Watson v Secretary, Department of Family

REASONS FOR JUDGMENT 1 The question of law raised in this application under s 44 of the Administrative Appeals Tribunal Act 1975 (Cth) relates to the proper construction and application of s 1075 of the Social Security Act 1991 (Cth) ("the SS Act"). 2 That question arises in this way. The applicants Craig Watson and Jan Watson, had their applications for several benefits under the SS Act rejected by Centrelink on the basis that their combined income was too high. A significant component in their combined income was a weekly benefit paid to Mr Watson under an income protection policy he had taken out with the National Mutual Life Association. The applicants complaint both in the administrative reviews they sought of Centrelink's decisions and in this application is that Centrelink misunderstood the proper character to be attributed to the payments Mr Watson received under the policy. In consequence, s 1075 should have been, but was not, applied in calculating their combined incomes. The Statutory Provisions 3 Section 8 of the SS Act contains the following definitions: "income, in relation to a person, means: (a) an income amount earned, derived or received by the person for the person's own use or benefit; or (b) a periodical payment by way of gift or allowance; or (c) a periodical benefit by way of gift or allowance; … income amount means: (a) valuable consideration; or (b) personal earnings; or (c) moneys; or (d) profits; … ordinary income means income that is not maintenance income or an exempt lump sum." 4 Section 1072 of the Act provides: "A reference in this Act to a person's ordinary income for a period is a reference to the person's gross ordinary income from all sources for the period calculated without any reduction, other than a reduction under Division 1A." 5 Section 1075(1) which is contained in Division 1A, is in the following terms: "Subject to subsection (2), if a person carries on a business, the person's ordinary income from the business is to be reduced by: (a) losses and outgoings that relate to the business and are allowable deductions for the purposes of section 51 of the Income Tax Assessment Act 1936 or section 8-1 of the Income Tax Assessment Act 1997, as appropriate; and (b) depreciation that relates to the business and is an allowable deduction for the purposes of subsection 54(1) of the Income Tax Assessment Act 1936 or Division 42 of the Income Tax Assessment Act 1997; and (c) amounts that relate to the business and are allowable deductions under subsection 82AAC(1) of the Income Tax Assessment Act 1936:" [emphasis added]. 6 The short point raised in this application is whether the payments under the income protection policy have the character of ordinary income from Mr Watson's business so as to allow the reduction for losses and outgoings permitted by s 1075(1)(a). Factual Setting 7 For about the last nineteen years Mr Watson has been engaged, first, as a life insurance agent and, latterly, as a financial planner with National Mutual Life and then with AXA Australia. He carried on that business as a sole proprietor with his wife providing paid assistance to him. 8 On 3 January 1996 he took out the income protection policy with National Mutual to which reference has been made. Under the policy the insurer undertook to pay Mr Watson a weekly benefit if he suffered either total disability through injury or sickness or a specified serious injury or sickness. The cover extended to the provision of a reduced weekly benefit if, after a specified period of total disability, Mr Watson continued to do some work but was "partially disabled". The term "partially disabled" was defined in the policy in the following way: "The person insured is partially disabled if, immediately after being totally disabled for at least 14 days, he or she is able to perform one or more income producing duties of his or her occupation but not all of them, or is working in another occupation, and - because of the disability - the amount the person insured earns for the work he or she does is less than the amount of his or her pre-disability income." 9 The term "income" had been given a particular but common meaning in the policy. It was this: "If the person insured owns part, or all, of a business or practice, income is money generated by the business due to the person insured's own activity, after all expenses in earning that income have been deducted." 10 The policy specified a formula to calculate the amount that would be paid to the insured in the event that the insured was entitled to claim for partial disability. The formula was described as follows: "The amount we pay is worked out by applying the formula: A - B x C A A equals the person insured's pre-disability income. B is the person insured's average weekly income during the period in which he or she is partially disabled. C is the amount in box 5 in the Schedule, as varied in any way." Pre-disability income was defined to mean: "the person insured's highest average weekly income in any 12 month period over the 3 years immediately before he or she became totally disabled." In the case of Mr Watson's policy, the box 5 figure was $410 although it appears that it has since been varied upwards to the sum of $454.30. 11 Finally, the policy specified the circumstances in which the weekly benefit payable to a partially disabled person would be stopped. These included when "the person insured stops being partially disabled". I would note that the definition of that term required that the person concerned was engaged in remunerative work. 12 In November 1996 Mr Watson was operated on for the removal of a cancerous brain tumour. He was later able to resume his business as a financial planner, albeit he was adjudged to be not able to perform all of the income producing duties of a financial adviser and became entitled to receive a weekly benefit payment under the policy for partial disability. 13 Mr Watson conducts his business at a loss. In the income tax year ending 2001, his gross fees and commissions received from carrying on the business were $22,513. His related business expenditure was $28,166, over a third of which being by way of payments to Mrs Watson for services rendered. The resultant net loss was $5,653. In the same financial year he received partial disability payments of $23,274. Those payments were at the maximum rate payable under the policy as his average weekly income during the period of partial disability (the sum B in the calculating formula) was nil. Under the policy's definition of income, there was no amount of income left after all expenses in earning that income had been deducted. The Tribunal's Decision 14 All that I need note here is the Tribunal's ultimate determination of the question whether the weekly payments made to Mr Watson under the policy were ordinary income from his business. It was only if an affirmative answer could be given to that question, that the s 1075(1) deduction could be made. The Tribunal concluded that: "the monies received by Mr Watson in terms of the income protection policy were neither sourced or originated from the financial planning business. Rather they came to Mr Watson as a result of the contract he had personally entered into with the insurance company. In terms of that contract, the payments were dependent upon the disability suffered by Mr Watson and his decision to perform some work. The reality is that the business per se performed no services whatsoever in the derivation of the benefit payable under the policy. In this circumstance, it cannot be said that the receipt of the insurance monies was an incident of activities undertaken by the financial planning business. 20. The Tribunal finds that the monies paid to Mr Watson by National Mutual do not represent income from the financial planning business. Thus, for the purpose of calculating his income under the social security legislation, those receipts are not capable of being reduced by losses incurred by the financial planning business." The Present Application 15 It is agreed by the parties, and it was so decided by the Tribunal, that the payments made under the income protection policy were income for the purpose of the SS Act. Where the parties diverge is on the question whether that income was ordinary income of Mr Watson's financial planning business. 16 Mr Watson's contention is, in substance, that that income has the same character as the income it replaces. Because of the definition of "partially disabled" in the policy, he had to work before he could receive the payments. The payments themselves were, under the formula, calculated by reference (inter alia) to his "pre-disability income" from the financial planning business and to his average weekly income during the period of partial disability. The connection between the business and the payment was direct. The purpose of the policy was in some degree to provide a substitute for income foregone because of the partial disability. The payments made were, then, properly to be seen as income from his business in another guise. 17 The respondent's contentions, put shortly, are (i) the weekly payments were not part of the ordinary income of Mr Watson's business but were payments made under the income protection policy to which he was entitled by virtue of his being partially disabled; (ii) the expenses he seeks to have deducted from the payments made under the policy were expenses that related to his financial planning business but they could only be applied to reduce the ordinary income of the business and not ordinary income from any other source; and (iii) Mr Watson's entitlement to be paid under the policy did not require that he continue to carry on a business (let alone the business he did before his disability), it merely required that remunerative work of some kind be undertaken. 18 My own view can be put shortly. It is unnecessary for me to outline at any length the effect of ss 1072 and 1075(1) of the SS Act. I would merely note the following. It is well accepted that, as a result of the amendment that introduced the precursors of ss 1072 and 1075 into the SS Act in 1991, ordinary income for social security purposes means gross income save in certain specified cases. One such case is where income is derived from a business in which case certain expenses incurred relating to that business can be deducted from the ordinary income of the business. Those expenses, though, cannot be deducted from income from any other source: see generally, Secretary, Department of Social Security v Ekis (1998) 85 FCR 382; see also Social Security (Rewrite) Amendment Bill 1991, Explanatory Memorandum, p181; Secretary, Department of Family and Community Services v Cantlay (2000) FCA 345. 19 Section 1075(1) has several interlocking requirements. The first is that the income from which a deduction can be made must itself be "ordinary income from the business". If it does not have that character no deduction under the sub-section can be made from it. The second requirement is that for expenses to be deductible under the sub-section they must (a) "relate to the business" and (b) they must be "allowable deductions" for the purposes of the stated provisions of the relevant Income Tax legislation. 20 The interaction of the two components of the second requirement were discussed by Drummond J in Ekis' case. That requirement is not in issue in this matter. It is the first requirement (that the income from which a s 1075 deduction is to be made must be income "from the business") that is the cause of the present controversy. 21 As I have noted, it is agreed by the parties that the weekly payments made under the income protection policy have the character of income. The matter to be resolved is whether they have the same or a different source from the income of the business. 22 It is clear that, in any given year of income since the weekly payments commenced, those payments were not made for any service rendered by Mr Watson in any such year. His entitlement to them, as the Tribunal found, resulted from the contract he entered into with the insurer. Nonetheless, it was Mr Watson's continued conduct of his business in those years that was one of the triggers to his entitlement to be paid. As I have also noted, his continuation in his previous business or in some other remunerative work was one of the prerequisites to being paid. This was because of the policy's definition of "partially disabled" and of the contractual provision that terminated payment if he stopped being partially disabled. In this sense the expenses he incurred in running his business could be said to have been incurred in producing his income under the policy. But whatever nexus there may have been between those expenses and his assessable income for the purposes of making deductions under Income Tax legislation - and I express no view on this: cf Ekis, at 386-387 - that nexus as such has no significance for the purposes of s 1075 of the SS Act unless the income in question is income from the business and not from some other source. 23 Notwithstanding the factual nexus I have noted above, and notwithstanding the use of pre-disability earnings from the business in computing the amount payable under the policy's formula, the weekly payment can only be said to originate in a source other than Mr Watson's business itself. The payments were ones contractually agreed to be made on the fulfilment of the conditions specified in the policy. The obvious purpose of the payments was to redress in some degree the income loss from Mr Watson's not being able to conduct fully or at all his business because of a disability covered by the policy. That purpose rather betrays the true character of the payments. Mr Watson contracted to receive them in accordance with the policy because he would not be deriving income from his business at all, or by the use of the abilities he would have possessed but for the disabling injury or sickness. 24 The contract presupposed that Mr Watson was carrying on a business and that, after the disability was suffered, he might if partially disabled continue to do so in some manner. But it secured a source of income for Mr Watson to be quantified according to an agreed formula in circumstances in which the business (or for that matter some other work) was not producing income up to the level of his pre-disability income. It was the relative absence of income from the business that this contractual source of income was designed to ameliorate. The purpose of the contractual income may be said to be to provide a surrogate for the income of the business. But the contractual income was not, and could never be the actual income of the business. It designedly had the character of income that was not income of Mr Watson's business. 25 It may be said that this conclusion appears somewhat anomalous if only because of the factual nexus between Mr Watson's business (past and present) and the weekly income he derives under his income protection policy. It is, nonetheless, one that gives effect to the general principle underlying the income assessment scheme of the SS Act. As a general rule, ordinary income means gross income but that exceptionally, business expenses can be deducted. But those expenses can only be deducted from ordinary income derived from the business concerned and not from any other source. 26 The application should be dismissed with costs.