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HMRC internal manual

Business Income Manual

Meaning of trade: mutual trading and members clubs: introduction: two early mutual insurance cases

The case of Last v London Assurance Corporation [1884] 2TC100 concerned a proprietary office carrying on an insurance business. The Corporation and its shareholders formed a body quite distinct in personality and in interest from those insured. A member of the Corporation might effect an insurance with it, but that circumstance could neither enlarge or diminish their rights as a partner. The Corporation was not carrying on a mutual trade.

The Corporation, as a branch of its business, dealt in what were called ‘participating’ policies. These were issued to all persons, whether members or not, who had insurable lives, and were willing to pay premiums on a higher scale than those charged for ordinary or non-participating policies. In consideration of these increased payments the Corporation undertook to return to the holders of participating policies by way of bonus or abatement of premium, two-thirds of any surplus funds applicable to such policies, which were to be ascertained and allotted every five years. The one-third retained by the Corporation admittedly represented business profits; and it was not in dispute that the remaining two-thirds would also have been profits of the Corporation except for its agreement to return that amount to the insured. The point at issue before the courts was whether the two-thirds of surplus payable to the participating policyholders fell to be deducted from receipts in ascertaining the Corporation’s trading profits. By a majority of two to one the House of Lords decided that the two thirds of profits paid to participating policyholders was in reality a share of profits. Their Lordships reaffirmed the position that the destination of profits once earned has no bearing on the computation of those profits for tax purposes, Lord Fitzgerald saying at page 129 of 2TC:

‘The premiums payable by the participating policy holders come into the coffers of the Company quarterly, half-yearly, or annually in ordinary course, and form part of the annual income of the concern. When received those moneys are probably invested, the profit of the investment also forming a part of the income, and I cannot see that they the less form part of its annual income because that at a subsequent period of time a part of the gross profits (if any) realised may be allotted to certain of the policy holders. It seems to me, on the contrary, to be annual “income” after deducting the proper expenses of earning it, and subject to income tax notwithstanding its subsequent special destination. The prospect of a future participation in profits is held out as an inducement to customers to insure in the participating series, and probably has proved to be successful, but it seems to me, my Lords, to be a very forced interpretation of the contract and position of the parties to put it down as part of the expenses of making the income.’

Lord Radcliffe, referring to this decision, said in Sharkey v Wernher [1955] 36TC275 at page 302:

‘Later decisions have shown that this simple proposition may cover what are to be regarded as two separate questions, whether a man can trade or deal with himself and whether a man can make taxable profit by so doing.’

These two questions can be restated as providing for the following approach to questions of mutual trading.

  1. Whether activities amount to a trade is essentially a question of fact (see BIM24045). That the dealings are limited to one person or to members only does not preclude trading.
  2. Whether a trade is a mutual trade requires that all of the conditions in BIM24020 are satisfied.

A leading early case on mutuality, Styles v New York Life Insurance Company [1889] 2TC460 seemed to have answered the first of Lord Ratcliffe’s questions in the negative. New York Life had no shares or shareholders and carried on the business of mutual insurers. The company had a branch in London and had no members other than the holders of participating policies, to whom all the assets of the company belonged. Each policyholder was a member of the company, and was entitled to a share of the assets of the company and liable to all losses and expenses incurred by the company. The majority of any annual surplus of premiums over expenditure was returned to members; either as an increase in the sums for which they were insured or as a reduction in their premiums. Nothing was paid out in cash. Any balance of surplus was carried forward. It seemed that the courts took the view that the company was not trading - the House of Lords taking the view that mutual insurance was not a trade at all. Lord Bramwell said that there could not be a trading profit where there was only one party to a transaction and because of the identity between the company and its members, there was effectively only one party here.

New York Life distinguished its position from that in the case of London Assurance Corporation (see above) citing the following differences.

  • London Assurance received premiums in pursuance of and derived profits from contracts between itself and their policyholders who were not members of London Assurance.
  • In contrast, the premiums paid to New York Life were contributed by members of the company.
  • The quantum of each member’s contribution to New York Life was an estimated amount required to cover the risks for the year and the necessary expenses.
  • Any surplus or balance remaining over and above the sum that may actually be required for such purposes is not profit or gain liable to assessment, but it is in fact an excess of contribution over expenditure.

The General Commissioners found that:

  • No part of the premium income of the company received under participating policies was liable to be assessed.
  • The company was, however, liable to be assessed in respect of profits made on annuities granted.
  • The company was also liable to be assessed on profits made from premiums paid under non-participating policies.
  • The company was liable to be assessed on all income derived by or from investment of all premiums or other money paid to them in the UK and invested in the UK or abroad, and as to the latter when such income is received in the UK.
  • The company was liable to be assessed on all profits (if any) derived in any mode other than by the annual premium contributions of the participating policyholders.

The High Court and the Court of Appeal, following the decision in Last v The London Assurance Corporation, held that the New York Life was assessable. In the lower courts the Judges seem to have attached importance to the fact that the society was incorporated, and was an entity distinct from the members composing it.

The House of Lords distinguished between policyholders who were members of the company (participating policyholders) and those who were not (non-participating). Lord Watson explained the difference at pages 469-470:

‘The Appellant Company, so far as regards its membership, is constituted upon the principles of mutual assurance. The Company issues life policies of two kinds, participating and non-participating; but the relations existing between the Corporation and the two classes of insured differ materially. There are no shares and no shareholders in the ordinary sense of the term; but each and every holder of a participating policy becomes, ipso facto, a partner of the Company with a voice in its administration, entitled to a share of its assets and liable for all losses and expenses incurred by it. On the other hand, the holder of a non-participating policy is not a partner of the Company; he is a creditor merely without any interest in its assets and without any liability for its debts.’

The profits on dealings with non-participating members were assessable and this was not disputed in the courts.

Lord Watson went on to find that the mutual insurance activities of the Company did not amount to a trade. At page 471 he said:

‘When a number of individuals agree to contribute funds for a common purpose, such as the payment of annuities, or of capital sums, to some or all of them, on the occurrence of events certain or uncertain, and stipulate that their contributions, so far as not required for that purpose, shall be repaid to them, I cannot conceive why they should be regarded as traders, or why contributions returned to them should be regarded as profits. That consideration appears to me to dispose of the present case. In my opinion, a member of the Appellant Company when he pays a premium makes a rateable contribution to a common fund, in which he and his co-partners are jointly interested, and which is divisible among them at the times and under the conditions specified in their policies. He pays according to an estimate of the amount which will be required for the common benefit; if his contribution proves to be insufficient he must make good the deficiency; if it exceeds what is ultimately found to be requisite, the excess is returned to him. For these reasons I have come to the conclusion that the transactions of the Appellant Company in so far as these relate to the participating policies, do not constitute the carrying on of a trade within the meaning of the Income Tax Acts, and that the surplus funds returned or credited to its members are not profits.’