Commissioner of Taxation v Haass

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.