Skip to main content
19 Jul 2012
Appeal Status

Accrual rules - applied to reinsurance treaties

2012 case note - confirms that the financing of working capital under reinsurance treaties is to be dealt with under the accrual rules.

Sovereign Assurance Company Limited & Others v Commissioner of Inland Revenue


The plaintiffs challenged the Commissioner's assessments made following completion of the disputes process. The plaintiffs had treated the cash flows in their tax returns on the basis that refundable commissions were assessable income and commission repayments were deductible expenditure. The High Court confirmed the Commissioner's position that the commission arrangements were to be considered separately from other components of the money flows under the applicable treaties. As such, the commission arrangements constituted a financial arrangement for the purposes of the accrual rules. The accrual rules required the commission repayments to be spread over the relevant period with refundable commissions being netted off against the commission repayments, and only the sums attributable to the interest debited to the bonus account remained and could be deductible by the plaintiffs.

Impact of decision

This judgment confirms that the financing of working capital under reinsurance treaties is to be dealt with under the accrual rules.


This proceeding is concerned with the income tax implications for the 2000 to 2006 income years of certain agreements entered into between Sovereign Assurance Company Ltd (Sovereign) and three German reinsurance companies: Gerling, Cologne Re and Hanover.

As a new life company, Sovereign faced a number of risks. One risk was mortality risk (ie, an insurance policy either lapses or the policyholder dies within a short period of time from when the policy was taken out). Another risk was "new business strain"; as a new company Sovereign's up-front costs in issuing a policy exceeded the amount it initially made from that policy (due to Sovereign paying commissions to brokers and agents who sell policies to policyholders). To mitigate these risks, Sovereign entered into reinsurance agreements with the German reinsurers ("the treaties").

The treaties provided for two sets of money flows between Sovereign and the reinsurers (the two sets of money flows were interchangeably referred to in the judgment as "commission arrangements"; see [101]). First, Sovereign paid premiums to the reinsurers in return for the reinsurers accepting liability to meet the costs of policies ending early (ie, due to mortality). There is no dispute over the manner in which Sovereign accounted for the money flows in both directions on the reinsurance of those mortality risks.

The second money flow component of the treaties involved the reinsurers agreeing to pay Sovereign "refundable commissions" and Sovereign was obliged to repay the refundable commissions in stipulated portions out of subsequent years' premiums. The refundable commissions were used to cover the initial costs of establishing life insurance policies. It is this part of the treaties that was in dispute as to the correct tax treatment of the refundable commission payments and repayments.


Dobson J held that the refundable commissions are to be considered separately from the other components of the money flows under the treaties and that those commission arrangements constitute a financial arrangement for the purposes of the accrual rules. By doing this, Dobson J distinguished this case from Marac Life Assurance Ltd v Commissioner of Inland Revenue [1986] 1 NZLR 694 (CA) as the accrual rules clearly contemplate that the money flows can be separately identifiable.

The refundable commissions' component of the treaties is not a contract of insurance so as to qualify as an excepted financial arrangement.

Once the accrual rules are applied to the additional component (representing the consideration for deferral of Sovereign's repayment of the amounts received as commissions), the base component of those money flows becomes irrelevant for income tax purposes. Accordingly, Sovereign's alternative contention that the commissions received and subsequent repayments should be added respectively to its assessable income and deductible expenses was also incorrect.

Dobson J also said that if he were wrong, then he finds for the Commissioner's alternative argument that the money flows were capital in nature.

Tax Administration Act 1994, Income Tax Act 1994