Edited version of private ruling

Authorisation Number: 1011804228638

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Ruling

Subject: Lump sum payment from income replacement insurance

Question

Is a lump sum payment that you will receive from an income replacement policy included in your assessable income?

Answer

Yes.

This ruling applies for the following period

Year ended 30 June 2011

The scheme commenced on

1 July 2010

Relevant facts

The arrangement that is the subject of the Ruling is described below. This description is based on the following documents. These documents form part of and are to be read with this description. The relevant documents are:

· the application for private ruling,

· insurance policy document and

· deed of release.

You took out an income replacement insurance policy.

Under the policy, you would receive a monthly amount in the event that you were unable to work because of sickness or injury up to the anniversary after your 65^th birthday. The amount would be stepped (benefit increased by a percentage per annum) and increased by the consumer price indexed amount.

In 200X, you advised the insurer that you were totally and permanently disabled from your pre-disability occupation and you made a claim for benefits. You have been receiving monthly income replacement benefits under the policy.

Your insurer has now offered you a lump sum as full and final settlement of any claims under the policy.

Relevant legislative provisions

Income Tax Assessment Act 1997 Subsection 6-5(2)

Reasons for decision

Subsection 6-5(2) of the Income Tax Assessment Act 1997 (ITAA 1997) provides that the assessable income of an Australian resident includes income according to ordinary concepts (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

· are expected

· are relied upon, and

· have an element of periodicity, recurrence or regularity.

Payments of salary and wages are income according to ordinary concepts and are included in assessable income under section 6-5 of the ITAA 1997.

An amount paid to compensate for loss generally acquires the character of that for which it is substituted (FC of T v. Dixon (1952) 86 CLR 540; (1952) 5 ATR 443;10 ATD 82). Compensation payments which substitute income have been held by the courts to be income according to ordinary concepts (FC of T v. Inkster 89 ATC 5142; (1989) 20 ATR 1516 and Tinkler v. FC of T 79 ATC 4641; (1979) 10 ATR 411).

Therefore periodic payments received during a period of total or partial disability under an income replacement policy are assessable on the same principle as salary and wages. 

The issue of whether the redemption or conversion of an entitlement to periodic payments to a lump sum affects assessability was considered in Coward v. FC of T 99 ATC 2166; (1999) 41 ATR 1138. In that case 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. Mathews J 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.

This is consistent with the approach taken by the Commissioner in Taxation Determination TD 93/3 which deals with the partial commutation of periodic payments to a lump sum. As outlined in paragraph 4 of TD 93/3, such a commutation would result in the lump sum remaining assessable, as its effect was simply to pay in advance the future weekly payments.

This view has also been confirmed in Sommer v FC of T 2002 ATC 4815; 51 ATR 102. The case involved a medical practitioner who had taken out an income protection policy. Following the rejection of the taxpayers claim for income replacement payments of $4000 per month, the matter was settled out of court with the taxpayer receiving a lump sum. The taxpayer argued that the amount was a payment of capital as it was paid in the consideration of the cancellation of the policy, and the surrender of his rights under it or that the payment was capital as it was an undissected aggregation of both income and capital.

In dismissing the taxpayers appeal it was held that the payment was in settlement of income claims of the taxpayer in circumstances where the purpose of the insurance policy was to fill the place of a revenue receipt. As a result, the payment was clearly on a revenue account. The fact that the payment was received in one lump sum did not change its revenue character.

In your case, your income replacement policy is to protect and provide income in the event of illness or disability. The monthly payments you received under your income replacement policy are income according to ordinary concepts.

You have been offered a lump sum payment in full settlement of your policy. That is your future monthly payments will be commuted to a lump sum. The lump sum will be paid to substitute you for your loss of income which you otherwise would have earned. As your periodic income replacement payments are ordinary income, a lump sum payment also retains the character of being ordinary income.

Accordingly, the lump sum payment payable under your income replacement policy is assessable under section 6-5 of the ITAA 1997 in the income year in which you receive the payment.

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