectively, although it might do so for the future, that is to say, in respect of premiums received in and after the tax year ended 30 June 1993, being premiums no part of which had been returned as assessable income in earlier years. The Existing Basis complied with condition 4 of CUAMIC's earlier authority from the Insurance Commissioner dated 16 October 1985.
Reasoning
It is convenient at the outset to refer to the distinction between the ``receipts'' or ``cash'' basis and the ``accruals'' or ``earnings'' basis of the derivation of income. Questions can arise as to which provides the appropriate basis on which to identify income derived by a taxpayer (cf Carden's case, supra; Arthur Murray (NSW) Pty Ltd v FC of T, supra), particularly when a taxpayer changes from one basis to another. The ``change of basis'' situations can be illustrated as follows:
Year 1 Year 2
Cash --> Accruals Amounts earned in year 1 and received
basis basis in year 2 are not assessable income in
either year: Henderson v Federal
Commissioner of Taxation, supra.
Amounts received in year 1 and earned
in year 2 (``prepayments'') are
assessable income in both years:
Country Magazine Pty Ltd v Federal
Commissioner of Taxation (1968) 117
CLR 162; and cf (1956) 7 Commonwealth
Taxation Board of Review (NS) Case 45.
Accruals --> Cash Amounts earned in year 1 and received
basis basis in year 2 are assessable income in
both years: Income Revenue
Commissioners v Morrison (1932) 17 TC
325.
Amounts received in year 1 and earned
in year 2 (``prepayments'') are not
assessable income in either year.
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The present case does not involve a change of either kind referred to above, since income has, throughout, been treated as being derived according to the accruals or earnings basis. The relevant change is from one accruals or earning basis to another for the purpose of better identifying when and in what amounts, premium is earned.
Section 17 of the Income Tax Assessment Act 1936 (``the ITAA'') levies income tax for each ``financial year'' ``upon the taxable income derived during the year of income'' by a person. Sub-section 6(1) defines ``taxable income'' to mean, relevantly, ``the amount remaining after deducting from the assessable income all allowable deductions'' and ``assessable income'' to mean ``all the amounts which under the provisions of [the ITAA] are included in the assessable income''. Sub- section 25(1) provides that the assessable income of a taxpayer that is a resident (such as CUAMIC) includes the gross income derived directly or indirectly from all sources, whether in or out of Australia. Neither the word ``income'' nor the word ``derived'' is defined.
It is common ground (a) that the whole of any premium received by CUAMIC in any particular year is assessable income (I will not distinguish between ``gross premium income'' and ``net premium income'' and will ignore refunds of premium); (b) that an ``accruals'' or ``earnings'' basis rather than a ``receipts'' or ``cash'' basis provides the appropriate means of identifying what part of a premium received is derived in a particular year of income; and, as a result of (a) and (b), (c) that ultimately there will be no discrepancy between the amount of premium received and the amount of premium that will have been earned.
Section 17 of the ITAA requires the amount of premium ``derived'' during each year of income to be ascertained. The question posed here is which of two competing approaches is ``appropriate'' or ``calculated'' ``to give a substantially correct reflex of the taxpayer's true income'' for the year ended 30 June 1993 (Carden's case, supra at ATD 131; CLR 154 per Dixon J).
I will refer to the two competing approaches as ``the Commissioner's approach'' and ``CUAMIC's approach''. According to the Commissioner's approach, the starting point is the receipt of a premium in year 1. What section 17 requires to be ascertained is that part of that premium that corresponds to the incidence of risk in that year, the remainder being, in effect (and no doubt in accounting practice), carried to an ``unearned premium account'' to be earned in subsequent years. According to the Commissioner's approach, once the part earned in year 1 is ascertained and brought to tax, then subject only to any review or appeal relating to the assessment, ``the die is cast'' in respect of subsequent years to this extent: the whole of the amount carried to the unearned premium account is irrevocably destined to be earned, and therefore derived, in year 2 and subsequent years. In year 2, some part of the amount standing to the credit of the unearned premium account will be treated as earned in that year and, accordingly, will be transferred to a ``premium earned account'' and returned as assessable income and taxed. The balance remaining in the unearned premium account will remain irrevocably destined to be earned, and therefore derived, in year 3 and subsequent years. According to the Commissioner's approach, it is not possible for tax purposes, for the amount standing at any time to the credit of the unearned premium account to cease to be destined to be earned, and so derived, as income in the current year or subsequent years by being treated retrospectively as having been already earned, and so derived, in earlier years.
According to CUAMIC's approach, all that matters is the percentage of incidence of risk in any particular year looked at in isolation. CUAMIC's approach must accommodate the proposition that there is no limit to the number of possible changes for income tax purposes in the basis of apportionment of the earning of premium over the years of the term of a mortgage, except one imposed by the availability of ``new information''. Any apportionment of a premium received must, of course, distribute the whole amount of the premium. But, according to CUAMIC's approach, the amount allocated to any particular year may be changed from time to time, even after it has been returned as assessable income and tax has been paid on it, the correctness of the amount allocated being always contingent on better information not becoming available.
(According to both CUAMIC's and the Commissioner's approaches, any credit balance in an unearned premium account is earned once the mortgage insurance policy ceases to expose CUAMIC to risk, such as where a claim under
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the policy is met by CUAMIC, but I need not discuss this aspect further.)In my view, the Commissioner's approach is to be preferred and CUAMIC's approach should be rejected. However, before I give my reasons for this conclusion, I will refer to certain aspects of the evidence. Two evidentiary matters are noteworthy. Firstly, the various documents relied upon by CUAMIC speak of the setting aside of part of the premium for the future and of consistent adherence to a pattern of incidence of risk, as distinct from an isolated apportioning of risk each year during the subsistence of a policy. Secondly, evidence given by Messrs Nott of CUAMIC and Atkins of Trowbridge does not alter that limited nature of the evidence led by CUAMIC.
The following documents may be noted. The Insurance Commissioner's letter of approval dated 16 October 1995, condition 4 (quoted earlier) required the making of ``provision'' in CUAMIC's accounts ``for unearned premiums'' on a basis calculated to reflect ``expected'' claims incidence and cost. It may be that it would not be inconsistent with the concern evinced by this requirement if the amount standing to the credit of an unearned premium account at any time or times were reduced, provided there always remained a balance reflecting expected claims incidence and cost over the remainder of the term of a policy. The fact is, however, that condition 4 goes only so far as to provide for a once and for all apportionment in year 1 extending over the term of the policy by reference to the expected claims incidence and cost over that term. Similarly, there is nothing in Trowbridge's reports dated 27 August 1992 and 10 February 1993 or in the Insurance and Superannuation Commission's approval of the Recommended Basis suggesting a departure from that concept.
Paragraph 9 of ASRB 1023 (quoted earlier) refers to a bringing to account of premium revenue ``in accordance with the pattern of the incidence of risk'' (emphasis supplied). This suggests that a pattern is to be laid down in respect of a premium received for the year of receipt and future years and adhered to.
In CUAMIC's letter dated 13 July 1989 to the Insurance and Superannuation Commission, after outlining its method of calculating ``unearned premium provision for residential mortgages'' being the respective parts of premium to be earned in years 2 to 11 inclusive, CUAMIC said this:
``We intend to apply this method in our Accounts as at 30 June 1989. We will not however go back and recalculate the earlier years, thus for example the unearned provision for the premiums written in 1987/88 will be brought forward on the basis as used in that year's Accounts.''
This statement was made as part of CUAMIC's application for approval of the Existing Basis. On 21 July 1989, the Insurance and Superannuation Commission approved of the method of calculation outlined in that letter. So far as the evidence reveals, when applying for the Commission's approval of the Recommended Basis in 1993, CUAMIC neither expressed nor disavowed a similar intention. At least this can be said: the Commission cannot be taken to have approved of CUAMIC's not continuing to bring forward to be earned any part of the unearned premium account. The approval is consistent with the utilisation of the Recommended Basis only for premiums received in the 1992/1993 year and later years.
Finally, CUAMIC relies on various statements to be found in Ruling IT 2663, ``Income Tax: Basis of Assessment of General Insurance Activities'' dated 20 December 1991 which is applicable to all income years commencing with the 1991/1992 income year. It seems appropriate to set out paras 23, 43 and 44 on which CUAMIC relies:
``23. If:
- (a) the risk insured against is not evenly spread over time; or
- (b) a general insurer consistently adopts a basis for calculating its UPP for accounting purposes different from the 365ths or daily basis,
the basis consistently used for calculating UPP for accounting purposes is also to be adopted for income tax purposes in apportioning premium income of a year, provided that the accounting basis of calculation is soundly based and produces a reasonable result.
...
43. Because the `365ths' or `daily' method is more accurate than the old 40% method and is likely to more accurately reflect a general insurer's true income, it is to be
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adopted for income tax purposes if the insurer consistently adopts the `365ths' or `daily' method from year to year for its commercial accountancy purposes. Once adopted for income tax purposes, that method is to be used consistently:
- (a) from one income year to the next; and
- (b) across all lines of general insurance business, unless the insurer can demonstrate that it is commercially impracticable to do this.
44. If the risk exposure of particular general insurance policies is not evenly spread over time, the `365ths' or `daily' method would not be appropriate. If, for accounting purposes, a soundly based method of apportionment has been consistently used from year to year, that method is to be used for income tax purposes, provided that it produces a result which truly reflects the extent to which the insurer is exposed to risk in the income years concerned. The method, once adopted for income tax purposes, needs to be used consistently in the sense described in paragraph 43.''
(emphasis supplied)
The repeated use of the word ``consistently'' in these paragraphs emphasises that according to the Ruling itself, it is necessary to adhere to a pattern once established, at least to the extent that it divides between past years on the one hand and present and future years on the other. A fair reading of IT 2663 is that it is directed to the question how much of a premium received can properly be treated as income not already derived but yet to be derived. The Ruling in itself provides no support for the ascertainment of premium income derived in a particular year by reference to the incidence of risk in that year without regard for the disturbance of the established ``pattern'' in so far as it relates to previous years.
Paragraphs 140 and 143 of IT 2663 address issues relating to the date of effect of the Ruling and the relationship between the Ruling and previous years of income. Paragraphs 140 and 143 are as follows:
``140. This Ruling requires that unearned premium income be included in assessable income on a basis different from the basis we have previously accepted, either in Taxation Ruling IT 79 or a private ruling to a particular insurer. To this extent, the Ruling applies from the income year commencing on 1 July 1991 (or equivalent substituted accounting period) unless the general insurer asks that the method apply to earlier income years. In these circumstances, assessments for earlier years may be amended on request to the extent permitted by section 170.
141....
142....
143. The decision in
Country Magazine Pty Limited v FC of T (1968) 117 CLR 162; 15 ATD 86 (the Country Magazine case) is relevant if assessments of a general insurer are amended to give effect to this Ruling. The decision in the Country Magazine case means that in calculating the taxable income of a general insurer for an income year (`the current year'), unearned premium income of the previous year, for example, must be brought to account in the current year on the same basis used to calculate unearned premium income of the current year. This is so regardless of the fact that unearned premium income of the earlier year may have been calculated on a different basis. This applies equally to amendments made to assessments to give effect to this Ruling on the incurring of losses or outgoings for the purposes of subsection 51(1) (refer to Taxation Ruling IT 2613).''
CUAMIC has not requested amendment of assessments for earlier years.
Of course, Ruling IT 2663 is not law. However, CUAMIC relies on it. I have referred to particular aspects of it in order that its limited effect may be understood. It does not address the issue raised in the present case.
Notwithstanding CUAMIC's concession that the whole of an amount of premium received is ultimately to be returned as assessable income and its contention that the only difference between it and the Commissioner is one of timing, the position contended for by it can lead to a different result. It can lead to the escape from assessment of premium income which has been received, a result not intended by the legislation. The scheme of the ITAA is that the whole of a premium received (which, it is common ground, is assessable income) will be brought to tax. The facts of the present case illustrate the possibility that part will not be: it is not certain that that part of a premium which
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CUAMIC now says should have been, but was not, returned by it as assessable income in earlier years, can and will be able to be the subject of an amended assessment. CUAMIC says that there has been in earlier years what, it now transpires, was an innocent overstatement of that part of a premium received to be carried to the unearned premium account and a commensurate innocent understatement in those years of that part earned in them. Under the current provision, in such a case the Commissioner is empowered to amend the earlier assessments only within four years from the dates on which the tax became due and payable under the original assessments: sub-s 170(2) of ITAA.More extreme illustrations than the present one can be imagined. Assume a ten year mortgage insurance policy for which a premium of $1,000 is paid in the first year; that the insurer treats $100 as earned in that year, transferring $900 to an unearned premium account; and that in each of years 2, 3, 4, 5, 6, 7, 8 and 9 it treats a further $100 of the $900 as earned. This would leave $100 in the unearned premium account at the beginning of year 10. According to CUAMIC's approach, if it could be shown that the true exposure to risk in year 10 was nil, or, for that matter, anything less than 10% of the total exposure to risk, part of the premium income received would have escaped assessment unless the Commissioner could and did issue amended assessments - a possibility which might be remote if, say, the need to amend focussed on the early years of the ten year period.
The present appeal must, however, be resolved in a manner which accords full effect to the High Court's holding in Henderson v FC of T 70 ATC 4016; (1970) 119 CLR 612 in which Barwick CJ, with whom McTiernan and Menzies JJ agreed, said this:
``... there cannot be any warrant in a scheme of annual taxation upon the income derived in each year of taxation for combining the results of more than one year in order to obtain the assessable income for a particular year of tax... Once it is decided that the partnership income derived in the year in question will be the net amount of its earnings of that year, it is, in my opinion, only the earnings of that year which can be included in the computation.''
(at ATC 4019; CLR 649)
Henderson's case was a ``change of basis'' case: if the cash basis is properly applied in respect of the earlier period and the accruals basis in respect of the later period, any escape of tax is explained by the change and does not falsify the earlier assessment.
In the present case, however, it is common ground that CUAMIC's premium income earned and therefore derived in the year ended 30 June 1993 can be the lesser amount contended for by CUAMIC only if that earned and therefore derived in earlier years was truly greater than the amount returned and taxed for those years. In order for CUAMIC to succeed, it must be accepted that the premium income derived by it in earlier years by reference to incidence of risk in those years was greater than that which was included in its assessed taxable income also by reference to incidence of risk, on which the tax payable by CUAMIC was assessed.
Section 166 of the ITAA required the Commissioner to make an assessment of the amount of the taxable income of CUAMIC in respect of the earlier years and of the tax payable thereon. By reason of the definition of ``taxable income'' in s 5, this provision had the effect of requiring the Commissioner to make an assessment of ``the amount remaining after deducting from the assessable income all allowable deductions''. Section 174 required the Commissioner to serve a notice of the Commissioner's assessments of the amounts of the taxable income of CUAMIC and of the tax payable thereon. Section 175 provides that the validity of an assessment is not affected by reason that any provisions of the ITAA have not been complied with. Sub-section 177(1) provides as follows:
``The production of a notice of assessment, or of a document under the hand of the Commissioner, a Second Commissioner, or a Deputy Commissioner, purporting to be a copy of a notice of assessment, shall be conclusive evidence of the due making of the assessment and, except in proceedings under Part IVC of the Taxation Administration Act 1953 on a review or appeal relating to the assessment, that the amount and all the particulars of the assessment are correct.''
There has, of course, been no relevant proceeding on a review or appeal relating to the
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assessments of years preceding the year ended 30 June 1993 in the present case.In my view, the scheme of the provisions to which I have referred is that in the absence of a proceeding under Part IVC of the TAA on a review or appeal relating to the assessments for earlier years, the amount assessed as premium income earned in those years is correct, leaving the balance to be earned in the year ended 30 June 1993 and future years. An alternative way of expressing this conclusion is to say that the scheme of those provisions is that CUAMIC can succeed only if its present appeal in relation to the year ended 30 June 1993 is associated with a proceeding on a review or appeal which would have the effect of increasing commensurately its assessable income, and therefore its taxable income, in respect of the earlier years.
The issue thrown up by the present appeal can be usefully compared with the kind of issue that arises from exchange gains and losses. A liability in a foreign currency may be incurred in one year of income and treated in the taxpayer's return for that year as an allowable deduction in the then equivalent number of Australian dollars. However, the payment in discharge of the liability may be made in a later year of income by which time the number of Australian dollars required for the purpose may be less or more than the number allowed as a deduction in the earlier year of income. If the number of Australian dollars subsequently required is more, it is said that there is an ``exchange loss''. If it is less, it is said that there is an ``exchange gain''. On the assumption that the liability was incurred on revenue rather than capital account, the exchange loss is an allowable deduction in the later year, that is, the year of payment (
Texas Co (Australasia) Ltd v FC of T (1940) 5 ATD 298; (1940) 63 CLR 382;
Armco (Australia) Pty Ltd v FC of T (1948) 8 ATD 335; (1948) 76 CLR 584;
Caltex Ltd v FC of T (1960) 12 ATD 170; (1960) 106 CLR 205) and the exchange gain is assessable income derived in that later year (
International Nickel Australia Limited v FC of T 77 ATC 4383; (1977) 137 CLR 347 (``International Nickel'');
Commercial & General Acceptance Ltd v FC of T 77 ATC 4375; (1977) 137 CLR 373). Similar principles apply where the taxpayer has sold on revenue account for a price payable in a foreign currency which is paid in a later income year after a movement in exchange rates.
In
Moreau v Federal Commissioner of Taxation (1926) 39 CLR 65 (``Moreau''), goods were purchased by the taxpayer from France at prices payable in French francs. The cost price in francs was entered in the taxpayer's books in pounds sterling at the rate of exchange prevailing at the time when the goods arrived in Australia. However, before the price became payable, the value of the franc fell. In the result, the number of pounds sterling required to pay the price in francs was smaller than that which had been entered in the taxpayer's books. The taxpayer's return for the earlier year had claimed a deduction based on the cost entered in his books and the Commissioner had assessed taxable income and the tax payable on that basis. The Commissioner subsequently issued an amended assessment on the basis that the lesser number of pounds sterling which had in fact been paid to discharge the taxpayer's liability had represented the correct amount of the allowable deduction.
The amended assessment was issued after the expiration of three years from the date when the tax payable on the original assessment was due and payable. That period of three years was the period then generally allowed for the issue of amended assessments. Under the legislation in force at the time, the Commissioner had power to make the amendment notwithstanding the expiration of that period if he had ``reason to believe'' that there had been an avoidance of tax owing to fraud or an attempted evasion. Isaacs J declared himself satisfied that the Commissioner had had reason so to believe, even though his Honour said that on the basis of the evidence before him, the taxpayer was not in fact guilty.
It does not appear from the report of the case whether the payment of the increased number of pounds sterling occurred in the subject year of income or in a later one. If it occurred in the subject year of income, it is clear that the amount of the allowable deduction in that year was the amount paid: International Nickel, at ATC 4385-4386; CLR 351 (Gibbs J), 4397; 371-372 (Murphy J). However, the judgment of Isaacs J can be read as holding that even if payment was made in a later year of income, the same principle applied and entitled the Commissioner to issue an amended assessment.
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Isaacs J noted that the price in French francs was unalterable; that on arrival of the goods into stock in Australia, the cost price in francs was entered in the taxpayer's books; and that alongside that actual price there was entered a conversion into pounds sterling which was ``the estimated or probable price in pounds, which, unlike the price in francs, was not invariable'' (at 70). After noting the fall in the value of the franc by the time the price became payable, his Honour said this:``The taxpayer's contention is that the number of pounds sterling originally reckoned at 25 francs to the pound is the proper cost price for income tax purposes; the Commissioner contends that the number of pounds sterling eventually and actually used to pay for the goods is the true cost price. I agree with the Commissioner. The taxpayer's error arose in thinking the Commissioner wished to tax the foreign profit made in conversion as an independent source of income. That is not so. The Commissioner really taxes the profits of the business and ignores the conversion as an independent transaction. It certainly enabled the trader to use a less number of pounds sterling to pay for his goods, but the important and only relevant fact in this connection is the actual amount of Australian money used for the purpose.''
(at 70)
If payment was in fact made in a later year of income, the facts bear some similarity to those of the present case, in that the amount of taxable income was assessed on the basis of the best information available at the time, and information becoming available in a later year was relied on as showing that the original assessment was erroneous. If payment was made in a subsequent year of income, Moreau would stand as authority for the proposition that such information may provide a basis for the making of an amended assessment by the Commissioner, even though the taxpayer had furnished a return on a different basis and taxable income had been assessed on that basis in the earlier year.
(The case is not on all fours with the present case. In the present case factual information was obtained in a later year which enabled a ``more accurate'' monetary amount to be assigned to an objective item of income which was admittedly derived in the earlier year. In Moreau, the difference was between the monetary value of a number of French francs as at two different times: the date of arrival into stock within the year of income and the date of payment, ex hypothesi after the year of income.)
However, the passage quoted from the judgment of Isaacs J in Moreau was the subject of comment by Gibbs J and Mason J in International Nickel. Gibbs J said that it had been open to Isaacs J to deal with the matter in the way in which he had, only if the variation in the exchange rate had occurred in the year in which the price was claimed as a deduction:
``... The fact that there had subsequently been a variation in the rate of exchange would not justify re-opening the transactions of a previous year, at least once an assessment had been made. The entry of the price in the books at the rate of exchange then prevailing would not amount to `an error in calculation or mistake of fact' within sec. 170 (3) of the Act simply because the rate of exchange had changed in a later year. This question need not be pursued because, as I have said, the stated case does not show when the goods paid for during 1967 were purchased.''
(at ATC 4386; CLR 352)
Mason J said in relation to Moreau:
``... his Honour seems to say that the initial cost is to be recalculated by reference to the amount actually expended in Australian currency to defray the purchase price and that the profit on the transaction or the profits of the business (which constitute the relevant income) are to be ascertained on this footing. However, the facts have not been fully stated in the report and support is not to be found in the later cases for the proposition that the cost of purchases as shown in the accounts for a particular year should be subsequently reopened and recalculated in the light of variations in the exchange rate which occur at some later date.''
(at ATC 4391; CLR 360)
In the present case, the factual information relied on to found Trowbridge's second report was information which was assembled after the year ended 30 June 1992 but which related to factual data extending over what the report referred to as ``the preceding 11 years''. The report does not, however, purport to state either an amount of money or percentage relating to the year ended 30 June 1992. For all that is
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shown, the amount returned as assessable income for that year and for any other particular earlier year may have been correct. Although what was said by Gibbs J and Mason J in International Nickel did not relate to factual circumstances on all fours with those of the present case, they strongly suggest that there is no basis for thinking that there was a failure to return all assessable income, and therefore an under assessment of taxable income and of tax payable, for the years earlier than that ended 30 June 1993.In any event, in accordance with the scheme of the relevant provisions of the ITAA which I attempted to explain earlier, CUAMIC's assessable and therefore taxable income for the year ended 30 June 1993 must be ascertained in a manner not inconsistent with the proposition that the assessments have been duly made in the earlier years.
Accordingly, the amount of $3,249,612 in question forms part of CUAMIC's assessable income for the year ended 30 June 1993.
Conclusion
In conformity with the foregoing reasons, the appeal will be dismissed and CUAMIC will be ordered to pay the Commissioner's costs.
THE COURT ORDERS THAT:
1. The appeal be dismissed.
2. The applicant pay the respondent's costs.
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