FEDERAL COURT OF AUSTRALIA

Commissioner of Taxation v Haass [1999] FCA 1088

TAXES AND DUTIES – ascertainment of assessable income – life insurance policy – intention at time of purchase to surrender policy when 10 year old child of policy holder commenced tertiary education –  loan from insurer for payment of premium – policy surrendered after two years when loan and interest equalled cash value – whether net return assessable income

Federal Commissioner of Taxation v The Myer Emporium Limited (1987) 163 CLR 199 applied

Westfield Limited v Federal Commissioner of Taxation (1991) 28 FCR 333 applied

Case 41/97 (1997) ATC 437 mentioned

Glennan v Commissioner of Taxation (1999) 99 ATC 4467 mentioned

COMMISSIONER OF TAXATION v HELMUTH WOLFGANG HAASS

T 3 OF 1999

HEEREY J

13 AUGUST 1999

MELBOURNE (HEARD IN HOBART)

THE COURT ORDERS THAT:

1.         The appeal be allowed.

2.         Decision of the Administrative Appeals Tribunal dated 5 February 1999 is set aside.

3.         The decisions under review by the Tribunal and the assessments are confirmed.

4.         Respondent pay the applicant’s costs of the appeal, including reserved costs.

Note:    Settlement and entry of orders is dealt with in Order 36 of the Federal Court Rules.

REASONS FOR JUDGMENT

1                     The Commissioner of Taxation appeals from a decision of the Administrative Appeals Tribunal that a return to the respondent of $18,009.03 under a life policy issued by National Mutual Life Association of Australasia Ltd was not assessable income.

2                     The question of law raised on the appeal is whether that amount was income according to ordinary concepts.

The respondent’s policy

3                     On 4 February 1990 the respondent signed a proposal for a life policy issued by National Mutual.  The life assured under the policy was the respondent’s daughter, then aged 10.  As the AAT found, the respondent had in mind surrendering the policy when the time came to fund his daughter’s tertiary education.  The applicant carried on business as a real estate agent but purchase of the policy was not a transaction in the ordinary course of that business. 

4                     Regrettably, the policy itself was not in evidence before the Tribunal.  However it was not disputed on the appeal that the policy had the following features:

(a)        Although purportedly a life insurance policy for a term of 35 years, the death cover component of the benefit was reduced to zero.  This was in return for a discounted premium of $100,000 per annum.

(b)        The benefit payable under the policy was a “cash (or surrender) value” which became payable two years after the commencing date of the policy provided two years’ premiums had been paid.

(c)        After payment of the second annual premium, the policy holder was able to borrow from National Mutual up to 92.5 per cent of the cash value of the policy.

(d)        If the principal and interest owed by the policy holder under any loan from National Mutual accumulated to an amount which exceeded the cash value of the policy, the policy would lapse.  This was referred to as a “journal surrender”.

5                     In the course of negotiations for the policy it was arranged between the respondent and the insurer’s agent that the respondent would pay $8,833.50 of the annual premium from his own funds and the agent would pay the balance.  This somewhat unusual feature was facilitated by the fact that the agent was entitled to receive extraordinarily high commissions. 

6                     At the time of negotiations the agent showed the respondent a table containing, for the first to tenth years, estimates of cash values, the amount of loans and interest which could be advanced for the payment of premium (or for any other purpose) and the net value of the policy.  The Tribunal accepted that the respondent did not at the time undertake calculations as to the benefits that could be obtained as a result of the surrender or lapsing of the policy at future dates.  The Tribunal said (par 24):

“We are therefore satisfied that, at the time of the purchase of the policy, the applicant [now respondent] had no intention of making a profit by obtaining a loan on the security of the policy and then allowing the policy to lapse.  He did not intend those events to occur when a need arose for funds for his daughter’s tertiary education, let alone in 1991.”

7                     On 21 February 1990 the respondent paid the first monthly premium of $8,833.50.  On 15 March 1990 he paid the balance of the yearly discounted premium ($91,167) having received on the same date a cheque from the agent for the same amount. 

8                     Policies of the kind issued to the respondent, referred to as PQ policies, were issued to many other policy holders in Tasmania and elsewhere.  During the second year in which PQ policies were in force the management of National Mutual became concerned at the potential cost to the company of this business.  Internal estimates made by National Mutual of its possible losses on these policies throughout Australia varied from $40 million to $200 million.  It therefore decided to take action to get policies of this kind off its books.  On 20 February 1991 National Mutual’s Life Insurance Manager for Tasmania wrote a pro forma letter to policy holders.  The one received by the respondent was as follows:

“Dear Policyowner,

BSDPZ Policy No:  1557362/9           Owner  H. W. Haass

                                                Renewal Date  20.2.91

With the renewal of the above policy upon us, I thought you might be interested in the attached computer printout which sets out some projected (illustrated) values in respect of the policy.  Please pay particular attention to the notes at the bottom of the printout in analysing the information.

In particular, I refer you to the following:-

1.         The policy has no surrender value until two years’ premiums have been paid and the policy has been in force for two complete years.

2.         The illustrated surrender value (assuming no debt) at the 25 month point i.e. after payment of the third premium, is less [emphasis in original]than the sum of the surrender value at the 24 month point and the premium due at that time.  you may conclude from this that if early cancellation of the policy is being contemplated, it is better not to pay the third premium.

3.         The policy provides that a maximum loan of $127278 may be applied for now, subject to payment of the second premium due at this time.  After payment of stamp duty, a net payment of $126842.53 would be available.

Should you choose to take the maximum loan on the policy you may be interested in the “Express Service” offer we are able to provide assuming certain conditions are met.  The effect of the Express Service offer is that if the conditions are met, we will make available a cheque for the net loan value at 3.15pm on the working day on which a bank cheque for the second years’ premium is received by 10.30 am that same day.

You may also be interested to know that if you choose to take the maximum loan set out above and then not pay any interest which subsequently accrues, the policy will lapse in a few months time.  This is because the policy debt will then exceed the underlying value of the policy.

I trust that this information is of assistance to you.

Yours sincerely,

Kevin Scott

Life Insurance Manager

P.S.     No interest will be charged on late payment of the premium within 30 days of renewal date of the premium.  However, if the premium remains outstanding at the end of the 30th day, the policy will automatically lapse, and no benefit whatsoever will be payable.  No subsequent application for revival of the policy will be accepted by National Mutual.”

9                     On 20 February 1991 the respondent paid the second yearly discounted premium of $100,000 and entered into a loan agreement with National Mutual to borrow $127,278.  After deduction of stamp duty he received a cheque for $126,842.53.  He did not pay any interest or principal on the loan.  On 17 September 1991, when the amount due under the loan together with the outstanding interest reached the then cash value of the policy, there was a “journal surrender”.

10                  In cash terms the respondent received $26,842.53 as a result of the transactions of 20 February 1991.  After deducting his initial payment of $8,833.50 he received a net return of $18,009.03.

The Tribunal’s decision

11                  The Tribunal discussed a number of authorities and in particular Federal Commissioner of Taxation v The Myer Emporium Limited (1987) 163 CLR 199 and Westfield Limited v Federal Commissioner of Taxation (1991) 28 FCR 333.

12                  In discussing the evidence the Tribunal said:

“23.     We therefore need to consider what intention, if any, the applicant had when he acquired the PQ policy.  If his purpose was simply to profit from the policy, and he had no intentions as to how he would do that, the profit constitutes assessable income.  If he proposed to profit by obtaining a loan, allowing the policy to lapse, and thus benefiting from the loan debt being extinguished, his gain constitutes assessable income.  If his purpose in acquiring the policy was to make a profit by that means or in one or more other specific ways, with a final choice to made at a later date, his gain constitutes assessable income.  But if he had in mind making a profit or gain in one or more specific ways other than by obtaining a loan, making no payments, and having the policy lapse, then the gain that he made as a result of that sequence of events does not constitute assessable income.

24.       As we have said, we accept that the applicant had in mind when purchasing the policy that he would use it to fund his daughter’s tertiary education when she reached that stage of her life.  Little was said as to what means, if any, he proposed to use to take advantage of the policy.  Although the applicant gave evidence, he was not asked whether he understood that, when a loan is obtained upon the security of a life policy, the policy will eventually lapse if the policy holder makes no interest payments.  We expect he had sufficient commercial experience to know that.  But policies normally lapse as a result of loan interest not being paid only as the result of inadvertence or impecuniosity.  It is most extraordinary for a policy holder to allow a policy to lapse as a result of non-payment of interest as part of a profit-making scheme.  There is no suggestion that deliberately causing the policy to lapse was discussed with the applicant, or considered by him, at the time of his purchase of the policy or at any time prior to its purchase.  Rather, that course appears to have been contemplated for the first time as a result of the letter that the insurer wrote to the applicant and all other owners of PQ policies. We are therefore satisfied that, at the time of the purchase of his policy, the applicant had no intention of making a profit by obtaining a loan on the security of the policy and then allowing the policy to lapse.  He did not intend those events to occur when a need arose for funds for his daughter’s tertiary education, let alone in 1991.

25.       The applicant was asked in his evidence in chief about how long he originally intended to keep the policy.  He said that no particular date was mentioned, but that he was advised that five years would be ‘a good time to focus on’.  He said that was not really his intention.  He said a number of times that he wanted to take advantage of the policy when his daughter reached the age when she might want to go to University.  We infer that the method by which he contemplated taking advantage of the policy at that time was the surrender of the policy.  The applicant clearly had sufficient commercial experience to know that, after a time, life policies can be surrendered and a cash payment received.  During his cross-examination he said, ‘I understood you could not cash a policy in at the beginning of a term, you had to wait until the end of the term …’.  However we do not think that passage accurately reflects the understanding that he had when he took out the policy given his early evidence as how long he proposed ‘keep the policy’ and a statement during his cross-examination that ‘All I had to do is organise my premium every year and at the time that I required the money it would be available to me’.

26.       Thus this was not a situation where a taxpayer intended to make a profit and had no intention as to the means by which the profit would be made.  It is a case in which he had a specific intention to make a profit by means other than the means by which he eventually achieved a return on his original investment.  On the basis of Westfield, it would follow that the return of $18,009.03 does not constitute assessable income.”

Conclusion on the appeal

13                  In Myer Emporium the High Court, speaking of an isolated venture or one off transaction, said (at 210):

“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.”

14                  In Westfield, Hill J, with whom other members of the Court agreed, said (at 344):

“… where a transaction falls outside the ordinary scope of the business, so as not to be part of that business, there must exist, in my opinion, a purpose of profit-making by the very means by which the profit was in fact made.”

Later on the same page his Honour said:

“While a profit-making scheme may lack specificity of detail, the mode of achieving that profit must be one contemplated by the taxpayer as at least one of the alternatives by which the profit could be realised.”

15                  In the present case the benefit expressly contemplated by the respondent was the receipt of cash in return for surrender of the policy.  A cash value for a life policy necessarily assumes the payment of premiums for some period at least, as the respondent recognised (“All I had to do is organise my premium every year”).  Whether he paid the premiums out of his own resources, or by borrowing from National Mutual or anyone else, premiums had to be paid.  The only essential departure from his initial plans was that he received the cash in return for surrender at an earlier time that he had first contemplated.  National Mutual’s letter of 20 February 1991 did not vary or offer to vary the policy in any way.  It was doing no more than drawing to the respondent’s attention, and no doubt encouraging the acceptance of, an option which was always available to the respondent and which happened to be to the benefit of National Mutual.  If a taxpayer were to acquire land intending to resell it at a profit in 10 years time, but as a result of unexpected circumstances resold after three years, profit from the resale would be assessable.  What happened in the present case was essentially no different. 

16                  For the sake of completeness I should note that there was some discussion of the fact that in Myer Emporium and Westfield the taxpayer was clearly carrying on a business.  In the present case, the respondent carried on the business of a real estate agent but the policy was made for private and domestic purposes, unconnected with his business, although of course it was a commercial transaction from the point of view of National Mutual. 

17                  This aspect was discussed in a decision of the Tribunal constituted by Deputy President G L McDonald in Case 41/97 (1997) ATC 437.  This case dealt with an identical PQ policy.  The Tribunal there noted that, in contrast with Westfield and other cases, the taxpayer was not engaged in any type of business.  The Tribunal however said that it was satisfied that the applicant entered into the transaction with the intention of securing a gain.  The Tribunal said (at 444):

“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’.”

18                  This seems to me a correct view.  It is consistent with the decision of the Full Court in Glennan v Commissioner of Taxation (1999) 99 ATC 4467 where it was pointed out that the taxpayer’s activities were not “a leisure activity or hobby, undertaken with little or no thought of financial gain”.

19                  The appeal will be allowed and the decision of the Tribunal dated 5 February 1999  set aside.  The decision under review by the Tribunal and the assessment are confirmed.  There will be an order that the respondent pay the applicant’s costs of the appeal, including reserved costs.

Associate:

Dated:              13 August 1999