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Edited version of your private ruling
Authorisation Number: 1012542362145
Ruling
Subject: Assessability of undercharged insurance premiums
Question 1
Will the undercharged premium amounts be assessable income pursuant to section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997)?
Answer
No
This ruling applies for the following period:
Year ended 30 June 2013
The scheme commences on:
1 July 2012
Relevant facts and circumstances
Under the State law, every applicable entity must have a general insurance policy with the taxpayer. That is, these applicable entities are legally obliged to take out an insurance policy with the taxpayer.
The taxpayer identified a system error which caused premiums to be under-calculated. This has resulted in these policies being undercharged. The undercharged premium amounts relate to policies covering the 30 June 2013 and prior financial years.
It has been determined that the undercharged premium amounts will not be recovered from the policy holders. No premium notices have been sent to the policy holders advising them of a reassessed premium amount.
Relevant legislative provisions
Income Tax Assessment Act 1997 Section 6-5
Question 1
Summary
The undercharged premium amounts will not be assessable income pursuant to section 6-5 of the ITAA 1997.
Detailed reasoning
As an Australian resident, the taxpayer's assessable income for the financial year ended 30 June 2013 under subsection 6-5(2) of the ITAA 1997 will include all ordinary income it has derived during that financial year.
Subsection 6-5(4) of the ITAA 1997 provides that in working out if the taxpayer derived the undercharged premiums during the financial year ended 30 June 2013, it will be taken to have received it as soon as it is applied or dealt with in any way on its behalf or as it directs.
Paragraphs 9 to 11 of Taxation Ruling TR 98/1 Income tax: determination of income; receipts versus earnings provide the Commissioner's view as follows on the earnings method for determining when income is derived:
9. The 'earnings' method is often referred to as the 'accruals' method or the 'cash and credit' method. Under the earnings method, income is derived when it is earned. The point of derivation occurs when a 'recoverable debt' is created.
10. The term 'recoverable debt' is used to describe the point of time at which a taxpayer is legally entitled to an ascertainable amount as the result of having performed an agreed task. A taxpayer may have a recoverable debt even though, at the time, they cannot legally enforce recovery of the debt.
11. Whether there is, in law, a recoverable debt is a question to be determined by reference to the contractual agreements that give rise to the legal entitlement to payment, the general law and any relevant statutory provisions.
The Commissioner's specific view on the timing of income derivation with respect to general insurance premiums is provided in paragraph 53 of Taxation Ruling IT 2663 Income tax: basis of assessment of general insurance activities:
53. The terms and conditions of an insurance contract entered into between a general insurer and an insured in relation to the payment of premiums by the insured are a major consideration in determining when the premium income of the insurer is derived. If the payment of the premium in respect of closed business has matured into a recoverable debt before it is actually received, and the insurer is not obliged to take any further step before becoming entitled to payment of the premium, we regard the premium as having been derived by the insurer: Henderson v. FC of T (1970) 119 CLR 612; 70 ATC 4016; (1970) 1 ATR 596, J Rowe & Son Pty Ltd v. FC of T (1971) 124 CLR 1; 71 ATC 4157; (1971) 2 ATR 497 and FC of T v. Australian Gas Light Co 83 ATC 4800; (1983) 15 ATR 105.
As per the facts provided, the State law provides that every applicable entity must have a general insurance policy with the taxpayer.
Therefore in respect of the undercharged premiums, the taxpayer will have a recoverable debt created as at 30 June 2013, and have derived assessable income in the financial year ended 30 June 2013, if the relevant statutory provisions of the State law have been satisfied with respect to the setting of and assessment of premiums.
Whilst it is evident that the taxpayer has set the undercharged premiums payable under each of the affected policies as per the State law, it has not assessed those premiums as no premium notices were sent to the affected policy holders advising them of a reassessed premium amount as required by the State law.
As a result, the taxpayer has no recoverable debt in respect of those undercharged premiums as at 30 June 2013.
In conclusion, the undercharged premium amounts will not be assessable income to the taxpayer for the financial year ended 30 June 2013 pursuant to section 6-5 of the ITAA 1997.
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