COURT
IN THE FEDERAL COURT OF AUSTRALIA
NEW SOUTH WALES DISTRICT REGISTRY
GENERAL DIVISION
Davies J.(1)

CWDS
  Taxation - appeal from the AAT - life insurance policy - annuity - crediting
a bonus described as "interest" - whether this sum was an annuity - whether
derived in the year of income.
  Income Tax Assessment Act 1936 (Cth) - s.27H

HRNG
SYDNEY
#DATE 12:3:1992
  Counsel for the Applicant:     Mr D. Bloom QC and Mr A.H. Slater
  Solicitor for the Applicant:   Freehill Hollingdale and Page
  Counsel for the Respondent:    Mr D.F. Jackson QC, Mr S.W. Gibb and
                                 Mr S.A. Janes
  Solicitor for the Respondent:  Australian Government Solicitor

ORDER
1.  The appeal be allowed.
2.  The decision of the Administrative Appeals Tribunal be set aside and there
be substituted therefor a decision remitting the matter to the Commissioner of
Taxation to reassess the Applicant's taxable income for the year ended 30 June
1988 on the basis that the sum of $4,443 was not income derived by him during
that year.
3.  The Respondent pay the costs of this appeal.
NOTE: Settlement and entry of orders is dealt with in Order 36 of the Federal
Court Rules.

JUDGE1
  This is an appeal from a decision of the Administrative Appeals Tribunal
which affirmed the Commissioner's decision on an objection lodged by the
applicant, Mr D.A.L.L. Clarke, with respect to an assessment of income tax for
the year ended 30 June 1988.
2.  A number of issues may have arisen out of the events with which we are
concerned but the only one which was considered by the Administrative Appeals
Tribunal ("the Tribunal") was whether a sum of $4,443 was assessable income in
the year of income as an annuity in accordance with s.27H of the Income Tax
Assessment Act 1936 (Cth) ("the Assessment Act").  If so, a deductible amount
should have been assessed in accordance with the section and the amount of the
assessable income thereby reduced.  Section 27H(1) read:-
    "The assessable income of a taxpayer of a year
    of income shall include -
    (a)   the amount of any annuity derived by
          the taxpayer during the year of
          income excluding, in the case of an
          annuity that has been purchased, any
          amount that, in accordance with the
          succeeding provisions of this
          section, is the deductible amount in
          relation to the annuity in relation
          to the year of income; and
    (b)   the amount of any payment made to
          the taxpayer during the year of
          income as a supplement to an
          annuity, whether the payment is made
          voluntarily, by agreement or by
          compulsion of law and whether or not
          the payment is one of a series of
          recurrent payments."
3.  Mr Clarke retired as a teacher on 17 July 1987, the day before his 60th
birthday.  He received a lump sum pay-out from the State Superannuation Fund.
This sum was invested in securities by way of rollover.  Of the sum, $50,000
was paid to Capita Financial Group Ltd ("Capita") in respect of what was
called a "Variable Income Annuity".
4.  Capita carried on a business of life insurance.  Mr Clarke acquired a
participating policy, the purchase price being $50,000 and the policy term
being 5 years.  Relevant provisions of the policy were as follows:-
    "1    In consideration of the payment of
          the purchase price specified in the
          schedule, Capita Financial Group
          Limited (hereinafter called
          `Capita') will provide the annuity
          payments and other benefits
          described herein.  This policy is an
          annuity certain policy and consists
          of the schedule and these
          Conditions.
     ...
    3     The assets of Capita's Statutory
          Fund No 1 shall alone be liable
          under this policy and the
          obligations arising out of this
          policy shall at all times and under
          all circumstances be subject to the
          Articles of Association of Capita.
     4    Any benefit which become payable,
          other than an annuity payment, will,
          subject to the Conditions of this
          policy, be paid by Capita to the
          person then holding title to the
          policy within one calendar month
          after the policy has been delivered
          to Capita and proof of the happening
          of the event giving rise to the
          claim has been given to the
          satisfaction of Capita.
     5    Subject to the Conditions of this
          policy, Capita will pay to the
          annuitant(s), in accordance with
          details in the schedule, the annuity
          payments specified therein.
          If at any time Capita is required to
          deduct income tax or other amounts
          from any or all of the annuity
          payments then such deductions will
          be made and the net amount paid as
          above.
     6    The person holding title to this
          policy may, within three months
          prior to the next review date
          specified in the schedule, notify
          Capita in writing of revised annuity
          payment details and a new next
          review date.  The revised details
          will, subject to Capita's agreement,
          be effective from the next review
          date previously applicable.
     7    Capita will, in respect of this
          policy, maintain an Investment
          Account and a Capital Growth
          Account.
     8    The purchase price paid will be
          credited to the Investment Account
          on the day received by Capita.
     9    Each annuity payment will be debited
          proportionally between the balances
          of the Investment Account and the
          Capital Growth Account on the date
          the payment becomes due.
     ...
    15    Allocations of surplus to this
          policy will be primarily in the form
          of interest on the Investment
          Account, calculated on the daily
          balance and compounded annually at a
          rate declared by Capita each year on
          the advice of its Actuary less the
          ongoing expense charge referred to
          in Condition 11.
    16    The rate of interest referred to in
          Condition 15 will be not less than
          85% of the rate of investment income
          (exclusive of capital growth) earned
          by Capita in the relevant year, with
          respect to the appropriate class of
          business and net of all taxes, on
          the relevant asset portfolio within
          the Statutory Fund applicable to
          policies of this type.  Capita may
          elect to apply the declared rate to
          a year ending up to four months
          later than that for which the earned
          rate was determined.
    17    Capita may, in addition, allocate
          further surplus to this policy by
          way of allocations to the Capital
          Growth Account or by any other
          method which its Actuary certifies
          as equitable.  Allocations
          previously made to the Capital
          Growth Account may be cancelled or
          reduced by Capita on the advice of
          its Actuary.
    18    The cash value of this policy at any
          time is:
          (a)   the balance of the
                Investment Account plus
          (b)   the balance of the
                Capital Growth Account
          Provided that Capita may vary or
          suspend this basis of determining
          the cash value subject to such terms
          and conditions as the Life Insurance
          Commissioner may think fit, if in
          the Commissioner's opinion the basis
          described above would be prejudicial
          to the financial stability of Capita
          or to the interests of the
          policyowner(s) of Capita.
    19    On the death of the annuitant or
          last surviving annuitant if more
          than one annuitant the person then
          holding title to this policy will
          provide Capita in writing the name
          of a person to become the new
          annuitant together with such other
          particulars as Capita may require
          and whose acceptance as annuitant
          shall be subject to Capita's
          agreement.
          Should such a name not be provided
          or such agreement not be given
          within three months after the
          relevant date of death then this
          policy will terminate.
    20    This policy will terminate if at any
          time its cash value is negative.
    21    At the end of the policy term this
          policy will terminate.
    22    On termination of this policy at any
          time other than in the circumstances
          described in Condition 20, the
          benefit payable will be the policy's
          cash value at the date of
          termination."
5.  The annuity payments specified, which could have been but were not varied
in accordance with condition 6, were $833.34 per month on and from 28 August
1987.   Accordingly, it was proposed that there be 60 payments of $833.34
each, a total of $50,000.  In the meantime, the policy provided that there
would be maintained in the accounts of the Statutory Fund an investment
account and a capital growth account in Mr Clarke's name.  As the policy was a
participating policy, it was proposed that there be distributions of surplus
made by Capita in respect of its Statutory No. 1 Fund.  The allocations of
surplus to the policy were to be primarily in the form of interest on the
investment account, the rate of interest to be not less than 85% of the rate
of investment income earned by Capita in the relevant year with respect to the
appropriate class of business net of all taxes on the relevant asset portfolio
within the Statutory Fund.  It was provided that Capita could, in addition,
allocate further surplus by way of allocations to the capital growth account
or by any other method which its actuary certified as equitable.  Each annuity
payment was to be debited proportionately between the balances in the
investment account and the capital growth account.  The cash value of the
policy at any time would be the balance of the investment account plus the
balance of the capital growth account.  This balance would be arrived at by
the crediting of the sum of $50,000 to the investment account, the crediting
of interest thereon, the crediting of other surplus to the investment account
or to the capital growth account and the debiting to these accounts of the
monthly annuity.  The policy was to terminate at any time when its cash value
was negative, at the end of the policy term or three months after the death of
the annuitant if the name of a person to become a new annuitant was not
supplied.
6.  In the year ended 30 June 1988, Mr Clarke received annuity payments
totalling $8,333.00.  In addition, a sum of $4,443 was credited to his
investment account and given the description "interest".  Both sums were at
first included by the Commissioner of Taxation in Mr Clarke's assessable
income.  No deduction for the purchase price was allowed under s.27H.
Subsequently, the assessment was amended to exclude the sum of $8,333.00,
apparently on the basis that the monthly payments were a part return of the
capital, the sum of $50,000 which Mr Clarke had paid to Capita.  In any event,
the Tribunal was not concerned and this appeal is not concerned with the
monthly payments.  The issue relates solely to the sum of $4,443 which was
described as interest and which was credited to the investment account
maintained in Mr Clarke's name and taken into account for the purpose of
calculating the cash value of the policy.
7.  The issue debated before the Tribunal appears to have been the subject of
a controversy which I need not discuss at length.  In brief, a view had been
accepted by the Taxation Office that an annuity for the purposes of rollover
and of s.27H need not be absolutely fixed in quantum but could have variables
added to it, as indeed s.27H itself recognises.  However, based on this view,
a number of life insurance companies developed investment packages which
sought to take advantage of the provisions of s.27H.  Capita developed its
Variable Income Annuity.  Subsequently, on some date relevant to Mr Clarke's
position, the Commissioner issued Income Tax Ruling IT2480 which, though it
did not name Capita, expressed the view that benefits such as those provided
by the subject policy were not annuities for they were not benefits having the
character of an annuity.
8.  Mr Clarke entered into a lengthy correspondence with the Commissioner and
his objection is many pages in length.  He appeared for himself before the
Tribunal and submitted that he was entitled to the benefit of s.27H.  However,
the Tribunal agreed with the view taken by the Commissioner and held that the
crediting of $4,443 described as interest was not a payment in the nature of
an annuity.
9.  I need not deal with the issue of annuity at any length.  I agree with the
Tribunal that the sum credited to the investment account did not have the
character of an annuity.
10.  In my opinion, for the sum of $50,000, Mr Clarke bargained for benefits
of two distinct types.  In the first place, he bargained for a monthly annuity
of $833.34.  The monthly payments had all the necessary characteristics of an
annuity.  They were sums paid regularly in consideration of the receipt of the
purchase price.  Mr D. Jackson QC, with whom Mr S.W. Gibb and Mr S.A. Janes
appeared for the Commissioner, faintly submitted that the $50,000 was merely a
sum lent by Mr Clarke to Capita and that the payments of $833.34 per month
were payments back of the capital which Mr Clarke had on deposit with Capita.
In my view, that contention is untenable.  Mr Clarke purchased a life
insurance policy.  Thereafter, he was entitled to benefits in accordance with
the terms of the policy, benefits which included an entitlement to an annuity
and an entitlement to the cash value of the policy as defined on its
termination.  In no sense was money lent by Mr Clarke to Capita and in no
sense was the $50,000 on deposit with Capita.  The payment of $50,000 to
Capita might loosely be described as an investment but the reality of the
transaction was that a life insurance policy was purchased for a lump sum.
One of the benefits which Capita contracted to provide pursuant to the policy
was the monthly annuity of $833.34.
11.  The sum of $4,443 credited by Capita to Mr Clarke's investment account in
May 1988 had characteristics quite different from that of the monthly annuity.
The sum was not paid to or received by Mr Clarke during the period of the
policy.  This sum of $4,443 had a character analogous to that of the annual
bonuses credited by a life insurance company to the value of a participating
policy.  Such sums are not ordinarily assessable income derived by a taxpayer.
Section 26AH of the Assessment Act provides that, if bonuses are received
within the period of 8 years from the commencement of a policy of life
insurance then, subject to certain exceptions, they are assessable income when
received.   A proportion of such sums is assessable income if received in the
9th and 10th years of the policy.  No such sum received thereafter is
assessable.  The crediting of the sum of $4,443 to the investment account in
May 1988 did not amount to the receipt of a bonus for the purpose of these
provisions.  See s.26AH(5).
12.  No sum is derived by the holder of a participating policy of the type
with which we are concerned when a credit is made to his or her investment
account or capital growth account.  Any allocation to the capital growth
account may be cancelled or reduced by Capita.  Under condition 18, the cash
value of the policy may be reduced if, in the opinion of the Life Insurance
Commissioner, the benefits provided in the policy would be prejudicial to the
financial stability of Capita or to the interests of the policy owners of
Capita.  If Capita's Statutory Fund No. 1 suffered a loss, the condition could
operate.  Moreover, if the annuity were increased, any sum credited to the
accounts could be taken out by way of annuity and not received by way of an
increase to the cash value of the policy payable on termination.  The position
was analogous to that of the accounts maintained in the superannuation fund
considered in Constable v. Federal Commissioner of Taxation (1952) 86 CLR 402,
in which Dixon C.J., McTiernan, Williams and Fullagar JJ. said at 418, "The
fund existed as one to a share in which he (the superannuant) had a
contractual, if not a proprietary, title.  His title was future, and indeed
contingent or, at all events, conditional." Similarly, in Read v. The
Commonwealth (1988) 167 CLR 57 at 67, Mason C.J., Deane and Gaudron JJ. said,
"Until a gain is realized it is not `earned, derived or received'."
13.  Thus, the sum of $4,443 credited to the investment account in May 1988
was not derived by Mr Clarke during the year of income.  It was not received
in fact and was not derived in the circumstances for which s.19 of the
Assessment Act provides, as s.26AH(5) recognises.
14.  I agree with the view taken by the Tribunal on the issue which Mr Clarke
raised before it.  The sum of $4,443 was not an annuity and did not form part
of an annuity.  However, I would allow the appeal on the ground that the sum
of $4,443 credited to the investment account in May 1988 was not income
derived by Mr Clarke in the year of income ended 30 June 1988.
15.  This point was not argued by Mr Clarke before the Tribunal but was raised
in the notice of appeal from the Tribunal's decision. During the course of the
hearing, in case there might be no sentence in Mr Clarke's long objection
which raised the issue, I ruled that the Court would hear the ground
notwithstanding that it might not have been taken in the notice of objection
and notwithstanding that it was not raised by Mr Clarke before the Tribunal.
In a matter of fundamental taxation law such as this, a taxpayer inexperienced
in taxation law ought not to be disadvantaged.  Mr Clarke's attention
understandably concentrated upon the taxation rulings issued by the
Commissioner.
16.  The decision of the Tribunal should be set aside and there should be
substituted therefor a decision remitting the matter to the Commissioner to
reassess Mr Clarke's taxable income for the year ended 30 June 1988 on the
basis that the sum of $4,443 was not income derived by him during that year.
The respondent should pay the costs of this appeal.