Edited version of your private ruling

Authorisation Number: 1012449607416

Ruling

Subject: Life insurance policy

Question

Is entity A entitled to a deduction for the costs of the life insurance policy?

Answer

No.

This ruling applies for the following periods

Year ended 30 June 2010

Year ended 30 June 2011

Year ended 30 June 2012

Year ended 30 June 2013

The scheme commenced on

1 July 2009

Relevant facts

Entity B is a former director of entity A.

Before entity B resigned as director, a new director, entity C was appointed. Entity C remains director of entity A.

Entity B incurred significant debts. Some of these debts were as guarantor for entity A's debts.

Entity C has taken out life insurance in their own name against the death of entity B. In the event of the death of entity B, the life insurance payout to entity C may be used to pay entity A's debts.

The life insurance premiums have been paid by entity A.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 8-1.

Reasons for decision

Section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997) allows a deduction for a loss or an outgoing to the extent to which it is incurred in gaining or producing assessable income, except where the loss or outgoing is of a capital, private or domestic nature.

A number of significant court decisions have determined that for an expense to be an allowable deduction:

· it must have the essential character of an outgoing incurred in gaining assessable income or, in other words, of an income-producing expense (Lunney v. FC of T; (1958) 100 CLR 478), 

· there must be a nexus between the outgoing and the assessable income so that the outgoing is incidental and relevant to the gaining of assessable income (Ronpibon Tin NL v. FC of T, (1949) 78 CLR 47), and

· it is necessary to determine the connection between the particular outgoing and the operations or activities by which the taxpayer most directly gains or produces his or her assessable income (Charles Moore Co (WA) Pty Ltd v. FC of T, (1956) 95 CLR 344; FC of T v. Hatchett, 71 ATC 4184).

Taxation Ruling IT 155 provides guidance regarding the assessability and deductibility of premiums paid and proceeds received in respect of key man insurance policies.

IT 155 states the Commissioners practice in relation to insurance policies taken out by businesses in respect to key persons is to:

· treat the premiums as non-deductible and the proceeds as non-assessable if a life policy is involved; and

· treat the premiums as deductible and the proceeds as assessable income if an accident or term policy is involved.

IT 155 makes reference to the decision in Carapark Holdings Ltd v. Federal Commissioner of Taxation (1967) 14 ATD 402 (Carapark). In Carapark, the Court carefully considered the facts in order to determine the purpose for which the taxpayer entered into the insurance contract. It was held that an insurance payment received by the taxpayer as policy holder following the accidental death of a company employee constituted assessable income of the taxpayer because the purpose of the insurance was to fill the place of a revenue receipt (which was the event insured against).

The decision in Carapark may also be used as a basis for determining claims for the deduction of premiums as an expense.

IT 155 also provides examples of situations in which premiums on insurance policies would not be deductible as an expense and the proceeds would not be assessable as income. These include:

(a)       insurance taken out by a company in respect of a director for the purpose of providing, in the event of death by accident, funds for the payment to his estate of a debt owing to the director (see 3 NZ TBRD Case 9);

(b)       insurance taken out by one partner in respect of another for the purpose of providing in the event of the other partner's death by accident, funds to buy out his estate's interest in the partnership; and

(c)       insurance taken out by a manufacturer in respect of a supplier of components for the purpose of providing, in the event of the supplier's death by accident, funds to buy the supplier's business.

Therefore, following the reasoning established in Carapark and in IT 155, the purpose for which a taxpayer may enter into an insurance contract may be for revenue or capital events. In general, if the purpose of entering into an insurance contract is for a revenue event, then the premiums will be deductible as an expense and any proceeds will be assessable as income. If the purpose of entering into an insurance contract is for a capital event, then the premiums will not be deductible as an expense and any proceeds will not be assessable as income.

In this case, a life insurance policy was taken out to cover the life of a former director of entity A. Any payout from the policy may be used to pay the company debts incurred by the previous director. Such a purpose is not considered to be revenue in nature and does not relate to the day to day income earning activities of the company. Therefore, the expenses incurred for the life insurance policy is not an allowable deduction as highlighted in IT 155.