Commissioner of Taxation (Cth) v Smith

In his income tax return for the year ended 30 June 1978 the taxpayer included as income the sum of $2,112. He also claimed a deduction under s. 51 of the Income Tax Assessment Act 1936, as amended for $91, this being the amount of a premium paid by him on the renewal of the policy for the year commencing 1 June 1978. The Commissioner included the sum of $2,112 in the computation of assessable income, but rejected the deduction. The taxpayer objected to the assessment, and on the objection being overruled appealed to the Supreme Court of Western Australia. Wickham J. decided that the moneys received under the policy were not income, and that no deduction should be allowed for the premium [1] .

The Commissioner appealed to the Federal Court, claiming that the payments under the policy were income, and the taxpayer cross appealed, claiming that the premium was an allowable deduction. The Federal Court (Bowen C.J., Franki and Toohey JJ.) unanimously allowed both the appeal and the cross appeal [2] . The Commissioner now appeals by special leave to this Court from the decision on the cross appeal, and the taxpayer pursues a cross appeal which seeks to restore the decision of Wickham J. in respect of the moneys received under the policy.

1. (1979) 38 F.L.R. 115; 29 A.L.R. 586; 10 A.T.R. 301; 79 A.T.C. 4553.

It is convenient to consider first the issue which is raised on the cross appeal, because if it is correct to include the moneys received under the policy in the assessable income of the taxpayer then that consideration is relevant to, though not necessarily determinative of, the question whether the premium is deductible under s. 51.

Mr. Rowland, counsel for the taxpayer, argues that the moneys received under the policy represent payments made for the loss of a capital asset. That asset is the taxpayer's ability to work as a medical practitioner, carrying with it the capacity to earn income. The policy, although the promise of the insurer is described in terms of an "indemnity" for disability, is not properly described as providing an indemnity against loss of income. There is no necessary correspondence between moneys receivable under the policy and the income loss suffered by the taxpayer. It follows, then, so Mr. Rowland says, that the moneys in question do not fall within assessable income by reference either directly to s. 25 (1) (a) or to s. 26 (j). In any event, so far as the bonus is concerned, there is no provision for this in the policy and therefore nothing in the circumstances to give it the character of income.

It will be seen that the taxpayer relies heavily on the construction of the policy, and of course it was the view he took of the policy which led Wickham J. to find for the taxpayer on this issue. So far as it is material to the present case, the policy provides that the insurer will pay a "monthly indemnity of $600 payable each month subject to proof of loss during any period of total disability sustained by the insured as the result of injury". The benefit is not payable in respect of the first thirty days of disability. "Total disability" is defined in the policy to mean "the inability of the insured by reason of injury to perform each and every gainful occupation for which he is reasonably suited by education, training or experience except that during the first two years of any such period of disability the insured shall be deemed to be totally disabled while he is both (1) unable to perform each and every duty of his occupation; and (2) not engaged in any occupation or employment for wage or profit". Benefits under the policy are to be reduced by any amounts paid under workers' compensation legislation.

From his review of the policy, Wickham J. concluded that "this is clearly an insurance against loss of an ability". So much may be conceded, as also the proposition that capacity or ability to earn is a capital asset. But, with respect, these conclusions do not carry the taxpayer far enough to establish the contrary of the Commissioner's assertion that the moneys paid under the policy were paid in substitution for income and therefore take the place of a revenue receipt. If the ability to earn is the tree, and income the fruit thereof, a policy of insurance against impairment of the fruit-bearing capacity of the tree may well take the form of providing the fruit until such time as the tree recovers its proper role. The degree of correspondence, if any, between the moneys payable under the policy and the actual pecuniary loss of revenue suffered by the insured is a relevant factor, but it is not necessary to look for an indemnity measured with any precision against the loss. Any fruit is better than none, whether or not it represents adequate compensation for the loss.

Mr. Rowland points to some features of the policy to support his contention that the moneys paid under the policy do not bear a revenue character. No indemnity is payable in respect of the first thirty days of disability. If the disability continues beyond two years, then the monthly indemnity continues notwithstanding that the insured is then earning an income of whatever proportions so long as it remains the case that he is disabled from performing "each and every gainful occupation for which he is reasonably suited by education, training or experience". It is true that these features of the policy make it unlikely that the moneys received under the policy will bear any direct correspondence to the loss of earnings suffered by the insured. But do they fix those receipts with a character other than income? The existence of a qualifying period of thirty days is in our opinion entirely neutral in this regard. The fact that after a period of two years' disablement during which the insured is unable to engage in any gainful occupation at all he may then engage in some occupation other than that for which he is suited without jeopardising the continued receipt of benefits under the policy does not give those receipts a character different from that which would have attached during a period without any earnings at all. Even after the period of two years has elapsed, the inference of loss still remains. The loss of "ability to earn" in one's own calling is most likely to be reflected in an actual loss of earnings.

It is also to be noted that payment of workers' compensation will reduce the benefits payable under the policy. The significance that attaches to the question in the Proposal form, namely, "What portion of your average earnings does the disability indemnity under all policies you have and are applying for represent?" may not be readily apparent, but at least it does not suggest that capital gain consequent upon a disablement is in contemplation.

In our opinion the conclusion is inescapable that the purpose of the policy is to diminish the adverse economic consequences of injury by accident. It was to provide a monthly indemnity against the income loss arising from the inability to earn. The revenue character of the benefits is so clearly stamped upon them during the period of two years during which the insured is totally disabled from earning that the remote possibility of him enjoying some windfall thereafter by reason of his securing gainful employment of the kind prescribed is of no consequence.

It follows from what we have said that the Commissioner is also entitled to include the benefits received by the taxpayer under the policy as assessable income pursuant to s. 26 (j).

The bonus of 20 per cent is also in our opinion rightly included in assessable income, for the reason that it was received as a bonus in respect of the payment of benefits under the policy, and necessarily partakes of the same character as those benefits.

It remains to consider the appeal of the Commissioner from the finding of the Federal Court that the premium paid by the taxpayer in June 1978 was an allowable deduction within s. 51 (1), as being within the description "All losses and outgoings to the extent to which they are incurred in gaining or producing the assessable income except to the extent to which they are losses or outgoings of capital or of a capital, private or domestic nature".

Mr. Franklyn, counsel for the Commissioner, argues that the payment claimed as a deduction does not fit this description. He puts his contention in two ways. In the first place, he says that it was not an outgoing incurred in gaining or producing assessable income. Alternatively, he claims it to have been of a capital or private nature. He denies the existence of a sufficient nexus between the payment and income, pointing to the fact that supervening events must occur before any income is received, and to the fact that the payment of each successive annual premium initiates a new policy which requires to be evaluated quite independently of the operation of the policy in earlier years and payments made thereunder.

In our opinion both of these submissions must fail in the light of the principles established by the earlier decisions of this Court: W. Nevill & Co. Ltd v. Federal Commissioner of Taxation [3] ; Ronpibon Tin N.L. v. Federal Commissioner of Taxation [4] ; Charles Moore & Co. (W.A.) Pty. Ltd. v. Federal Commissioner of Taxation [5] ; Federal Commissioner of Taxation v. Finn [6] . In Charles Moore, which was a case where employees of the taxpayer were robbed at gunpoint as they took the previous day's takings to the bank, the judgment of the Court contained these words [5] :

But unfortunately it "(i.e. the robbery)" is still a familiar and recognised hazard and there could be little doubt that if it had been insured against the premium would have formed an allowable deduction. Phrases like the foregoing or the phrase "incidental and relevant" when used in relation to the allowability of losses as deductions do not refer to the frequency, expectedness or likelihood of their occurrence or the antecedent risk of their being incurred, but to their nature or character. What matters is their connection with the operations which more directly gain or produce the assessable income. The section does not require that the purpose of the expenditure shall be the gaining of the income of that year, so long as it was made in the given year and is incidental and relevant to the operations or activities regularly carried on for the production of income. What is incidental and relevant in the sense mentioned falls to be determined not by reference to the certainty or likelihood of the outgoing resulting in the generation of income but to its nature and character, and generally to its connexion with the operations which more directly gain or produce the assessable income. It is true that the payment of the premium in June 1978 did not result in the generation of any income in that year, but there is a sufficient connexion between the purchase of the cover against the loss of ability to earn and the consequent earning of assessable income to bring the premium within the first limb of s. 51 (1). Likewise the periodic nature of the payment and other provisions in the policy which contemplate its renewal from year to year militate against its characterization as an outgoing of a capital nature. Nor is there any reason whereby it could assume a domestic or private nature. 1. (1937) 56 C.L.R. 290, at p. 305. 2. (1949) 78 C.L.R. 47, at pp. 56-57. 3. (1956) 95 C.L.R. 344, at p. 351. 4. (1961) 106 C.L.R. 60. 5. (1956) 95 C.L.R. 344, at p. 351.

We would add that we find ourselves in agreement with the reasons of the Federal Court as expressed by Toohey J. [8] .

1. (1979) 38 F.L.R. 115; 29 A.L.R. 586; 10 A.T.R. 301; 79 A.T.C. 4553.

The question of costs remains to be considered. It was a condition of the grant of special leave that the order for costs in the Federal Court is not to be disturbed and that the Commissioner should pay the costs of the appeal and cross appeal in this Court, in any event. That condition determines the matter so far as the proceedings in this Court are concerned. However, the Federal Court did not make any order as to costs. The costs both of the hearing in the Supreme Court and of the appeal and cross appeal to the Federal Court are matters over which the parties are in dispute. The Court has had the benefit of written submissions on the matter, and it is agreed that we should deal with it.

We would make an order in favour of the taxpayer in respect of all his costs in all three courts. We reach this conclusion in relation to the earlier hearings because of the special circumstances of the case. The consequence of the decision which we have reached on the appeal and the cross appeal is that the benefits received by the taxpayer are to be included in his assessable income, and the premium paid on the subsequent renewal of the policy is an allowable deduction under s. 51. This is precisley the form in which the taxpayer made his return. The Commissioner disallowed the deduction, where upon the taxpayer objected and the litigation serial began. We think there is substance in the taxpayer's submission that, in the Supreme Court and the Federal Court, his claim that the benefits were not assessable was dependent on the stand taken by the Commissioner against the deductibility of the premium. In a very real sense, therefore, the central issue was the question whether the premium was deductible. It is on this issue that the Commissioner has failed. In our opinion the taxpayer is entitled to all his costs.

The appeal by special leave and the cross appeal should be dismissed. The payment of the premium should be treated as allowable expenditure, as an outgoing made in order to earn assessable income. The payments to the taxpayer are in the nature of payments to compensate for loss of income. The insurance policy provided for payments of $600 per month during the period of incapacity (with some qualifications which are not material). In fact the insurer paid $720 per month, because of its favourable experience with the group through which the taxpayer insured. The payments resembled periodical payments of workers compensation, and should be treated as income.

The taxpayer argued (relying on Atlas Tiles Ltd. v. Briers [9] and certain statements in Cullen v. Trappell [10] ), that the receipts should be treated as capital. It would be unfortunate if the sterile controversy about loss of future earnings as contrasted with loss of future earning capacity which has emerged in personal injury cases were to be carried over into tax cases.

1. (1978) 142 C.L.R. 202. 2. (1980) 146 C.L.R. 1.

The fact that the receipts were calculated on a monthly basis points significantly, in a taxation sense, to the receipts being of an income nature. The premiums paid to achieve that income (if the contingency occurred) should be treated as allowable expenditure. If the premiums were paid to achieve a lump sum payment, for example for the loss of an eye, or for total or even partial permanent incapacity, presumably this should be treated as a capital receipt and the premium paid should be treated as of a capital nature. In general, if receipts under such a policy would be treated as income, the premiums should be treated as allowable expenditure, and if the receipts would be treated as capital the premiums should not be allowable expenditure. Of course, there are circumstances where the premiums could be regarded as paid to acquire, if the contingency occurred, a benefit in the nature of an annuity; although the periodical sums received would be income, the premium could be regarded as paid to obtain a capital asset, the annuity. The Commissioner's argument was, as I understand it, that this was the arrangement here. To regard the policy in this way would introduce undue technicality and over-concentration on the analysis of intermediate steps. A practical business approach is to treat these amounts as the taxpayer did in his original return, that is, the premium as allowable expenditure and the receipts under the policy as assessable income. The Commissioner should pay the costs in all courts.