CASE 41/97

Members:
GL McDonald DP

Tribunal:
Administrative Appeals Tribunal

Decision date: 3 October 1997

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GL McDonald (Deputy President)

Background

1. The applicant is appealing against a decision of the respondent to disallow an objection against a notice of amended assessment, which issued on 26 April 1994, to include an amount of $30,000 in the applicant's assessable income for the tax year ending 30 June 1991.

2. At the hearing Mr D. Bessell, a barrister and solicitor, represented the applicant and Mr S. Loader, assisted by Mr K. Foley, departmental advocates, represented the respondent. The Tribunal had before it the documents filed for the purposes of s. 37 of the Administrative Appeals Tribunal Act 1975 (the ``T'' documents) and other documentary evidence tendered during the course of the hearing. Each party filed a statement of issues, facts and contentions. The applicant and Mr L, managing director of A Insurance Agencies Pty Ltd, gave oral evidence in support of the application. Mr W, who was at the relevant time the personal business manager for X Ltd in Tasmania, as well as the following, all of whom worked for Mr L's firm as sub-agents, Mr S, Mr K, Mr DT and Mr T gave oral evidence on behalf of the respondent.

The law

3. The relevant legislative provisions contained in the Income Tax Assessment Act 1936 (``the Act'') are as follows:

``25(1) The assessable income of a taxpayer shall include-

• (a) where the taxpayer is a resident-
• the gross income derived directly or indirectly from all sources whether in or out of Australia; and
• (b)...

which is not exempt income, an amount to which section 26AC or 26AD applies or an eligible termination payment within the meaning of Subdivision AA.''

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``26 The assessable income of a taxpayer shall include-

• ...
• (e) the value to the taxpayer of all allowances, gratuities, compensations, benefits, bonuses and premiums allowed, given or granted to him in respect of, or for or in relation directly or indirectly to, any employment of or services rendered by him, whether so allowed, given or granted in money, goods, land, meals, sustenance, the use of premises or quarters or otherwise, not being-
  • (i)...
  • (ii)...
  • (iii)...
  • (iv)...
  • (v)...
• ...
• (h) the amount of any fee or commission received for procuring a loan of money;
• ....''

The facts

4. The facts, as reflected in the statements of issues, facts and contentions filed by each party and as established by the evidence, are largely not in dispute and the Tribunal can set out its findings as to them as follows. X Ltd developed a policy referred to in these proceedings as the ``AB'' policy. According to Mr W the policy was developed on the mainland but, because of locally held concerns as to the benefits to the company, was not promoted by X Ltd in Tasmania. However, two of X Ltd insurance agents, who dealt in X Ltd corporate business in Tasmania, came to know of it and they approached the X Ltd Tasmanian office to secure the right to commence marketing it.

5. X Ltd described the ``AB'' policies as an investment insurance policy that was ``... a special policy which has had life cover reduced for a premium discount'' (exh C, clause 1). It was a term of the policy that should the life insured die, the amount payable would be the greater of

• (a) the cash value of the policy, or
• (b) the premiums paid plus interest credited less debits by way of loans, unpaid premiums and interest (exh C, clause 2).

While the ``AB'' policy had some curious aspects, its desirability for the policyholder is readily apparent. The premium was to be $100,000 per annum over the maximum 35 year life of the policy, but the policy was to be self- funded on the basis that the first year's premium would be met from a rebate of agent's commission (and bonuses) and that thereafter the premium would be met from borrowings against the value of the policy. The desirability from the agent's point of view is also readily apparent. The commission of 60 per cent for the first year and 20 per cent for the second along with volume and discretionary bonuses (which together totalled more than the $100,000 first year premium payable by the policyholder) were to be paid up front so that even after the remission of the first year's premium the agent would be left with a surplus. Additionally, for years 3, 4 and 5 of the policy the agent was to be paid 12 per cent of the annual $100,000 premium.

6. The desirability accruing to X Ltd in issuing the policy is, however, not so readily apparent. Fortunately, that is not a matter which need concern the Tribunal in these proceedings. Mr W told the Tribunal that the Tasmanian management of X Ltd had misgivings about the value of the policy to X Ltd. Mr W said that with respect to the ``AB'' policies X Ltd was ``the goose that laid the golden egg''. However, it was determined after the approach had been made by Mr L and another Tasmanian X Ltd agent, that the policy should be available for marketing in Tasmania. Mr W said that the X Ltd head office directed changes to the payment of commission to all proposals submitted after 5:00 p.m. on 6 February 1990. His statement continues (exh 2):

``After they had submitted the proposals for the AB policies [Mr L's firm] [was] required to go back to their clients and have them sign a letter of comfort, a receipt of policy document, a new presentation and an important policy notes. This requirement was imposed by [X Ltd] Head Office and was not normal practice.''

In his oral evidence Mr W said that it subsequently became apparent to X Ltd that it would be the loser from the issue of the ``AB'' policies and that, subsequently, it was keen to get those policies off its books.

7. Exhibit B was a sheet of projections according to the evidence of Mr W, issued by X Ltd at or about the time the policy was to be made available, setting out the yield the

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policyholder could expect. The calculation inter alia assumes (wrongly) a tax deductibility for the premium paid by the policyholder. The calculation shown by the end of year 5 of the policy shows a net value of $100,000 accruing to the policyholder. It has that same value for the remaining 30 years, i.e. there is no increase after the fifth year in the value of the policy from the policyholder's point of view. The point was made, and the Tribunal accepts it, that the figures are but projections and factors such as the variation in the interest rate would affect the outcome. Mr L made the point that, because of the fall in interest rates from the initial 15 per cent, a policy taken out in 1990 would be very worthwhile in today's market.

8. According to Mr L his firm was allocated a quota of 100 such ``AB'' policy contracts by the X Ltd manager (Mr S) in Tasmania. Clearly Mr L, through his agency, had an interest in securing sales of the policy. Apart from any surplus arising from the commission and bonuses after payment of the policyholders first year premium, he stood to receive commission totalling $1.2 million per year from the sale of 100 policies in years 3, 4 and 5. To secure the payment of this commission, Mr L had his sub- agents ensure policyholders signed an agreement with his firm that the policy would be maintained for a minimum five year period (T3). Clause 5.1(d) of the agreement between Mr L's firm and the purchaser of the ``AB'' policy required the purchaser to sign a transfer of the policy in favour of the agent. Clause 7.1 authorised X Ltd to send all notices to the agent if so requested by the agent, i.e. the agent was enabled to retain complete control over information passing between X Ltd and the policy and the policyholder.

9. The applicant was one of the people Mr L approached to take up a ``AB'' policy. She and Mr L had been in a personal relationship since 1982. The applicant is employed as a teacher. She is employed there on a full-time basis, and is not involved in any business ventures. The applicant told the Tribunal that she relied on Mr L to give her financial advice and trusted the advice he gave her. She said that Mr L advised her that the superannuation scheme in which she participated at her place of employment would not, because of the relatively short time she would be a contributor, particularly if she was to retire at age 55, provide her a sufficiently high return to maintain her standard of living. Her discussions with Mr L about the ``AB'' policy led her to conclude that it would give her long term security. She mentioned that she wanted to maintain the policy for at least 10 years because she understood that after the expiration of 10 years any benefit accruing from the policy would not be taxable. She said that, given she was aged 44 at the time she took up the policy, the expiration of the 10 year period would coincide with the time she proposed retiring. Having discussed the matter with Mr L she signed a proposal form (exh A). That form is dated 2 February 1990. The applicant said that she had made an error with respect to the date and that on the stated date she was in fact with Mr L in another State. She told the Tribunal that she signed on 7 February 1990 - the date of the Hobart Cup. She said that she was sure of this as she could trace her movements from her diary entries.

10. The proposal requires a person to be nominated as the life to be insured. In fact, as exhibit B shows, the premium is reduced from $110,199 to $100,000 upon the withdrawal of the cover for the life insured. The applicant said that she did not have any children and that she nominated her niece Vicki Cox to be the life insured. There were suggestions that in relation to some other of the 100 policies entered into by Mr L's firm that lives initially nominated had to be changed because, given the maximum term of the policy, it was necessary to nominate someone sufficiently young and that this had not been done in all cases. The circumstances surrounding the manner in which those changes were apparently made to some of the other policies were criticised in Mr K's statement, but not regarded as unusual by Mr DT.

11. According to the evidence of Mr S, one of Mr L's firm's sub-agents, in the 6 to 8 weeks prior to Hobart Cup Day in 1990, he had spoken to a number of potential clients concerning the ``AB'' policy. It appears, however, that not any of the clients of Mr L's firm had, by Hobart Cup Day (7 February 1990), signed a proposal form in relation to the policy. Mr L told the Tribunal that on 5 February 1990 X Ltd informed him that it would not accept any further new ``AB'' policy business. According to the evidence of Messrs S and K a meeting of sub-agents, employed by Mr L, was called for late in the afternoon of 7 February 1990. It is reasonable to conclude from the evidence that this meeting was called in response to X Ltd's

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advice that no further new ``AB'' policy business would be accepted and that by 7 February 1990 not any of the 100 potential contracts allocated for distribution by Mr L's firm had been concluded. At the meeting, according to Mr S, Mr L allocated the number of policies to be sold by each of the sub-agents and the agents were told to have the proposal forms ready for submission to X Ltd by 10:00 a.m. the next morning. According to Mr L's evidence he had proposals for over 100 ``AB'' policy contracts, but at the insistence of X Ltd only 100 were to be accepted. On the advice of Mr L the applicant signed a proposal and it was included amongst the 100 policies submitted.

12. According to the evidence of Mr L, after the proposals had been submitted, X Ltd made some changes to the policy, including reducing the bonus rates to be paid to agents by 15 per cent, increasing the interest rate on the amounts borrowed from 15 to 15.5 per cent and adding back the $10,199 premium reduction. Additionally, it seems that X Ltd required a letter of comfort prepared by it to be signed by the proposers (exh C). The applicant signed the letter (exh C). The letter expressly points out that should the policy be surrendered within two to five years from the commencement date ``... there is... a risk that the profit from the policy could be assessed under section 25 or section 25A of the Income Tax [sic] as it could be deemed to be `profit-making scheme''' (clause 4). The letter also points out that any interest on amounts borrowed to purchase a life insurance policy are not tax deductible (exh C, clause 8). It seems further that X Ltd produced, and the applicant signed on 16 or 17 March 1990, an estimate of the value of the policy at the end of a 10 year period (exh E). Curiously, this showed the net value of the policy to the policyholder as reaching its maximum in the second year of the policy and by the tenth year, the policy was showing a loss to the policyholder of $298,536.

13. Exhibit G is the insurance policy, issued by X Ltd in favour of the applicant and it records the commencing date of the policy as 12 March 1990. It also includes on page 5 a further illustrative chart, again showing different figures from those found in either the first issued projection (exh B) or the subsequently issued projection (exh E). Also, curiously, the same page contains some notes indicating events as having occurred after the date the policy was entered into, e.g. there appears the statement ``an interim bonus reduction of 15 per cent was implemented on all conventional policies on 20 August 1990''. The Tribunal notes on the second last page of the policy it is recorded as having been examined, presumably by a X Ltd examiner, but the Tribunal is unable to determine because of the confusion relating to the mention of dates after the commencement date of the policy, the actual day the policy document was issued. However, the Tribunal accepts the date stated in the document as being the commencement date, i.e. 12 March 1990.

14. The evidence of Mr W, as supported by that of Mr L and as is apparent from exhibit E to the respondent's statement issues, facts and contentions, that X Ltd subsequently wanted to terminate the ``AB'' policies once it had determined that those policies would not be profitable for it. It was Mr L's evidence that in March 1991 he received a telephone call from Mr TS, X Ltd's then manager for Tasmania, requesting a meeting. In his statement Mr L outlines his understanding of what happened at the meeting as follows (exh H):

``At that meeting Mr TS said to me, `the AB policies are to be journal surrendered. No more premiums are to be paid. If not your agency will be terminated'.

I said to TS to, `You can't do that'.

TS replied, `I f.... well can - I'll do it now'.''

In the result, Mr L said that he felt that he had no option other than to comply with Mr TS's ultimatum.

15. It seems that at much the same time as the above discussion between the State manager of X Ltd and Mr L occurred, X Ltd wrote to all ``AB'' policyholders, apparently with the exception of those clients of Mr L's firm, setting out projected values with respect to the policy which illustrate after the payment of the third premium the value of the policy would be less than its surrender value. The letter suggested it might be better for the policyholder not to pay the third premium and that X Ltd would pay to the policyholder the net value of the policy as at the second year after the premium was paid and that thereafter the policy would lapse (see annexure E to the respondent's statement of issues, facts and contentions).

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16. It appears at the March 1991 meeting between Mr L and the State manager for X Ltd that it was agreed that the policies sold by Mr L's firm would be cancelled or ``journal surrendered'' after the sum representing the value of the policy at the end of the first year had been borrowed and the second year premium paid. That sum was $128,866.45 per policy. One hundred thousand of it was to be used to pay the second year's premium. The sum was forwarded by X Ltd to Mr L's firm for disbursement to the policyholders. Of the balance, Mr L offered his clients, with the exception of the applicant, a sum of $20,025 each with the remainder being retained to pay commission, legal and other expenses. Mr L had a further agreement (T4), prepared for signature of clients acknowledging the cancellation of the earlier agreement (as set out in T3) without the client incurring any penalty for the early termination and recording the payment of the $20,025 to the policyholder with the balance being applied to reimbursing Mr L's firm for ``costs, losses and outgoings incurred by [the firm]'' (T4, p.14 - clause F(2)). Upon these events occurring, X Ltd was to journal surrender the policies (i.e. cause them to lapse or not be proceeded with).

17. Mr L told the Tribunal that the applicant was upset at having the policy terminated earlier than she anticipated. The applicant said that she had taken out the policy ``... to ensure my financial security should the relationship [ i.e. with Mr L] break-up, which it did in 1993, or should Mr L die''. Mr L said that, because of the existence of their personal relationship, he was feeling guilty about the early cancellation knowing that she had relied on his advice to take up the policy to supplement her superannuation payments. In her case he determined to remit the whole of the balance beyond payment of the $100,000 second year premium and top it up to $30,000. It is this sum which has been assessed as part of the applicant's taxable income for the 1991 year and which is in dispute in these proceedings.

18. T8 is a letter dated 19 March 1993, from the applicant's tax agent to the Deputy Commissioner in answer to a query as to the deposit of inter alia the $30,000 into her account from Mr L's firm. The reply states that ``... this was from the proceeds of a mature life insurance policy, which she was told at the time would not be taxable to her... she believes it [ the policy] was taken out in approximately February 90 and redeemed in March 91''. This was put to the applicant during the course of the hearing, she said that she could recall talking to her tax agent and mentioning that the proceeds were from an insurance policy she had but could not recall the detail.

The issues

19. The respondent claimed that the amount assessed is income. In its contentions the respondent acknowledges that the assessed amount was ``... paid in connection with a commercial transaction between the applicant on the one hand and BLIA [Mr L's firm] and [X Ltd] on the other''. However, while it is contended that the receipt of the assessed amount was an isolated transaction, the transaction itself could not be looked at in isolation as it was made to facilitate a scheme entered into by Mr L's firm in which it would derive substantial benefits in the form of premium income and additionally would gain a benefit from retaining the balance of the loan moneys remaining after the payment of the assessed amount [to the applicant] and the second premium [to X Ltd]. It was stated that the applicant was one of one hundred proponents recruited by Mr L's firm to maximise its return from the sale of as many of the ``AB'' policies as possible. In return for the applicant signing the proposal she was promised that the first year's premium would be paid by Mr L's firm and that she would receive an indeterminate sum of money at some time in the future. This would occur not later than the fifth year of the policy, because during that year the interest and loans owing would exceed the cash value of the policy. During the course of the hearing, the respondent drew attention to the characterisation of the applicant's ``AB'' policy, claiming that it was void because she had no insurable interest in the life of her niece. Section 19 of the Insurance Contracts Act 1984 (Cth) identifies the circumstances when an ``insurable interest'' will come into existence. It does not include the relationship of an aunt/ niece. Section 18 of that latter Act provides that, if no insurable interest exists then the policy is void. Consequently, the respondent claims that the amount assessed should be regarded as income under the provisions of s. 25(1) of the Act and relies on the authority of
FC of T v The Myer Emporium Ltd 87 ATC 4363.

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20. The respondent also claims that, in completing the proposal for the contract of life insurance by entering into the agreement with his firm to assign the proceeds of the loan from X Ltd to Mr L's firm, the applicant provided a service to Mr L's firm and that, consequently, the $30,000 is assessable income pursuant to the provisions of s. 26(e) of the Act. Additionally, it is also claimed that the sum is assessable under the provisions of s. 26(h) as a fee or commission for procuring a loan of money.

21. The applicant disputes the Commissioner's assessment that having regard to the overall characteristics of the ``AB'' policy and surrounding circumstances, the applicant intended at the time of taking out the policy to make a gain or profit from its early termination. On behalf of the applicant it was contended that the Commissioner's assessment of the circumstances is incorrect and that it was always the applicant's intention to keep the policy for the period up to her retirement, i.e. for at least 10 years.

Discussion

22. The Tribunal accepts the evidence of Mr W, and is satisfied, however curious it may appear, that the ``AB'' policies issued by X Ltd were genuine policies. As exhibit C shows, X Ltd regarded the policies as being special investment insurance policies with life cover reduced for a premium discount. As alluded to earlier in these Reasons for Decision, there appears to have been some confusion within Mr L's office with regard to some, at least, of the 100 ``AB'' policy proposals allocated for his firm to fulfil as to the requirements to identify suitable people who would constitute an insurable interest. In her evidence the applicant said that she understood the need for the existence of an insurable interest and that it was her understanding that in her case the need was met by the nomination of her niece's life. The Tribunal accepts the nomination by the applicant of her niece as the life to be insured results in the contract being void under the provisions of s.19 of the Insurance Contracts Act 1984 (Cth). X Ltd regarded the contract as binding despite the apparent fundamental difficulties associated with there being no insurable interest. The Tribunal notes that the contract does not depend on the assumption of any risk on the life said to be insured. As exhibit C shows payment under the policy is dependent on the amount accumulated from earnings on the premium paid (in the first year) or borrowed against the total accumulated funds (in subsequent years). The evidence confirms, and the Tribunal accepts, that the policy was more accurately described by X Ltd in exhibit C as an investment policy, rather than a life insurance policy.

23. The policies were promoted by Mr L through his firm which is an insurance agent for X Ltd. As such the Tribunal accepts that he is engaged in the business of selling insurance policies, including life policies, for the purposes of making a profit and that profit would be characterised as income and assessable for taxation. The Tribunal is satisfied that Mr L's firm promoted and secured the sale of 100 X Ltd ``AB'' policies in Tasmania and that its motive for doing so was to obtain the generous commission payable. It is accepted that proposals for the policies were signed on 7 February 1990, including that for the applicant, and that there was some urgency to ensure that this was completed because of X Ltd's notification that it would not be accepting any new proposals for ``AB'' policies beyond that date.

24. In the instant case the Tribunal accepts the evidence of the applicant that she accepted the offer of Mr L to participate in the ``AB'' policy with the intention that she would only consider cashing it in after she retired, i.e. after a period of approximately 10 years. The Tribunal is satisfied that she did not enter into the transaction with the intention of facilitating Mr L's commission in exchange for the payment of an indeterminate sum within two, three or five years. While it may be the case that Mr L was actively promoting the policies and was looking towards the payment of commission, it seems inconceivable that he would want the policies cancelled at a period earlier than the end of, at least, the fifth year given the very high commissions payable in the third, fourth and fifth years. That, however, was not a concern to the taxpayer who was, the Tribunal is satisfied, not participating in any ``scheme'' in order to secure the payment of those commissions to Mr L or his firm. The Tribunal is satisfied that at the time she signed the policy she was probably unaware of many of the details and this may explain the initial response to a query from the Commissioner of Taxation contained in her tax agent's letter of

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19 March 1993 (T8). However, it is clear that her intention was to achieve the long term benefit described. In the instant case the applicant is in receipt of wages as an employee. She is not engaged in the business of insurance or of selling insurance. There is no evidence to support the proposition that she was in any way connected in any business undertaking to Mr L's insurance agency. That she may have had a personal relationship with Mr L does not lead to a conclusion that she also had a business relationship with him or his firm. The fact that he invited her to participate as a proposer for the X Ltd ``AB'' policy and that as a result he received commission, does not implicate her as being part of his business.

25. The respondent referred the Tribunal to the decision of the High Court in Myer in support of the proposition that the $30,000 gain made by the taxpayer was taxable because it represented a gain arising from a transaction which, while not carried out in the ordinary course of business, was a gain resulting from a transaction entered into by the taxpayer with the intention or purpose of making a profit. The facts in the Myer case are clearly distinguishable from those in the present case, in that in Myer the Court was considering whether a once off business transaction of a type which the company was not ordinarily engaged should be characterised as income. In that case the Court held that a company which carried on business as a retail trader and property developer which lent $80 million to a subsidiary over a set period at a set interest rate, but which later assigned to an associated finance company its right to receive the interest payable for the remainder of the period of the loan in exchange for a lump sum payment of $45.37 million had received income. The factual situation in Myer and subsequent interpretations arising from it in cases such as
Westfield Ltd v FC of T 91 ATC 4234 and
FC of T v Cooling 90 ATC 4472 are clearly distinguishable from the circumstances of the instant case where the taxpayer is not engaged in any type of business.

26. However, the Tribunal is satisfied that the applicant entered the transaction with the intention of securing a gain. In Myer the Court said that (87 ATC 4363 at 4366-4367):

``... But a gain made otherwise than in the ordinary course of carrying on the business which nevertheless arises from a transaction entered into by the taxpayer with the intention or purpose of making a profit or gain may well constitute income. Whether it does depends very much on the circumstances of the case. Generally speaking, however, it may be said that if the circumstances are such as to give rise to the inference that the taxpayer's intention or purpose in entering into the transaction was to make a profit or gain, the profit or gain will be income, notwithstanding that the transaction was extraordinary judged by reference to the ordinary course of the taxpayer's business. Nor does the fact that a profit or gain is made as the result of an isolated venture or a `one-off' transaction preclude it from being properly characterized as income.''

While the applicant is not engaged in any business, the Tribunal is satisfied that the policy is properly characterised as being an investment rather than a life policy and consequently she should be regarded as entering into a commercial transaction. It follows that any gain arising is to be regarded in the ordinary course of events as ``income''.

27. It was suggested on behalf of the applicant that the sentence following the section quoted above in Myer, 87 ATC 4363, at 4367, viz-

``... The authorities establish that a profit or gain so made will constitute income if the property generating the profit or gain was acquired in a business operation or commercial transaction for the purpose of profit-making by the means giving rise to the profit .''

(emphasis added)

and comments made by Drummond J to the same effect in
Selleck v FC of T 96 ATC 4903 (at 4911) affect the applicant's situation because it was never the applicant's intention or purpose to make a gain by having the policy journal surrendered. That reasoning, however, does not, in the Tribunal's view, apply in the instant case. Because the Tribunal has found that the policy is more correctly characterised as an investment rather than a life policy and that when viewed objectively the applicant must be regarded as having entered a commercial transaction in order to make a gain. Any gain would ordinarily be regarded as income. That it was paid at a time earlier than she may otherwise have hoped or expected does not change its character as ``income''. Given the

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characterisation of the policy by the Tribunal, the applicant's understanding that if she held on to the investment for a period of not less than 10 years, any gain made would be tax exempt (presumably as the result of the application of s. 26AH of the Act) does not arise for consideration.

28. Given the finding of the Tribunal that the applicant was not employed by and did not render a service to Mr L or his firm, no issue arises for determination under the provisions of s. 26(e) of the Act. The findings also preclude the operation of s. 26(h) of the Act.

29. It was the evidence of Mr L, which the Tribunal accepts, that he received on account of the applicant the sum of $28,865.45 from X Ltd. With respect to his other clients, he debited expenses, commissions, etc, to reduce that sum to $20,025. There is no suggestion that he determined to charge the applicant for those expenses. Indeed, the evidence was the other way, namely that he determined to reimburse her the full amount and increase that amount by topping it up to $30,000. Clearly, the difference between $30,000 and $28,866.45 received from X Ltd is properly characterised as a gift from Mr L to the applicant. As such it is not income and not assessable. That he did not charge for costs and other outgoings said to be incurred by his firm, in the applicant's case results in the total of $28,865.45 as constituting assessable income.

30. Accordingly, the decision under review should be varied and the matter remitted to the respondent with a direction that the applicant's assessable income for the year in question include the sum of $28,865.45.