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Ruling
Subject: Lump sum payment
Question
Is the lump sum payment you received from an income protection policy assessable when received?
Answer
Yes.
This ruling applies for the following periods
Year ended 30 June 2012
Year ending 30 June 2013
The scheme commences on
1 July 2011
Relevant facts and circumstances
You had been in receipt of monthly insurance payments.
The insurer advised you by letter that they had performed a review of your file and based on the information they had received, it was evident that you would be unable to return to work prior to the end of the benefit period.
The insurer deposited a lump sum payment into your account representing the remaining total benefit payable under the policy, and they finalised your claim.
The insurer has withheld tax from the lump sum and they have provided you with a PAYG Payment.
Relevant legislative provisions
Income Tax Assessment Act 1997 Section 6-5
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 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.
Income protection insurance replaces an individual's regular salary or earnings if they are unable to work for a period of time due to sickness or injury, by providing a regular income stream for an agreed period of time.
The High Court of Australia has established, in several cases, that for income tax purposes, an amount paid to compensate for a loss generally acquires the character of that for which it is substituted, and that compensation payments which substitute income are income under ordinary concepts.
In your case, you had been in receipt of monthly payments and part way through the financial year the insurer decided to payout your remaining benefit and finalise your claim.
The computation of the monthly payments into a lump sum does not change its character of compensation for loss of income. The lump sum is a receipt of income only, that is, there is no capital component in the payment.
Therefore, the lump sum amount paid by the insurer was an advance of your future monthly payments and is assessable under section 6-5 of the ITAA 1997 as ordinary income.
In order to determine when income received as a commutation of monthly earnings is derived by a taxpayer and in turn which year of income it relates to, we refer to section 6-5 of the ITAA 1997.
When payment is included in assessable income
As noted under section 6-5 of the ITAA 1997, ordinary income is assessable in the income period in which it is derived, it provides no definition of derived. It only expands the meaning of the word to include amount that have been constructively received.
Taxation Ruling TR 98/1 deals with the derivation of ordinary income and states that the general rule with non-trading income is that it is derived when it is received.
Paragraph 42 of TR 98/1, states that salary, wages or other employment remuneration is assessable when received. This is irrespective of whether that income relates to either a past or future income period.
Accordingly, the lump sum payment is assessable under section 6-5 of the ITAA 1997 in the financial year in which you received the payment.
We acknowledge the circumstances and associated tax liabilities. However, the Commissioner has no discretion to assess the advance payment in any other income year or to reduce your taxable income in future income years.
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