Edited version of private ruling

Authorisation Number: 1011547013104

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Ruling

Subject: Assessability of compensation receipt

Questions and answers:

Is the lump sum compensation amount you have been offered from your income protection policy assessable income?

No.

Does the lump sum compensation amount you have been offered from your income protection policy give rise to any capital gains implications?

No.

Is the lump sum payment offered to you by your insurance company able to be treated as a 'structured settlement'?

No.

This ruling applies for the following period:

Year ended 30 June 2011

The scheme commences on:

1 July 2010

Relevant facts and circumstances

This ruling is based on the facts stated in the description of the scheme that is set out below. If your circumstances are materially different from these facts, this ruling has no effect and you cannot rely on it. The fact sheet has more information about relying on your private ruling.

You took out an income protection policy some years ago.

You ceased work and made a claim under your policy in a particular year.

You have been in receipt of income protection benefits under the policy since that time.

There have been times since you started receiving benefits that payments were held up and not made due to actions of the insurance company.

You have been offered a lump sum payment by your insurance company.

You are unaware of how the insurance company came up with the amount and they will not provide details to you.

If you accept the lump sum payment you will be releasing your insurer from any further liability under your policy as per the Deed of Release.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 6-5

Income Tax Assessment Act 1997 subsection 6-15(1)

Income Tax Assessment Act 1997 Division 54

Income Tax Assessment Act 1997 subsection 108-5(1)

Income Tax Assessment Act 1997 paragraph 118-37(1)(b)

Reasons for decision

While these reasons are not part of the private ruling, we provide them to help you to understand how we reached our decision.

Section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997)

Section 6-5 of the ITAA 1997 provides that the assessable income of a resident taxpayer includes ordinary income derived directly or indirectly from all sources during the income year.

Ordinary income has generally been held to include three categories, namely income from rendering personal services, income from property and income from carrying on a business.

Other characteristics of income that have evolved from case law include receipts that:

· are earned

· are expected

· are relied upon, and

· have an element of periodicity, recurrence or regularity.

The compensation amount being offered to you is not income from rendering personal services, income from property or income from carrying on a business. The payment is also a one off payment and thus it does not have an element of recurrence or regularity.

A compensation amount generally bears the character of that which it is designed to replace. If a lump sum payment is paid for the loss of a capital asset or amount then it will be regarded as a capital receipt and not ordinary income.

Taxation Determination TD 93/58 states that any part of a lump sum compensation amount will only be assessable as ordinary income:

· if the payment is compensation for loss of income only...; or

· to the extent that a portion of the lump sum is identifiable and quantifiable as income. This is possible where the parties either expressly or impliedly agree that a certain portion of the payment relates to a loss of an income nature.

TR 95/35 provides that an insured person's right of indemnity under a policy of insurance falls within the definition of a right to seek compensation.

In your case you have been offered a payment in return for giving up your rights to make any future claims against your insurance policy. Consequently, the lump sum payment you have been offered would be a capital receipt and not ordinary income.

As the payment is not ordinary income it will not be assessable income to you under section 6-5 of the ITAA 1997.

Capital gains tax

Subsection 108-5(1) of the ITAA 1997 defines a capital gains tax (CGT) asset as any kind of property or a legal or equitable right that is not property.

You make a capital gain or capital loss if and only if a CGT event happens. CGT events are the different types of transactions or happenings which may result in a capital gain or a capital loss.

The disposal of an asset gives rise to a CGT event. In your case the disposal of your right to seek compensation gives rise to a CGT event.

However, paragraph 118-37(1)(b) of the ITAA 1997 states that a capital gain may be disregarded where the amount received relates to compensation or damages for a wrong, injury or illness you suffer personally.

In your case the purpose of the lump sum is so that you give up your rights to seek compensation under your policy. As any claim under your policy relates directly to a personal illness or injury, any capital gain or loss you make from surrendering your rights will be disregarded.

Therefore the amount received will not be statutory income.

Structured settlement

Division 54 of the ITAA 1997

Under Division 54 of the ITAA 1997, certain annuities and lump sums provided to personal injury victims under structured settlements may be exempt from tax.

For the purposes of Division 54, a structured settlement is a settlement of a claim that satisfies all the conditions specified in section 54-10.

These conditions include:

· the payment is compensation or damages for, or in respect of, personal injury suffered by a person, and

· the claim is based on the commission of a wrong, or on a right created by statute

The lump sum amount you will be receiving is not a settlement for personal injury or damages based on the commission of a wrong or a right created by statute. It therefore does not meet either of the above conditions.

Accordingly, Division 54 will not apply in your case.

Tax consequences for you

Subsection 6-15(1) if the ITAA 1997 provides that if an amount is not ordinary or statutory income it is not assessable income.

The lump sum amount being offered to you by your insurance company is not assessable income in your hands.

Note: Although the lump sum amount is not assessable income in your hands any amount that is earned from the use of the lump sum may be assessable. The non assessable characteristic of the lump sum is not carried through to income derived from it.

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