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Ruling

Subject: Income tax: capital gains: treatment of compensation receipts

Question and answer

Is your receipt of a release payment exempt from CGT under Section 118-37 of the Income Tax Assessment Act 1997?

No

This ruling applies for the following period

30 June 2012

The scheme commenced on

1 July 2011

Relevant facts and circumstances

You took out a risk protection package

Insurance policy

The risk protection pack consisted of:

· Life and Trauma Deluxe Protection policy

· Additional life insurance policy benefit

· Professional Income Protection policy benefits

· Business Expense Protection policy benefits

The risk protection package provided for:

· a lump sum payment if the insured suffered a listed medical condition under the Life & Trauma Deluxe policy

· a lump sum if the insured died

· weekly benefits if the insured suffered either partial disability through injury or sickness

· total disability through injury or sickness

· a specified serious injury or sickness

· a terminal illness

· nursing bed care and rehabilitation expenses

· weekly benefits if the insured's business suffered financial losses because of total disability

Work history prior to insurance claims

At this time you were in a private practice.

Medical and disability history

You were injured.

The injury required surgery from which you suffered post operative complications which required hospitalisation.

This was diagnosed an ongoing medical condition

You were unable to perform your work duties at the same level prior to the injury

You were forced to retire from work as a result your symptoms

First insurance claim

Claim was made

Your claim was accepted and total disability benefits were paid

Your insurer then determined that no further benefits would be paid under this claim.

Second insurance claim

You made another claim in respect of ongoing symptoms.

The claim was rejected.

Legal proceedings

Legal proceedings commenced against the insurer for failure to pay benefits under the risk protection package which included amounts for disablement, future claims within the risk protection package, premiums paid, interest and costs.

Settlement terms

A settlement agreement has been negotiated between you and the insurer for a release payment

The release payment you received is an un-dissected lump sum payment. The release payment is made without any admission of liability, the payment requires you to discontinue the legal proceedings, releases your insurer from all past, present or future claims and brings the risk protection package to an end, prior to the stipulated end of the policy per the risk protection package schedule. Under the Release Agreement, the insurer has no future obligation to make any payment under any risk protection package component.

The payment entitlements finalised included total/partial disability benefits, rehabilitation expense benefits, life insurance and trauma insurance lump sums, nursing care benefits, death and terminal illness monthly insurance benefits, and business expense benefits.

There is no statement in the risk protection package nor the Release Agreement as to how the release payment was calculated or how the release payment is to be treated for tax purposes.

Relevant legislative provisions

Income Tax Assessment Act 1997

Section 6-5

Section 118-37

Reasons for decision

Section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997) provides that the assessable income of a taxpayer includes income according to ordinary concepts (ordinary income).

Ordinary income has generally been held to include 3 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

· have an element of periodicity, recurrence or regularity.

The lump sum payment you accepted 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 nature of the payment described in the scheme generally bears the character of that which it is designed to replace. If the 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 Ruling TR 95/35 deals with the capital gains treatment of compensation receipts. The ruling provides that an insured person's right of indemnity under a policy of insurance falls within the definition of a right to seek compensation. The whole of the settlement amount is thus treated as capital proceeds from a CGT event happening to your right to seek compensation.

Your settlement is a result of legal action where entitlement to receive income from the income protection policy was in dispute. It is not a lump sum payment which substitutes for an income stream but rather for entering into a Deed of Release with your insurer for the purpose of surrendering your rights under the policy. The lump sum payment is a capital receipt and is not ordinary income. Therefore the amount is not assessable under section 6-5 of the ITAA 1997.

Section 6-10 of the ITAA 1997 provides that amounts that are not ordinary income but may be assessable under another provision are called statutory income.

Receipt of a lump sum payment may give rise to a capital gain (statutory income). However paragraph 118-37(1)(b) of the ITAA 1997 disregards payment or receipts for capital gains purposes where the amount relates to compensation or damages a person receives for any personal wrong, injury or illness.

Applying paragraph 118-37(1)(b) to your circumstances, the lump sum payment referred to as a release payment is an un-dissected amount with a series of conditions. The release payment is made without any admission of liability and the payment requires you to discontinue the legal proceedings, releases your insurer from all past, present or future claims and brings the risk protection package to an end, prior to the stipulated end of the policy per the risk protection package schedule. Under the Release Agreement, the insurer has no future obligation to make any payment under any risk protection package component.

The payment entitlements finalised included total/partial disability benefits, rehabilitation expense benefits, life insurance and trauma insurance lump sums, nursing care benefits, death and terminal illness monthly insurance benefits, and business expense benefits.

Taxation Ruling TR 95/35 deals with the capital gains treatment of compensation receipts. The ruling provides that an insured's right of indemnity under a policy of insurance falls within the definition of a right to seek compensation.

The whole of the settlement amount is thus treated as capital proceeds from a capital gains tax (CGT) event (CGT event C2) happening to the taxpayer's right to seek compensation.

However, paragraph 118-37(1)(b) of the ITAA 1997 disregards a capital gain made from a CGT event where the amount relates to compensation or damages received for any 'wrong, injury or illness you suffer personally'. Therefore any capital gain made from the CGT event happening to the taxpayer's right to seek compensation is disregarded under paragraph 118-37(1)(b).

As the amount of the release payment is un-dissected sum no part of which has as evidenced by the settlement documentation relates to any personal injury suffered by you; accordingly, the whole amount and its basis of acceptance represents consideration for the disposal of the right to seek compensation, therefore no part of the release payment will be exempt under paragraph 118-37(1)(b) of the ITAA 1997. (Paragraph 204 of Taxation Ruling TR 95/35)

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