Decision impact statement
Watson v Deputy Commissioner of Taxation
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Court Citation(s):
[2010] FCAFC 17
(2010) 182 FCR 104
2010 ATC 20-167
75 ATR 224
Venue: Federal Court of Australia
Venue Reference No: SAD 76 of 2009
Judge Name: Dowsett, Stone & Bennett JJ
Judgment date: 4 March 2010
Appeals on foot:
No
Impacted Advice
Relevant Rulings/Determinations:
Subject References:
Non commercial losses
business
assessable income from the business activity
income protection policy
Decision Outcome:
Favourable
Precis
The issue in this case was whether or not insurance proceeds paid to the taxpayer under an income protection policy were assessable income 'from' his business activity for the purposes of section 35-10 of the Income Tax Assessment Act 1997.
Brief summary of facts
At all relevant times the taxpayer carried on a financial planning business. In the income year ended 30 June 2004 he was an authorised representative of Financial Lifestyle Solutions ("FLS"). He had previously been an authorised representative of AXA Financial Planning ("AXA").
Since 3 January 1996 the taxpayer has held an income protection insurance policy with The National Mutual Life Association of Australasia Limited ("the Policy"). The Policy expires on 2 January 2025.
Relevantly, the Policy provides for the payment of benefits:
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- in consideration of the payment of premiums, and upon suffering total disability from injury or sickness, benefits will be paid in the form of weekly benefits, nursing care and rehabilitation expenses, and upon suffering partial disability, benefits will be paid in the form of weekly benefits;
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- total disability means inability to do at least one of the income producing duties of his or her occupation, partial disability (following a period of total disability) means an ability to do one or more income producing duties of his or her occupation but not all of them, or he or she is working in another occupation, and because of the disability is earning less than pre-disability income;
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- Weekly benefits for total disability are up to 75% of average income at the time the policy was applied for; weekly benefits for partial disability reduce to take into account income earned while the person is partially disabled;
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- If the person insured owns part, or all, of a business or practice, income is money generated by the business due to the insured person's own activity, after all expenses in earning that income have been deducted;
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- Pre-disability income means the insured person's highest average weekly income in any 12 month period over the 3 years immediately before he or she became totally disabled.
In 1996 the taxpayer underwent major brain surgery for the removal of a tumour. Consequently, he received benefits under the Policy. Since May 1997 he has received partial disability benefits.
In the taxpayer's income tax return for the year ended 30 June 2004 he:
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- included as assessable income the following amounts:
Amounts received from AXA and FLS (acknowledged to be from the financial planning business activity) $9,896 Amounts received under the Policy $25,719 Eligible termination payment $9,946 - •
- showed an amount of $14,834 for expenses incurred in carrying on his financial planning business activity;
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- showed a deferred non-commercial business loss of $4,938 (being the excess of the amount of $14,834 for expenses incurred in carrying on his financial planning business activity over the income of $9,896 received from AXA and FLS);
The Commissioner assessed the taxpayer's taxable income as $35,665. The amount of $4,938, shown as a deferred non-commercial business loss in the return, was not deducted from the taxpayer's total assessable income of $35,665 (being the total of the amounts received under the Policy and the eligible termination payment) to arrive at his taxable income. Instead, that amount was treated as if it was not incurred in the income year ended 30 June 2004, but was an amount attributable to the taxpayer's business activity that could be deducted from assessable income from the activity for the next income year in which the activity was carried on (ie., the loss deferral rule in subsection 35-10(2) was applied).
The taxpayer objected against this assessment and the Commissioner subsequently disallowed that objection.
The taxpayer appealed against the objection decision to the Federal Court which dismissed the appeal. He subsequently appealed against the decision of the primary judge.
Issues decided by the court
The only issue raised by the appeal was whether the policy income was assessable income 'from' the taxpayer's business activity for the relevant year. The appeal was dismissed.
The Full Federal Court unanimously agreed with the primary judge that the payments made under the insurance policy were not assessable income 'from' the taxpayer's business activity, for the purposes of the non-commercial loss rules in Division 35 of the Income Tax Assessment Act 1997.
The Court considered that the policy income was received because the taxpayer was not able to carry on the business activity to the same extent as before he became ill. As such, the policy income had its origin in the policy and '... was derived from his incapacity to conduct business activity, not from the [business] activity which he actually undertook'.
Tax Office view of Decision
The decision is consistent with the ATO view. The Court held that income will be 'from' a particular business activity where it has its starting point, or source, or origin, in that activity. To determine whether this is so required the 'extent and the nature of that business activity' to be identified.
Although the legislation does not use the expression 'causative connection' the Court acknowledged the use by the primary Judge of these words as 'an alternative description of the relationship implicit in the word "from".'
We consider that an amount of assessable income will have its starting point or source or origin in a particular business activity where, having regard to the nature and extent of that activity, there is some part of it that gives rise to, or produces, that income.
Administrative Treatment
Implications on current Public Rulings & Determinations
The decision is consistent with the ATO view expressed in TR 2001/14. This view, broadly, is that for assessable income to be 'from' a particular business activity, that income must have a causative connection to that activity. This will be because the activity is the source or origin of that income.
An addendum for TR 2001/14 was published on 27 April 2011 to note the decision of the Full Federal Court.