EMPLOYERS' MUTUAL INDEMNITY ASSOCIATION LIMITED v FC of T

Members: Sheppard J

Burchett J
Gummow J

Tribunal:
Full Federal Court

Decision date: Judgment handed down 2 October 1991

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Burchett J

As regards the application of the general principle (stated in
Californian Copper Syndicate (Limited and Reduced) v. Harris (Surveyor of Taxes) (1904) 5 T.C. 159 at 165-166) which determines whether a gain or loss realised upon the sale of an investment will be upon revenue account or upon capital account, a line of cases has established that the businesses of banks and insurance companies generally stand in a special position. The nature of the undertaking carried on by a bank or an insurance company requires it to deal in money, and in the investment of money. Its investments are an integral part of its business. The consequence is that, unless there is something to set a particular investment aside as not falling within the business of banking or insurance, a gain or loss realised by a bank or insurance company upon its sale will be upon revenue account. The short point in the present appeal is whether the facts found by the Administrative Appeals Tribunal permitted the Tribunal to hold that certain investments of the appellant insurance company had been so separated from its business of insurance that, subject to any question of the conduct of a distinct business of investment (see London

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ATC 4855

Australia Investment Company Limited v. F.C. of T. 77 ATC 4398; (1976-1977) 138 CLR 106;
CMI Services Pty Ltd v. F.C. of T. 90 ATC 4428 ; (1990) 94 ALR 153 ), realisations of those investments were upon capital account.

Gummow J. having set out the facts at some length, it is unnecessary for me to recapitulate them. They show, plainly enough, that the investments in question were held in an account to which the appellant did not resort in its every day operations. The investments formed an ultimate reserve against contingencies that were not, perhaps, expected, but must nevertheless be provided against in an insurance business. The requirement is not merely one of prudence, or proper business practice, but of statutory obligation. Although the appellant sought to say that it did not regard the particular fund to which the investments belonged as a part of the insurance business, or as a reserve to meet the contingencies of that business, the words of Starke J. in
Colonial Mutual Life Assurance Society Limited v. F.C. of T (1946) 8 ATD 137 at 139-140; (1946) 73 CLR 604 at 608 are in point:

``The intention of a taxpayer cannot be considered as determining what it is that his acts amount to; and the real thing that has to be decided is what were the acts that were done in connection with the business and whether they amount to a trading which would cause the profits that accrued to be profits arising from a trade or business...

Now in the present case the business of the Society was the assurance of lives, the granting of annuities and other cognate business and the investment of its funds. Some of its investments were varied or switched from time to time in order to increase the effective interest yield to the Society. It was a normal operation or step in the carrying on of its business.''

The general rule, as it applies to a bank, was stated by the Privy Council in
Punjab Co-operative Bank, Limited, Amritsar v. Commissioner of Income-Tax, Lahore [1940] AC 1055 at 1072-1073 :

``In the ordinary case of a bank, the business consists in its essence of dealing with money and credit. Numerous depositors place their money with the bank, often receiving a small rate of interest on it. A number of borrowers receive loans of a large part of these deposited funds, at somewhat higher rates of interest. But the banker has always to keep enough cash or easily realizable securities to meet any probable demand by the depositors. No doubt there will generally be loans to persons of undoubted solvency which can quickly be called in, but it may be very undesirable to use this second line of defence. If, as in the present case, some of the securities of the bank are realized in order to meet withdrawals by depositors, it seems to their Lordships to be quite clear that this is a normal step in carrying on the banking business, or, in other words, that it is an act done in `what is truly the carrying on' of the banking business.''

That kind of holding of funds in reserve by a bank was distinguished from a situation involving a reserve supply of spare parts held by an air transport company in
Guinea Airways Limited v. F.C. of T. (1950) 9 ATD 197 at 200-201; (1949-1950) 83 CLR 584 at 593 , where Kitto J. said:

``In argument it was suggested that the principle of
Commissioner of Taxation v. Commercial Banking Co. of Sydney Ltd. (1927) 27 S.R. (N.S.W.) 231 ; 44 W.N. 65 might be applied. In that case, as in Punjab Co-operative Bank Ltd., Amritsar v. Commissioner of Income-Tax, Lahore (1940) A.C. 1055, the question considered was the nature of a profit made upon a change of investment of moneys held by a bank to be available as a `second line of defence' should the exigencies of its business make it necessary to resort to them, and it was held that the profit was of an income nature. There is a superficial resemblance but a fundamental difference between such a case and the present. In the case of a banker, money is his stock in trade, and any profit or loss he makes in dealing with money in the course of his business is on revenue account, notwithstanding that the money is in a sense held in reserve. In a case such as the present, however, money is not stock in trade, and neither are spare parts and stores bought with it; and if either money or goods be lost while held as a fund or stock to meet future needs, the loss is a loss on capital account.''

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ATC 4856

See also -
F.C. of T. v. Marshall and Brougham Pty Ltd 87 ATC 4522 at 4530; (1987) 17 FCR 541 at 551-552 .

That a similar process of reasoning must place insurance companies in the same category as banks was confirmed by the High Court in Colonial Mutual Life Assurance Society Limited ( supra, at ATD 145; CLR 619-620):

``But an insurance company, whether a mutual insurance company or not, is undoubtedly carrying on an insurance business and the investment of its funds is as much a part of that business as the collection of the premiums... In our opinion there is no substantial distinction between the business of an insurance company and that of a bank in this respect. The acquisition of an investment with a view to producing the most effective interest yield is an acquisition with a view to producing a yield of a composite character, the effective yield comprising the actual interest less any diminution or plus any increase in the capital value of the securities. Such an acquisition and subsequent realisation is a normal step in carrying on the insurance business, or in other words an act done in what is truly the carrying on of the business of the Society.''

The second part of this passage was accepted as a true statement of the position by Menzies J. in
Australasian Catholic Assurance Company Limited v. F.C. of T. (1959) 9 ATD 577 at 579; (1959) 100 CLR 502 at 507 . See also
F.C. of T. v. Equitable Life and General Insurance Co Ltd 90 ATC 4438 at 4439, 4458; (1990) 93 ALR 609 at 610, 633 ;
F.C. of T. v. Cooling 90 ATC 4472 at 4480 ;
AGC (Investments) Limited v. F.C. of T. 91 ATC 4180 at 4182, 4189 ;
Unitraders Investments Pty Ltd v. F.C. of T. ; GRE Insurance Ltd v. F.C. of T. 91 ATC 4454 at 4462 ; and
RAC Insurance Pty Ltd v. F.C. of T. 90 ATC 4737 ; (1990) 95 ALR 515 . Apart from banks and insurance companies, there are, of course, other businesses which share the characteristic of dealing in money and investments in the manner discussed in the authorities to which I have referred. This is made clear in a number of cases, including F.C. of T. v. Marshall and Brougham Pty Ltd (supra), and
Australian National Hotels Ltd v. F.C. of T. 88 ATC 4627 at 4632; (1988) 19 FCR 234 at 239 .

When it is appreciated that the revenue character of losses and gains of the kind in question is so broadly based on the nature and incidents of an insurance business, the question becomes whether the facts found by the Administrative Appeals Tribunal could, consistently with the law, have been held to have taken the relevant investments outside the course of the appellant's insurance business. The appellant relied on the decision of a full court of this Court in
The Chamber of Manufactures Insurance Ltd v. F.C. of T. 84 ATC 4315 ; (1984) 2 FCR 455 (I have corrected an obvious error in the name of this case by reference to the report in 84 ATC 4315). In Chamber of Manufactures Insurance, the Court, while accepting that the rule stated in Colonial Mutual Life Assurance Society would ``usually'' apply, drew attention (at ATC 4318; FCR 458-459) to the fact that ``in some cases'' the position would be otherwise. The Court continued (at ATC 4318-4319; FCR 460):

``Even in a case such as the present, the position might have been different had the taxpayer maintained two quite separate funds - the first acknowledged as a reserve fund and demonstrably sufficient to meet claims and expenses in all reasonably foreseeable contingencies - the second categorised and dealt with as an investment fund. Whether profits from the sale of investments in the second fund were taxable would depend upon factors unrelated to insurance such as those referred to in the London Australia Investment Co. case [London Australia Investment Co Ltd v. F.C. of T. (supra)].''

The exception thus stated relies upon the complete separation of an investment activity, or the holding of investments, from the business of insurance. The special character of that exception was made very clear by Kitto J. in
The National Bank Australasia Limited v. F.C. of T. 69 ATC 4042 at 4048; (1968-1969) 118 CLR 529 at 538-539 , where he held a particular investment in shares did not form part of the bank's business of banking. Kitto J. said:

``The purchase of the shares bore no resemblance to an investment of banking funds, made to earn income pending a need for their deployment in the making of advances and the like; it bore no

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ATC 4857

resemblance to an investment by way of erecting a second or third line of defence against a time of stringency or emergency. It was an acquisition, not of the kind that might be repeated in the course of the profit-earning process, but made once and for all for the sake of enhancing, even if only for the time being, the profit-earning potential of the enterprise as a whole... The acquisition of those shares did not follow any pattern of investment that the National Bank had followed; it is to be accounted for solely as part and parcel of the take-over of the Queensland National Bank's whole undertaking, so that in respect of purpose it was, as I have suggested, akin to a purchase of goodwill rather than a purchase of property to be turned over in the course of business. As the purchase of the shares stood outside the course of the banking business, the sale of them likewise stands outside it.

The profit from the sale was in my opinion a capital profit according to ordinary business concepts.''

It will be apparent from this passage that an investment fund of a bank (or of an insurance company) will not be excluded from its banking (or insurance) business because it is unlikely to be utilised for the making of a payment in that business, being reserved as ``a second or third line of defence''. Like the last line at Torres Vedras, it may not need to be called upon, but it is nevertheless an integral part, although only as an ultimate reserve, in the whole operation. It was not as a reserve, but because their purchase ``stood outside the course of the banking business'' that the shares in National Bank of Australasia did not yield a revenue profit upon their sale.

The facts of the present case, as found by the Administrative Appeals Tribunal, fall short of establishing the fundamental separation of the investments in question from the business of the appellant which its case requires. Bearing in mind especially the statutory criterion of solvency and the terms of the appellant's own Articles of Association, there is no escape from the conclusion that the investments were to be counted in its reserve funds. Since their sale was therefore an integral part of the conduct of the appellant's business of insurance, the resulting gain was upon revenue account. The appeal must accordingly be dismissed with costs. However, I agree with Gummow J. that the form of the order made below should be varied. An order of the kind proposed was made in a comparable situation in
F.C. of T. v. The Swan Brewery Company Limited 91 ATC 4637 at 4646 .