Edited version of private ruling

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Ruling

Subject: Assessability of lump sum income protection insurance payment

Is the lump sum payment you received included in your assessable income in the income year the payment was received?

Yes.

This ruling applies for the following period:

1 July 2009 to 30 June 2010.

The scheme commenced on:

1 July 2009.

Relevant facts:

You had an income protection insurance policy (the policy).

You have been collecting income protection benefits under the policy.

Under the terms of the policy, your entitlement to the income protection benefits would cease on your 65^th birthday.

You accepted an offer of a lump sum amount from your insurer as full and final payment of their remaining liability to pay you income protection benefits under the policy.

Relevant legislative provisions:

Income Tax Assessment Act 1997 Section 6-5

Reasons for decision

Assessability of payments that substitute income - general

Subsection 6-5(2) of the Income Tax Assessment Act 1997 (ITAA 1997) provides that the assessable income of an Australian resident includes ordinary income derived directly or indirectly from all sources, whether in or out of Australia, during the income year.

Based on case law, it can be said that ordinary income generally includes receipts that are earned, expected, relied upon, and have an element of periodicity, recurrence or regularity.

Payments of salary and wages are examples of ordinary income.

Receipts that are not salary or wages, but are a paid as a substitute for salary or wages that would normally have been earned, expected and relied upon by a taxpayer, are also assessable as ordinary income. The general principle being that such payments take on the character of the salary or wages they replace. That is, if the substituted amount was an amount of ordinary income, the amount paid to compensate for the loss of that amount will also be ordinary income.

This general principle was affirmed by the courts in Federal Commissioner of Taxation v. Dixon (1952) 86 CLR 540; (1952) 10 ATD 82; (1952) 5 AITR 443; (1952) 10 ATD 82 where it was found that when a taxpayer is paid an amount to compensate for a loss, the payment will generally acquire the character of that for which it is substituted.

Compensation payments which are a substitute for income (salary and wages for example) have also been held by the courts to be assessable as ordinary income (Federal Commissioner of Taxation v. Inkster (1989) 24 FCR 53; 89 ATC 5142; (1989) 20 ATR 1516; Tinkler v. FC of T 79 ATC 4641; (1979) 10 ATR 411; Case Y47 91 ATC 433; AAT Case 7328 (1991) 22 ATR 3422).

In your case, you were receiving income protection benefits under the policy. By applying the principles of law referred to above, we consider that these benefits took on the character of the income they replaced and were assessable as ordinary income under the provisions of section 6-5 of the ITAA 1997.

Assessability of lump sum payments that are a substitute for income

Where regular payments (such as those paid under an income protection policy to replace salary or wages that would have normally been earned, expected and relied upon) are commuted to a lump sum, the lump sum amount also retains the character of the lost salary or wages for income tax purposes. That is, if the payments replaced by the lump sum were assessable as ordinary income, then the lump sum will also be assessable as ordinary income.

This is consistent with the Australian Taxation Office (ATO) view expressed in Taxation Determination TD 93/3 which deals with the partial commutation of weekly compensation payments for loss of income or salary. TD 93/3 specifies that any lump sum that results from a commutation of such weekly payments will continue to be assessable as ordinary income because the character of the lump sum does not change from that of the weekly payments it replaces.

The issue of whether or not the redemption or conversion of an entitlement to assessable periodic payments to a lump sum affects the assessability of the lump sum has also been considered by the courts.

In Coward v. FC of T 99 ATC 2166; (1999) 41 ATR 1138 Mathews J:

· found that payments made to replace income take on the character of the payment they replace and that the method of payment does not alter the character of the payment, and

· held that as the weekly compensation payments made to the appellant until he turned 65 were paid for loss of earnings and thus constituted income, a lump sum representing a redemption of those future weekly payments was also income.

In your case, you accepted a lump sum payment as full and final payment of your income protection benefits under the policy. The lump sum retains the ordinary income character of the income protection benefits it replaced and is assessable as ordinary income under the provisions of section 6-5 of the ITAA 1997.

Derivation of income

As noted above, under the provisions of section 6-5 of the ITAA 1997, ordinary income is assessable in the income year in which it is derived.

Subsection 6-5(4) of the ITAA 1997 provides that in working out whether a taxpayer has derived an amount of ordinary income and when it was derived, the taxpayer is taken to have received the amount when it is applied or dealt with in any way on the taxpayer's behalf or as the taxpayer directs.

Taxation Ruling TR 98/1 deals with the derivation of income and states that the general rule with non-trading income (such as salary and wages) is that it is derived when it is received.

In your case, you are taken to have derived the lump sum payment when it was made to you.

Conclusion

The lump sum amount you received is assessable as ordinary income in the income year the payment was made to you.

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