Colonial Mutual Life Assurance Society Limited v Federal Commissioner of Taxation [1946] HCA 60

The Society is a mutual life-assurance company limited by guarantee. Its profits are divisible only amongst its policy-holders. Every person effecting a policy for a life or other assurance annuity or endowment with the Society with participation in profits becomes a member of the Society. The Society carries on as its principal business that of life assurance, either full life policies, or endowment policies and annuities, and also carries on the business of accident

insurance. The Society has been in business since 1873 and has ssurance fund at the end of the year

(1) (1911) 2 KB. ¢ (19 K.B. 4 610: See pp. 616, 617.

1940 in the ordinary department of life assurance (excluding the life H- C. or A.

assurance fund in the industrial department and the accident insurance fund) standing at over £21,000,000. A number of grounds of objection were made to the assessment but the only ground which was argued before Starke J. and raised on this appeal is whether the net profit of £27,713 made on the sale and maturity of certain investments in Australia, New Zealand, Great Britain and South Africa during the year of income is a capital profit and not taxable as the Society contends, or an income profit and therefore part of the assessable income of the Society as the Commissioner contends.

From the evidence tendered on behalf of the Society it appears that the solvency of a life-assurance company depends upon its accumulated funds being at any time sufficient to meet its estimated liabilities under its policies. The Society makes an annual actuarial investigation in order to ascertain its position in this respect. Any net surplus in the fund over these liabilities, after allowing for the expenses of the business and other contingencies, is available for distribution amongst the policy-holders in the form of a bonus or in such other manner as the directors may decide. An actuarial liability has to be provided for a policy immediately upon its issue, which is in effect that portion which must be set aside from each premium to provide for the payment of the policy at its maturity, assuming that the portion set aside earns a certain rate of interest. In the case of the Society the assumed rate is three per cent per annum. Estimates are made of certain expenses and liabilities which must be deducted from the balance of each premium, and the residue after such deductions, together with the other income earned by the assets of the Society after deducting therefrom such amounts as are required to be retained for various purposes, represents the net surplus.

The fundamental policy of the Society in investing its funds is based on buying sound securities in order to hold them until maturity.

The predominant if not the sole consideration in acquiring securities is to obtain the most effective interest yield during the period between the date of acquisition and that of maturity. The greater the eflec- tive interest yield from the investment of the premiums over the assumed rate of three per cent, the greater the net surplus available for distribution among the policy-holders and the more attractive the policies of the Society become to the public in comparison with those of its competitors. In the year ending 31st December 1940 the effective interest yield was £4 8s. Id. per cent. In order to maintain and increase the effective interest yield securities are "switched " from time to time, that is to say some are realized

CoLontaL Morvan Lire ASSURANCE Socrery Lrp. v. Fepprat IMLIS- NER OF TAXATION.

and the proceeds of sale immediately re-invested in other securities ; but the percentage of funds so switched is small in comparison with the total holdings. In the accounting period it was higher than usual, due to the disturbance of interest rates and conditions of investment generally on account of the war, but even then the sales were only eight point seven per cent of the total stocks and debentures. The important factor in this investment process is that in calculating the effective interest yield from a security the Society takes into account not only the annual interest payable on the security, but also the price below or above par at which the security is acquired. Two illustrations are given in the evidence - one of £100 four and one-half per cent stock purchased at £102 13s. six years before maturity which would give an effective annual yield of four per cent over the intervening period, and the other of £100 three and one-half per cent stock purchased at £97 7s. 3d. six years before maturity which would also give the same effective annual yield, in the first instance after apportioning and charging the depreciation in the capital value of the security between the date of purchase and that of maturity against the annual interest, and in the second instance apportioning and adding the accretion in the capital value of the security to the annual interest. Although this depreciation or accretion in capital value is thus apportioned and taken into account in arriving at the annual net surplus, the Society claims that the only amount which should be returned as assessable income of the Society is the actual annual interest received from the securities.

Prima facie the depreciation in or accretion to the capital value of a security between the date of purchase and that of realization is a loss of or accretion to capital and is therefore a capital loss or gain and does not form part of the assessable income: Lomaa v. Peter Dixon & Son Ltd. (1). Butin the words of the Lord Justice Clerk in Californian Copper Syndicate v. Harris (2) which have been so often quoted, "it is equally well established that enhanced values obtained from realization or conversion of securities may be so assessable, where what is done is not merely a realization or change of investment, but an act done in what is truly the carrying on, or carrying out, of a business."

The Income Tax Assessment Act defines "income from personal exertion" to mean income consisting of inter alia the proceeds of any business carried on by the taxpayer. Section 26 (a) provides : - "The assessable income of a taxpayer shall include - (a) profit arising from the sale by the taxpayer of any property acquired by him for the purpose of profit-making by sale, or from the carrying on

(1) (1943) K.B. 671. (2) (1904) 5 Tax Cas. 159, at p. 166.

or carrying out of any profit-making undertaking or scheme." Such H- © oF A.

profits are included in the definition of income from personal exertion. It is not contended that the inclusion of the proceeds of any business carried on by the taxpayer in the definition of income from personal exertion makes all the proceeds of a business income for the purposes of the Act; and it is common ground that, as Jordan C.J. held in Scott v. Commissioner of Taxation (1) in relation to a similar provision in the Income Tax (Management) Act 1934 (N.S.W.), the definition only refers to proceeds which would be held to be income in accordance with the ordinary usages and concepts of mankind, except in so far as the Act states or indicates an intention that receipts which are not income in ordinary parlance are to be treated as income.

The appellant contends that the maxim expressio wnius exclusio alterius applies, and that receipts which are of a capital nature are only made income for the purposes of the Income Tax Assessment Act so far as they are caught by the express provisions of s. 26 (a). But we cannot see why such receipts should not be income where they would be income according to ordinary usages and concepts. Starke J. found, and this finding has not been attacked, that the purpose of the appellant in varying or switching its securities from time to time was to increase the effective interest yield irrespective of whether the variation was or was not likely to produce an accretion to capital. The new investments were not therefore acquired for the purpose of profit-making by sale. In view of this finding the respondent cannot bring the case within the first limb of s. 26 (a). As Rowlatt J. pointed out in Devon Mutual Steamship Insurance Association v. Ogg (2), " There must be the finding that the purchase was made with the intention of selling at a profit, in other words, of initiating a trade. Here that is negatived. It seems to me that Mr. Latter [in this case Mr. Hudson] cannot get the case on its legs without a finding in the affirmative on that point."

The crucial question is whether the net profit of £27,713 is a profit arising from the carrying on or carrying out of a profit-making scheme, and if it is not whether this net profit is income according to ordinary usages and concepts. As Lord Parker said in Liverpool and London and Globe Insurance Oo. v. Bennett (3), " This question ought, in my opinion, to be determined on ordinary business principles, having regard to the circumstances under which, and the purposes for which, the investments were made and are held by the appellant company."

Since the future interest to be earned by the investment of the premiums is taken into account in determining what portion of the

premium must be set aside to pay the policy at its maturity, and the expenses and other contingencies of the business must be met by the investment of the balance, it is clear that the investing of its funds is part of the business of the Society.. It was held in Northern Assurance Co. v. Russell (1) that the profits or gains of a company carrying on the business of life assurance can only be ascertained by actuarial calculation, and that the profits and gains are not, as in the case of contracts of insurance like fire insurance which are for one year only, the amount of the net premiums and other income received during the year less the amounts required to meet claims and the expenses and other outgoings of the business, but the net surplus after provision has been made for the liabilities of the com- pany on certain assumptions as to the rate of mortality, the rate of interest, and the amount of expenses likely to be experienced in the future. The Lord President of the Court of Exchequer, Scotland, laid down in that case five propositions as useful guides to the Income Tax Commissioners dealing with cases of this description. Of these propositions we need quote only 2 and 5: " (2) that the interest of investments which has not suffered deduction of Income Tax at its source must be taken into account in ascertaining the assessable amount of profits and gains of the company . . . (5) Where the gain is made by the company (within the year of assessment . . .) . . . by realizing an investment at a larger price than was paid for it, the difference is to be reckoned among the profits and gains of the company" (2). In Clerical, Medical, and General Life Assurance Society v. Carter (3) it was held that a life assurance company could be made liable to income tax on the interest of invest- ments made by the company for the purposes of its business, although the income tax on interest from such investments which had been deducted at the source exceeded the amount of the profits of the company for the year of assessment. It appears from this and other cases that under the English Income Tax Acts the Commissioners have the choice of bringing interest from investments into account in determining the annual profits or gains of the company from a trade exercised in the United Kingdom under Case 1 of Schedule '"' D," or of separately assessing the interest as income from property under other cases. If it is brought into account in determining the annual profits or gains the amount of tax on the interest deducted at the source must be credited against the amount of tax on the annual profits or gains. In Last v. London Assurance Corporation (4) the company was assessed on the annual profits or gains. The form of

in) 571. (8) (1889) 22 Q.B.D. 444, (2) (1889) 2 Tax Cas t

final assessment made after the decision of the House of Lords appears in the footnote to the Clerical, Medical, and General Life Assurance Society v. Carter (1), in the court below, the final item being for the amount remaining to be assessed or the amount of which tax had been overpaid, as the case might be. But the result of assessing the tax on interest from investments separately was that interest on investments made and retained abroad escaped tax : Gresham Life Assurance Society Ltd. y. Bishop (2). This led to the case of the Liverpool and London and Globe Insurance Oo. v. Bennett (3), where a fire and life insurance company had interest-producing investments abroad and at home, the interest from the investments abroad being received abroad and not remitted to the United King- dom. It was held that the income of the foreign investments formed part of the profits and gains of the company's business and was properly taxed under Case 1. Lord Shaw said: " The series of pro- positions in Northern Assurance Co. v. Russell (4) and Scottish Union and National Insurance Co. v. Smiles (5), which were formulated as instructions to the Commissioners, cover the present case, and have never been judicially controverted as a convenient guide" (6). It also appears from the form of final assessment in Last's Case (7) and from Royal Insurance Co. Ltd. v. Stephen (8) that profits and losses made upon a realization of investments are, in accordance with the fifth proposition in Northern Insurance Co. v. Russell (4), usually taken into account in assessing the profits and gains taxed under Case 1. On the other hand, in Brice v. Northern Assurance Co. (9), (one of the three cases before Hamilton J. which led to the appeal to the House of Lords in Liverpool and London and Globe Insurance Co. y. Bennett (10)) it was proved to the satisfaction of the Commis- sioners that it was not part of the business or trade of the company to deal in investments or to vary its investments or to make profits by so doing ; that investments were not made or sold with the inten- tion of earning profits and were rarely realized and then only for special reasons, and that any sums realized in excess of the cost of such investments were treated as and were capital and carried to Capital Investment Reserve Fund or used in writing off depreciation on other securities and were not in any way used or dealt with as profits or gains or taken into account for dividend purposes. Accord- ingly, the Commissioners held that a sum of £6,690, the net proceeds

of sale of investments, was not profit or gain derived or arising from

. the company's trade or business and that it was capital and not

subject to be assessed to income tax. There was an appeal to Hamilton J. on this point but in view of this finding it was abandoned. His Lordship, however, appears to have agreed with the finding and said: "I take it that throughout the object of these investments it is not to do what I venture to call a stock-jobbing business, it is not to invest money with the object of getting in and getting out of rapidly moving investments, but is, as is stated expressly in the Liverpool and London and Globe Case (1) in order to have a fund created out of accumulated profits in past years and not distributed, and which may be easily realizable if required " (2). The same view that a profit on the sale of investments was not on the facts of that case a profit made by trading by a company carrying on an insurance business other than life assurance but was a profit made on a change of investments for the purpose of securing a higher rate of interest was taken by the Commissioners and upheld on appeal by a majority of the Court of Session, Scotland, in Commissioners of Inland Revenue v. Scottish Automobile & General Insurance Co. Ltd. (3). But the insistence by Lord Shaw upon the correctness of the whole of the series of propositions enunciated in Northern Assurance Co. v. Russell (4) after he had presumably read the remarks of Hamilton J. in the court below, and the criticism by the Privy Council of some dicta in Commissioners of Inland Revenue v. Scottish Automobile & General Insurance Co. Ltd. (5) in Punjab Co-operative Bank Ltd., Amritsar v. Commissioner of Income-Tax, Lahore (6), coupled with the willingness of the Inspector of Taxes in Royal Insurance Co. Ltd. vy. Stephen (7) to allow a loss on realization amounting to £754,000 as a deduction in computing its profits assessable under Case 1, tends to show that the sounder view is that profits and losses on the realiza- tion of investments of the funds of an insurance company should usually be taken into account in the determination of the profits and gains of the business.

There is in England an additional complication where the taxpayer is a mutual insurance company. Apart from statute, surpluses arising out of the transactions of purely mutual insurances between an association as insurer and its members as the insured are not assessable to income tax as profits and gains of a trade because the common fund is composed of sums provided by the contributors out of their own moneys, and any surplus after satisfying claims whether

(5) (1931) 16 Tax Cas. 381. (6) (1940) A.C. 1 at p. 1072. 47) (1928) 14 Tax Cas. 22.

it goes back to the contributors in reduction of their premiums or in 1. ©. or A.

enhancement of the sum insured, is in essence a return of their own moneys which they have overpaid and is not a profit : New York Life Insurance Co. v. Styles (1); Jones v. South-West Lancashire Coal Owners' Association (2); Municipal Mutual Insurance Ltd. v. Hills (3); Inland Revenue Commissioners v. Ayrshire Employers Mutual Insurance Association Ltd. (4). In Hills' Case (5) Lord Warrington of Clyffe said: " Tt is now settled by the decisions above referred to, and is not disputed, that the mere carrying on of such a business is

not a trade, nor are the surpluses profits, for the purposes of Income Taxartioy.

But the position is different under the Income Tax Assessment Act. Under Part III., Div. 8, of this Act, all companies carrying on the business of life assurance are assessed for ordinary income tax on the

. same basis, whether they are companies which carry on business with a view to making profits for their shareholders or are mutual assurance companies. The definition of a mutual life assurance company was introduced into s. 110, which is one of the sections in Part III., Div. 8, and into s. 160c (1a) by the Income Tax Assessment Act 1942. But these amendments do not affect the assessment under appeal and in any event the amendment of s. 110 has no operative effect in Part II, Div. 8, and appears to have been introduced for the pur- poses of Part I11a, which deals with further tax on the undistributed income of a company. Part III., Div. 8, includes ss. 110-116. Section 111 provides that "' the assessable income of a life assurance company shall not include premiums received in respect of policies of life assurance, or considerations received in respect of annuities granted." Section 115 provides, that four per cent (reduced to three per cent by Act No. 22 of 1942) of the " calculated liabilities " of a life assurance company shall be an allowable deduction. The assessable income of a life assurance company, whether it is a mutual assurance company or not, is therefore all the income of the company except its premiums, and from that income there can be deducted the ordinary deductions authorized by the Act as modified by Part III., Div. 8, and the special deduction allowed by s. 115.

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 collec- tion of the premiums. The purpose of investing the funds of the appellant is to obtain the most effective yield of income. The

(1) (1889) 14 App. Cas, 381. (4 (2) (1927) A.C. 827. (6 (3) (1931) 16 Tax Cas, 430,

~ diminution or increase in the capital value of the investment between the date of purchase and that of maturity, and the apportionment and deduction or addition over the intervening period of that diminution from or increase to the interest actually payable on the investment is a material ingredient in the ascertainment of this yield. In Konstam, Law of Income Taa, 8th ed. (1940), p. 126, it is stated that "the buying and selling of investments is a necessity of insurance business ; and where an insurance company in the course of its trade realizes an investment at a larger price than was paid for it, the differ- ence is to be reckoned among its profits; conversely any loss is to be deducted." This view is in line with that of the Privy Council in the case of a bank in Punjab Co-operative Bank Ltd., Amritsar v. Commissioner of Income-Taa, Lahore (1). 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 acquisi- tion 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 realization 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 society employs an expert staff whase business it is continu- ously to supervise and plan the investment and, if necessary, the realization and re-investment of its funds as they exist and are augmented from time to time by fresh premiums with a view to obtaining the most effective interest yield. The accretion in capital value is used for the purpose of increasing the effective interest yield from the investment and therefore for an income purpose : Cunard's Trustees v. Inland Revenue Commissioners (2). It is as much a source of income as the interest payable on the invest- ment: Inland Revenue Commissioners v. Desoutter Bros. Ltd. (3). We can see no distinction in substance between the profit or loss made when an investment is subsequently converted into cash by sale and when it subsequently matures and is paid off. As Rowlatt J. said in Royal Insurance Oo. Ltd. v. Stephen (4): " At the bottom of this principle of waiting for a realisation, I think there is this idea : while an investment is going up or down for Income Tax purposes the Company cannot take any notice of fluctuations, but it has to take notice of them when all that state of affairs comes to an end,

(1) (1940) A.C, 1055, at pp. 1072, (3) (1945) 174 L.-T. 162. 1073. (4) (1928) 14 Tax Cas., at p. 28.

when an investment ceases to figure in the Company's affairs, when it is known exactly what the holding of that investment has meant, plus or minus to the Company, and then the Company starts so far as that portion of its resources is concerned with a new investment. Then one knows where one is and it is no longer a question of paper, it is a question of fact and that is a realisation." It is not necessary to show a regular business of buying and selling to bring a source of profit within the meaning of the word " trade " in Case | of Schedule D of the English Act: Cordy v. Barry (1). The profit of £27,713 was as much a profit from the carrying out of a profit-making scheme as the interest payable on the investments from which this profit was derived. It was therefore a profit within the meaning of the second limb in s. 26 (a). Alternatively it was a profit according to the ordinary usages and concepts of mankind.

Solicitors for the appellant: Moule, Hamilton & Derham. Solicitor for the respondent: @. A. Watson, Acting Crown Solicitor for the Commonwealth. (1) (1946) W.N. (Eng.) 170.